A year after the Bush tax cuts, the U.S. economy stands at the front end of an economic boom.
Recent government reports on consumer spending, industrial production, corporate investment, and business sales suggest overall second-quarter growth could come in around 6 percent annualized. That would put the trailing four-quarter recovery rate at 5.7 percent — the fastest pace since 1984.
That year followed the big Reagan tax cuts. This year follows the big Bush tax cuts. A coincidence? No. The incentive power of lower marginal tax rates on economic growth is one of the most underrated mainstream economic ideas.
Most economists obsess over Federal Reserve interest-rate policies, or the effect of energy prices, or consumer spending, or budget and trade deficits. Even when they observe tax changes, they look either at the temporary effects of tax rebates or the big-budget deficit impact on Keynesian aggregate demand.
It rarely occurs to economic thinkers that people work or invest to generate the highest possible after-tax return. When it pays more, after tax, to take investment risks, more individuals are willing to change their behavior and assume greater risk. Tax risk less, and get more of it. Tax production more, and get less of it.
This was the essence of Reaganomics. It recognized the power of the individual to make choices in daily economic life. It also recognized the crucial economic theory of marginality. At the margin, what truly matters is the extra work effort, the extra investment dollar, and the extra unit of profit, all measured in after-tax terms.
We all must work to earn a living. But what really drives an economy into full throttle is when people are induced to work harder — putting more hours into the new job or new business start-up. We own our own labor. Each of us decides how much of it to supply. This decision is largely driven by after-tax returns to labor — or to production, investment and risk-taking.
The Reagan tax cuts two decades ago focused primarily on personal income, reducing the top marginal rate from 70 percent to 50 percent, and then 28 percent. The Bush tax cuts of 2003 were aimed principally at investment, lowering the government’s take roughly 50 percent.
Almost immediately an economy buffeted by recession, stock market collapse, and corporate scandals — all inherited from the prior administration and smacked by a brutal terrorist attack and the need to launch two wars — suddenly came alive.
New government data show over the last year consumers are spending 9 percent more at retail, companies are investing at a 9.5 percent higher rate in new business equipment, and manufacturing industries are producing at a near 6.5 percent higher clip, all while our high-tech industries are expanding 30 percent. Overall, business sales are rising 11 percent.
This is a remarkable comeback for the American economy. Owing to the post-tax-cut surge of investment funding for business expansion, 1.4 million new jobs have been created over the past nine months. As a result of new job creation, personal incomes have grown 5.7 percent over the last 12 months. Wage and salary income has risen 4.8 percent. After-tax, after-inflation disposable income has climbed 4.3 percent.
Election-year critics carp at the unfolding of a strong recovery. It’s a repeat of 20 years ago. Ronald Reagan told Mikhail Gorbachev to “tear down that wall.” Walter Mondale’s supporters tried to tear down the recovery statistics.
Today, John Kerry similarly argues incomes are shrinking. The data say otherwise. Mr. Kerry once talked about the jobless recovery. But the avalanche of new jobs rendered that claim null and void. His advisers talk about 1.2 million net jobs lost since Mr. Bush took office. That too will be erased as we head to 3 million new jobs this year.
Here’s another 20-year parallel. Mr. Mondale wanted to raise taxes. So does Mr. Kerry. This is no way to win a presidential election. Until the Democrats recognize the economic-growth incentive power of tax cuts, they’ll never be competitive.
The Kerry camp’s bad news bears don’t understand elections are decided on the margin. The most recent trend is clearly the responsibility of the incumbent. Voters know this. They may wait to see if the recovery has legs into summer and early fall; that’s why recent polls suggest a race too close to call.
But as in 1984, the current tax-cut-sponsored recovery has very strong legs. Prosperity numbers will keep rolling in. Optimism will keep mounting. Mr. Bush’s 2004 bet on the incentive power of lower tax rates on economic growth will pay off handsomely, as Mr. Reagan’s did two decades ago.
Lawrence Kudlow is a nationally syndicated columnist and is chief executive officer of Kudlow & Co., LLC, and CNBC’s economics commentator.