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Tax Returns: Congress's Inaction Risks Endangers Our Economic Prosperity

The Journal Editorial Report

Paul Gigot: This week on "The Journal Editorial Report": As millions of taxpayers rush to meet the filing deadline, we'll examine the record of the Bush tax cuts and the prospects for future reforms in Congress. Plus, Iran's nuclear ambitions: Word this week that the rogue nation is one step closer to an atomic bomb, as President Bush denies reports that attack plans are on the table. Those topics and our weekly "Hits and Misses"--but first, these headlines.

Gigot: Welcome to "The Journal Editorial Report." I'm Paul Gigot. The millions of Americans struggling this weekend to decipher their complicated tax forms may find it hard to look on the bright side. But there is plenty of good news when it comes to the economy. With low unemployment and robust growth, business and consumer confidence are high. So what can be done to keep the good times rolling? Brian Wesbury is the chief economist with First Trust Advisors. He joins me now from Chicago. Brian, welcome.

Wesbury: Good afternoon, Paul.

Gigot: Let's talk about taxes. Three years ago we had this debate over tax cuts and 2003 tax cuts--big debate. Three years later, we have a pretty good economy. How crucial do you think those tax cuts have been to this expansion?

Wesbury: Well, I think they've been absolutely crucial. If you really look back, the recovery started in November 2001, but it was a very weak recovery. In fact, job growth was declining on average 70,000 jobs per month, real GDP was only 1.8% per year, and business investment was falling. But once the tax cuts were passed in May of 2003, everything turned around. Job growth is now 200,000 a month. The economy is growing 3.5% to 4% clip. Business investment is growing at a double-digit rate. And to top it all off, government revenues, tax revenues, are soaring--up 10% so far this year over last year.

Gigot: After having risen 15% last year.

Wesbury: Right.

Gigot: But a lot of people would say, look, this is just the normal business cycle. It was bound to come back. And besides, the real hero here is the Federal Reserve, which has kept money growth pretty expansionary. What's your response to that?

Wesbury: Well, there's lots of people that want to discount the tax cut and say, hey, this is just a normal business cycle. But it's way--it's not normal. We had 9/11. We had a stock market crash. We had deflation. And we had huge declines in business investment. And something had to turn that around, literally almost on a dime, in May of 2003. And I think when you look at this, what you sense is that with war, with 9/11, with the stock market crash, the risks for investors had been elevated, and the way you kind of offset that balance is you've raised the rewards. And so by cutting taxes on investment, we raised the after-tax rewards, and that balanced out this risk-reward ratio. And that's when the economy turned around. It's not just a normal recovery.

Gigot: Well, Robert Rubin and some other critics of Bush economic policies would say, look, whatever good the tax cuts did then, and between 2003 and now, we have this big problem, and it's called the budget deficit. So now is the time to raise taxes, to reduce that budget deficit, because interest rates are rising. That's fueled by the higher deficits. Take on that Rubin argument.

Wesbury: Yeah, well, there is a lot of people that have continually focused on the deficit over the years. Just to kind of think back about the last 25 years, none of the horrible things that were supposed to happen from a deficit ever did. But really when we get down to it, the real issue about the size of the government is not the deficit but how much we spend. And what we've seen in the last few years is that government spending has soared. Now, what's great is that in the last couple of years, tax revenues have soared, which have kept the deficit a little bit weaker. But the bottom line is that the deficit, to me, represents spending on fighting terrorism, and we have to do that to keep this country safe over time. We also have to keep tax rates low in order to keep the economy growing so that we can afford to fight the war on terror.

Gigot: Can we afford a tax increase now, in the name of cutting the deficit? Is the economy strong enough now to be able to absorb something like that?

Wesbury: Yeah. I don't think so. In fact, it never is. We always ought to work to keep tax rates low. In the end, taxes are there to fund the government, and what we should do is make sure that the tax code is the least burdensome possible, on entrepreneurs especially. And what I have seen in recent years is that when we cut taxes, business investment, entrepreneurial activity, surges. And we need to keep that going, because that revenue increase is the only thing that's keeping the deficit from exploding today.

Gigot: All right. So the economy is quite healthy today. But what are the biggest threats you see right now to this expansion continuing?

Wesbury: Well, there's a couple of them. I mean, obviously government spending outside of the war on terror is increasing rapidly. That's a bother to me. Trade protectionist fears are a little bit of a bother to me. But there's two other things that I think are most important. And that is, No. 1, inflationary pressures are beginning to increase. That's because the fed was way too easy for too long. And No. 2, Congress seems to be having a difficult time extending these tax cuts. Right now the capital gains and qualified dividends tax cuts are scheduled to end in 2008. They need to extend them at least to 2010. Without that certainty, we could see the stock market suffer. We could see investments suffer.

Gigot: OK, Brian, it sounds like we've got to pay attention to what's going on in Washington. That's the biggest threat to the expansion now. Thanks for coming in.

Wesbury: Thank you, Paul.

