Keeping the Economy Going: Failing to Learn the Lessons of Even the Recent Past

Thursday in the Wall Street Journal, Stephen Moore noted that we aren’t even learning from a past as recent as 5-8 years ago. The same guy who’s in the Oval Office now was in it during most of that time. As the supply-side tax collections boom ends and economic growth slows, Moore advocates steps yours truly has been advocating for many months.

He starts by flashing back to 2001 (bolds are mine):

In response to the bursting of the tech bubble, Washington served up a Keynesian brew of demand-side stimulus. The Fed cut interest rates 11 times, hoping to pump liquidity into the market, and President Bush signed into law a tax rebate of up to $600 per household. (Sound familiar?)

There’s a spirited argument about whether those rebate checks helped pull the economy out of recession. The evidence is mixed. The statistics tell us that the economy did pull out of the recession in late 2001. Instead of sprinting forward to make up for lost ground, however, as often happens at the start of a recovery, the economy and job market grew at a snail’s pace. The stock market also remained bearish. Former Federal Reserve Board Member Wayne Angell noted at the time that “the economy will not fully recover until the stock market does.”

Only after President Bush’s 2003 investment tax cuts — the second attempt Congress and the administration made at stimulating the economy — did the economy start to gain speed. The key was to cut capital gains and dividend tax rates to 15%, from 35%, and to offer new tax write-offs for businesses investing in new plants and equipment.

….. The investment tax cuts had two positive effects on the economy. First, almost from the day the tax cuts were enacted the stock market capitalized the value of the lower taxes on corporate profits and capital gains. Within months, the Dow Jones Industrial Average rose nearly 10%. And, we now know, the investment slump was converted into an investment boom. Business capital spending, down 4.8% in 2001 and 6.1% in 2002, surged in 2004 by 7.4% and in 2005 by 9.5%. It was this investment spurt that financed job and GDP growth in recent years. In short, what we experienced was a classic supply-side recovery.

The most recent GDP numbers for the fourth quarter of 2007 confirm that we’re experiencing a replay of the investment slump of 2001-02. Consumer spending is slowing down, but it is still within its normal growth range (it grew 2% last quarter) and the numbers out yesterday were better than expected. Consumers are more cautious in their spending mostly because of the negative wealth effect of declining home values.

….. And, like earlier in the decade, the real economic drag today is from a slowdown in investment. Gross private investment topped $1.9 trillion in 2006. Last year it fell by $88.3 billion (with more than half of that drop coming in the fourth quarter alone). Most of that decline came in residential housing, but other areas, such as business spending is slowing too.

Why is investment declining? One explanation is that firms and investors know that there is a tax hike on the way when the Bush tax cuts expire in 2010. “The two big negatives for investment loom on the horizon,” says economist Michael Darda, “higher tax rates and higher inflation due to easy money.” Mutual fund data from the fourth quarter of 2007 confirm that a weak dollar and the risk of higher taxes are pushing capital overseas.

Republicans blundered by not insisting that extending the Bush investment tax cuts be part of any package. The GOP should also be pushing a permanent supply-side tax cut that would include expensing for business purchases, inflation-indexing for capital gains, and a corporate tax cut to bring capital back home.

On this one, “I blame Bush” (and the GOP Congress) is an unfortunately accurate criticism.