Democrat tax cut myths

Kevin Hassett:

The debate over the Bush tax cuts is heating up, and the Democrats aren't making any sense.

If you wander into a rally for any of the Democratic presidential candidates, you are sure to witness a lengthy diatribe documenting the terrible damage that President George W. Bush's tax policies have done to the economy. Hillary Clinton said in a recent debate, ``I put fiscal responsibility first... We have to move back toward a more fair and progressive tax system and begin once again to move toward a balanced budget with a surplus.''

If you listen to Clinton, the restoration of ``fiscal sanity'' and resumption of higher tax rates will have a profound positive impact on every corner of the economy.

Clinton and her Democratic competitors have a big problem. The facts don't support their negative characterization of the Bush tax cuts. Indeed, everything Bush's opponents said would happen after taxes were reduced didn't happen.

Recall that supporters of marginal-tax-rate reductions argued that the lower rates would induce individuals and firms to work more and take more risks. This heightened activity would lift the economy and, over time, even help the Treasury recapture a good bit of the revenue lost when the rates were initially cut.

Opponents warned that increased deficits would limit or even overpower the effects of the tax cuts by driving up interest rates.

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Looking back at more than six years of economic history since the Bush tax cuts, two observations stand out. First, the deficit increased much more than was expected at the time Bush took office.

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Second, interest rates never rose. Even though the change in the fiscal situation was at least twice as large as the anticipated 1 percent of GDP, interest rates have been lower than they were in 2001 for almost Bush's entire presidency. Bush took office on Jan. 20, 2001, a time when the 10-year Treasury bond yielded 5.17 percent. Today, it yields about 4.28 percent and has been well below 5.17 percent on average every year in between.

Fine, a skeptic might say, but other things changed. True, but they also changed in a direction that would suggest interest rates should be higher. Inflation has surprised on the upside because of high energy prices. GDP growth during the past year has been 2.6 percent, compared with 0.8 percent in 2001.

Interest rates in the U.S. are low, of course, because rates everywhere else are, too. Government debt from the U.S. is a close substitute for debt from many other countries, and their rates move in tandem. A global savings glut and a flight to safety are far more important determinants of U.S. interest rates than the Bush deficits.

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Interest rates dropped after the Reagan tax cuts too, as did inflation. The Democrats are just wrong on that issue. The growth in revenue from tax cuts is obviously a lagging indicator of their effectiveness. the writers assumption that renew the tax cuts would lead to higher deficits is wrong. The deficits come not from falling revenue but increased spending. If Republicans win and renew the tax cuts without increasing spending the deficit will disappear and we will be back in surplus. We are approaching that point now, something that the Democrats and the writer seem to ignore.