Sen. Obama is currently claiming that President Bush’s economic policies are the cause of the stagnating U.S. economy. He is correct. Obama also claims that Sen. McCain will continue Bush’s failed policies, and to win McCain must show that he understands where Bush went wrong.
There are four major Republican economic ideas. Two of them work and two of them don’t. Unfortunately, President Bush chose the two that don’t work, and that is the reason for the current U.S. economic stagnation. These two Republican economic ideas work:
- Reduce the size of U.S. government.
- Cut business taxes.
These two Republican economic ideas don’t work:
- Cut capital gains taxes.
- Welcome foreign investment that costs jobs.
Reduce the size of government
Rather than reduce the size of the federal government, the Bush administration grew it. From 2000 to 2007, the federal government’s expenditures grew from 19.2 percent to 21.6 percent of GDP. One of the Democratic Party myths is that rising defense expenditures were to blame. But defense consumption by the federal government rose by less than 0.2 percent of GDP over that period.
Not all Republicans are so foolish. Rep. Ron Paul recommended drastic cuts in federal spending as the centerpiece of his campaign for president.
Cut business taxes
The Bush administration did not cut the corporation income tax rate As a result, the U.S. corporate income tax (federal and state combined) continues to be one of the highest in the world with 35 percent being the maximum federal corporate income tax rate and with state corporate income taxes adding about 4 percent. Every other country but Japan has a lower corporate income tax. To his credit, McCain has advocated reducing the corporate income tax to 25 percent, which would make the U.S. tax rate much more competitive.
The poor quality of economic advice President Bush received is best evident by the final report of the 2005 President’s Advisory Panel on Federal Tax Reform. The two “ideal” plans the panel recommended would just reduce the corporate income tax to 31.5 percent and 30 percent, still leaving the U.S. corporate income tax one of the highest in the world.
Gov. Mike Huckabee advocated going even further in his campaign for the presidential nomination. Huckabee recommended a 23 percent FairTax to replace the corporate income tax, the personal income tax, the payroll taxes, the gift tax and the estate tax as the centerpiece of his run for president.
Change the treatment of capital gains
President Bush cut the capital gains tax from about 20 to 15 percent as part of his 2003 tax cut. He thought that doing so would encourage investment in our country’s future. The result was the opposite. Fixed investment declined in each of the last eight economic quarters and has been so dismal that the United States economy grew by less than 1 percent during each of the last two quarters. Instead of reinvesting profits, corporation after corporation has been buying back its own stock, partly in order to artificially produce capital gains.
Both parties are half blind respecting the taxation of capital gains. The advocates of capital gains tax cuts fail to see that a low rate of taxation on capital gains encourages the consumption of capital. They point to the increased revenue that results whenever the capital gains tax is reduced as if the consumption of the society’s wealth were a good thing. The low capital gains tax rate has caused the extremely low savings rate among the rich in our society today. We are consuming our countries’ future, and the advocates of capital gains tax cuts applaud!
Obama wants to raise the capital gains tax. The advocates of raising capital gains taxes, including Obama, expect to get increased revenue. They are in for a surprise. Although they will get increased savings by the rich, which is a good thing, they will cause a different sort of problem, a locked in effect in which the owners of capital are tied to poor quality investments because changing from one investment to another requires the payment of a huge capital gains tax.
In our book, “Trading Away Our Future,” we propose the same exemption from the capital gains tax that is already in place when you sell one home and buy another with the proceeds. We advocate that capital gains be taxed at the same rate as all other income, except when you sell an income-producing asset to buy another income-producing asset – in which case, the reinvested capital gain would be subtracted from the basis of your new asset and the capital gains tax would be postponed until the second asset is sold and its proceeds are consumed.
End the welcome to foreign investment that costs jobs
When foreigners lend us money or purchase our existing assets, they bid up the dollar in foreign exchange markets and bid down their own currency. The result is that our businesses have more trouble competing with their businesses. An important economics paper in 2006 by three International Monetary Fund economists demonstrated that the more a developing country borrows from abroad, the slower its economic development because of the harm to its exporting industries.
In 1984, President Reagan’s secretary of the treasury wanted to run a big U.S. government budget deficit without raising the interest rate, so he got Congress to pass a tax loophole making interest earned by non-resident foreigners tax-free. The predictable result was that the increased foreign loans caused increased U.S. trade deficits.
The goal of welcoming foreign loans, no matter what the source, soon became conservative mantra. In 2001 and 2002, the IRS wanted to report the amount of interest being earned by foreign tax cheats, but Daniel J. Mitchell of the prominent conservative think tank the American Heritage Foundation, went so far as to claim that reporting interest income to foreign governments “threatens [our] economy and financial markets.”
In the meantime, foreign governments, beginning with Japan, discovered that the American government welcomed their purchase of U.S. government bonds and private financial assets. By supporting the dollar and keeping U.S. interest rates low, they followed a mercantilist strategy of exporting to the United States without importing from the United States, and they succeeded at stealing industry after industry from America.
A few smaller countries soon adopted Japan’s mercantilist strategy, but things did not get completely out of hand until China adopted it. During the Bush administration, the Chinese government loaned over a trillion dollars to the United States. Our trade deficits in goods and services with China predictably worsened while China stole industry after industry. Each billion dollars of our trade deficit with China, shown on the graph below, represents about 9,000 well-paid U.S. manufacturing jobs lost. (Each U.S. manufacturing worker produces about $111,000 of value-added.) By 2007, China had already stolen about 2.25 million jobs through these loans.
Our current trade agreements are not helping because we don’t insist that trade be balanced. At best such deals nibble away at foreign tariffs, but do nothing about their damaging loans. All we need to do to reverse the hemorrhaging of American manufacturing jobs would be to impose Import Certificates on the mercantilist countries that would gradually balance our trade with them over a period of five years. That strategy was initially proposed by Warren Buffett, and we have elaborated on it in our book.
If Import Certificates are adopted, then China will have to import from us in order to continue to export to us. They will remove their 30 percent tariffs on Michigan auto parts, their 30 percent tariff on Harley Davidson motorcycles, and their 40 percent tariff on Bucyrus mining equipment. The result would be a prosperous economy led by a U.S. manufacturing boom.
McCain’s dream team
Rather than repeat the Bush policies, McCain needs to make it clear that he has no intention of continuing them. He can do so by announcing at the Republican convention that Rep. Paul, Gov. Huckabee and Mr. Buffett will be on his economic team.
Our suggestion would be the choice of Huckabee as his running mate, and put in charge of tax reform; Paul could be director of management and budget in charge of finding ways to cut federal spending; and Warren Buffett could be the secretary of the treasury with instructions to implement Import Certificates to balance trade. If Sen. McCain picks this team, not only would he win the presidential election, but he would also preside over an economic boom after the election.
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Dr. Raymond Richman is the president of Ideal Taxes Association. He is professor emeritus of public and international affairs at the University of Pittsburgh with a Ph.D. in economics from the University of Chicago. Dr. Howard Richman is executive director of a nonprofit (Pennsylvania Homeschoolers Accreditation Agency) and an Internet economics teacher. Dr. Jesse Richman is assistant professor of Political Science at Old Dominion University. They are the authors of “Trading Away Our Future: How to Fix Our Government-Driven Trade Deficits and Faulty Tax System Before it’s Too Late.”