February 9, 2005
Reagan's Heir
By Lawrence Kudlow

While the mainstream media cut down thousands of trees in order to produce reams of newspaper reports on whether President Bush is reducing the deficit or not, the really important aspect of the budget submission is that it is pro-growth.

On Kudlow & Company I asked OMB director Josh Bolten if the President’s proposal to make the tax cuts permanent was in the budget. He answered yes. This is crucial. Bush is not backing off. And it also sends an important message to Sen. Connie Mack’s tax reform commission that a 15 percent tax-rate on capital gains and dividends, along with abolishing the estate tax, is a high presidential priority.

Beyond this important threshold, Bush deserves credit for his toughest effort thus far to restrain federal spending. Overall discretionary spending is aimed at slightly less than the projected inflation rate. Excluding homeland security and defense, discretionary spending actually falls in inflation-adjusted terms. There is also some tentative efforts to reduce the growth rate of entitlement spending, especially Medicaid.

In aggregate terms, federal spending as a share of GDP is projected to trend around 19.5 percent. This is a historically low spending share of the economy. If it is maintained, then more resources will remain in private hands to foster entrepreneurship, new business creation, jobs, and wealth.

As for the deficit, it is projected to fall to about 1.3 percent of GDP over the next five years from 3.5 percent currently. This is well below European and Japanese deficits. Should the U.S. economy grow faster than the 3.3 percent yearly estimate in the OMB baseline, then the budget will move into balance over the next five years.

More importantly, at lower tax-rates Treasury coffers are rapidly filling up with rising tax collections. The Laffer Curve is alive and well. Over the past twelve months individual income tax collections have increased by 15 percent. Non-withheld individual collections, which include stock market-generated capital gains and dividends, have increased 14 percent. In June 2003 the President signed tax reform legislation that lowered the top personal tax-rate to 35 percent immediately. Investment tax cuts also were part of the reform. The economy’s recovery rate doubled almost immediately from the new dose of supply-side incentives.

Mr. Bolten is well aware of these developments, and sounded much like a supply-sider in the interview. He noted that upper-income taxpayers were paying more of the total share of tax collections even while their marginal rate had been reduced. Hence the tax reform has led to even greater progressivity. In fact, with greater work and investment incentive and reduced tax evasion, another supply-side policy experiment has once again proven to be successful.

Deficit teeth-gnashing will undoubtedly go on forever. But there is no evidence that a temporary deficit increase to finance recovery investment has had any ill effect on the economy. Just as well-run businesses sometimes borrow to invest in future expansion, so must the federal government. The latest government statistics show that private sector GDP growth is rising at better than 5 percent, while core inflation is a tame 1.5 percent. At 5.2 percent unemployment, the economy is moving steadily towards full utilization of the available workforce.

As for former Clinton Treasury Secretary’s Robert Rubinomics, which is to say deficits always cause bond rates to rise, there is once again no evidence. Treasury bond yields are only slightly higher than 4 percent, suggesting a 1950’s scenario rather than some declinist and pessimistic future disaster.

The Bush administration has laid down principled markers on economic and budget policy. Namely, the surest path toward deficit reduction is federal budget restraint and tax cut-spurred economic growth. As the prosperity pie grows larger and incomes rise, revenues fill in the deficit gap while spending is slowed.

Sustained economic growth makes all of us more prosperous. Tight budgets and lower tax-rates will sustain the current prosperity boom for years to come. The stock market bubble is receding into the past. Though no one acknowledges it, today’s economy looks a lot like the low inflation recovery in the 1990’s and the 1980’s. As the stock market continues to rise in the years ahead, the budget deficit will continue to fall.

Of course all this is a legacy of Reaganomics. Were the great California president still alive, he would have been 94 last Sunday. While his soul rests in heavenly peace, his vision and his ideals are alive and well here on earth.

Much credit is due to President George W. Bush for maintaining and expanding on the Reagan vision. Whether spreading freedom and democracy abroad, or ownership policies for more economic freedom at home, Mr. Bush continues to stoke the fires of liberty.

Lawrence Kudlow is a former Reagan economic advisor, a syndicated columnist, and the co-host of CNBC’s Kudlow & Company.

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