Gotta Grow: Taxation in a time of war.(Brief Article)

Tax cutting is a contact sport in Washington, but the Bush economic team appears not to understand this. They have been mau-maued by Democratic class warriors into accepting demand-side tax cuts, and ignoring one of the wise insights that won Milton Friedman a Nobel Prize-that people will not permanently alter their spending behavior in response to temporary government cash injections. The Bush team should have learned its lesson when the $600 consumer-rebate plan failed to stimulate growth this summer. While after-tax disposable income did rise-temporarily-the cash was quite predictably used to pay down credit-card and household debt instead of to make new investments.

Unchastened, the White House is now angling for a congressional deal for yet another temporary consumer tax rebate-this one aimed primarily at low-income earners, most of whom pay only Social Security and other payroll taxes. What the Bush team is forgetting is that profitless companies are rapidly laying off employees, and that worker incomes lost through increased joblessness will overwhelm any tax-rebate benefits. More generally, the administration fails to see that this is not a consumer-led recession, but one led on the supply side by investors and businesses. For a supply-side problem, supply-side incentives-not demand-side tax rebates-are the cure.

The facts are well known and undeniable: Over the past year, consumer income has actually increased by 3 percent, but business income (net of taxes and inflation) has plunged 15 percent. With profits hemorrhaging, investment has collapsed. During the year's first half, overall domestic business investment dropped an annualized 12 percent, with technology investment falling by an unbelievable 48 percent annual rate. By contrast, inflation-adjusted consumer spending increased during this period at a modest but still respectable 2.7 percent annual rate.

One of the problems is Treasury secretary Paul O'Neill. If O'Neill had spent this year telling the business-recession story in speeches around the country, he would have had a much better chance of moving the policy agenda toward seriously reducing the corporate tax burden. O'Neill, however, was too busy marketing Fed chairman Alan Greenspan's argument that consumer tax rebates and lower interest rates would lead to a second-half recovery. When that forecast proved wrong (even before the September 11 attacks), O'Neill proposed to Bush a near halving of the corporate tax rate from 35 percent to 20 percent, but Greenspan blew that idea out of the water in various meetings on Capitol Hill.

One concrete measure O'Neill should be pushing right now is depreciation reform for tech-equipment purchases. Massive technology spending in the 1999 runup to Y2K was borrowed from 2000 and 2001; it was this, along with an unprecedented Federal Reserve deflation, that wrecked the economy and the stock market. By next year, however, obsolete tech equipment will need to be replaced, and accelerated write-offs will make it cheaper for businesses to purchase new equipment. This, in turn, will allow business-equipment manufacturers to reduce their selling prices.

More broadly, the White House needs to talk more often about ...