Gigot: When we come back: President Bush has called for an extension of his tax cuts. But as midterm elections approach, can Congress deliver? Plus, nuclear standoff with Iran. Secretary of State Condoleezza Rice urges strong steps from the U.N. Security Council as the U.S. keeps the focus on diplomacy. But is a military contingency plan necessary? Our panel weighs in after this short break.

Gigot: Welcome back. According to the latest Fox News poll, more than half of all Americans now have to hire a professional to do their taxes. What are the prospects for tax reform, as well as for making the Bush tax cuts permanent? Joining me on the panel this week, Wall Street Journal columnist and deputy editor Dan Henninger, as well as Jason Riley and Bret Stephens, both Wall Street Journal editorial board members.

Dan, I want you to solve a mystery for me--a political mystery. The 2003 tax cuts have done pretty much what its supporters advertised--helping the economy. Yet the Republicans in Congress can't even get their act together to extend them for a couple of years. Why not?

Henninger: Well, because we have to make a distinction, Paul. You said Republicans in Congress. That bill is in the tax-writing committees, and the heads of those committees are committee chairman first and Republican second, OK? Now, Chuck Grassley, the head of the Senate Finance Committee, and Bill Thomas, the head of House Ways and Means, literally could not agree on how much relief to give to the alternative minimum tax. And there were a lot of other cats and dogs that were going into this bill, and each one was insisting on his prerogatives, and the bill failed.

Now I think this is going to cause some real problems for the Republicans going down the road, because they wanted to have this tax bill done by Monday, April 17, tax day. They failed. I think the Democrats' incentive for doing a tax bill now is greatly diminished. The Democrats do want AMT reform, but by holding up this bill, they can tag the Republicans with the failure for passing any sort of tax bill. They'll have an issue going into the November campaign. The Republican base is going to be upset about both the AMT reform and the dividend and capital gains cuts.

Gigot: I think there will be a price to be paid too in the stock market if they don't extend those. Because even though the investment tax cut--that's the 15% tax rate on capital gains and dividends--wouldn't expire until 2009 under current law, the stock market is going to have an immediate--it's already priced in, I think, the fact that it will be extended. If they're not, there's going to be an impact.

Stephens: That's exactly right. And Brian Wesbury talked about the uncertainty factor going up after Sept. 11. But another part of the uncertainty factor is, these tax cuts are temporary. They are going to be phased out in 2008 or 2010. And that's part of what I think is holding the stock market back. They don't know if these are going to be extended. And if you're an investor, and you're looking at something beyond the next two, three, four years, you just don't know what tax climate you're going to be in on that horizon. And that's a big problem for investors.

Gigot: Dan raised an interesting question, Jason, which is the alternative minimum tax. That's this sort of secondary tax code we have. It really should be the called the mandatory maximum tax, because you pay more either under the AMT or under the regular tax code. But this is hitting more and more taxpayers--four million a couple of years ago, andd if Congress doesn't act, as Dan said, 19 million in 2006.

Riley:Yeah, in fact, by the end of the decade, I believe, the alternative minimum tax is going to be bringing in more income--tax income--for the federal government than the regular tax code. So it is a very big problem. And in fact, the point you made about Democrats wanting it is very interesting, because it hits, disproportionately, people in high-tax states, the blue states. And so you have people like Chuck Schumer and Hillary Clinton coming out and saying, we have to do something about the alternative minimum tax. But it's important for the Republicans to remember that that's their carrot for bringing Democrats in to broader tax reform and reducing rates. And so, you can't give away the AMT too quickly, because you want to get something in return.

Gigot: But it's good news, because what you're saying is that the AMT gives Democrats a real incentive, maybe even an imperative, to get on the tax-reform train, in the same way they didn't have any kind of incentive to get on with Social Security reform.

Stephens: And that's what makes the failure of Republicans that much more inexcusable. And I want to add something to what Dan said. I think the administration deserves a lot of blame here. You know, President Bush started out his second term saying tax reform was a priority. He had Connie Mack and John Breaux, the former Republican and Democratic senators, put a tax commission together. They came out with a sensible reform plan. That reform plan is going nowhere. Bush never mentioned tax cuts in his State of the Union Address, which is just inexplicable. And there's total disarray in Congress. The disarray has a lot to do with a lack of presidential leadership.

Gigot: Briefly, Dan, consequences of having a weak Treasury?

Henninger: Consequences of having a weak Treasury, for sure--no real leadership there. And, you know, it's getting more difficult. It's going to get difficult to do tax reform, because 60 million of 150 million American households don't pay taxes anymore. And incidentally, what are we talking about illegal immigrants who don't pay taxes, when 39% of American households don't pay taxes either? Maybe they should be deported.

Gigot: Well they do pay payroll taxes, but not the income tax--

Henninger: Not the income tax.

Gigot: --which is very significant. OK, all right. Last word Dan. Still ahead, President Bush denies reports that the U.S. is planning a military strike on Iran. But as the rogue nation rebuffs renewed calls to halt its nuclear activities, is diplomacy enough?

Condoleezza Rice: We're consulting with our allies about what the next steps need to be. But there's no doubt in my mind that if the Iranians continue down this course, there has to be some course of action by the Security Council.

Gigot: Secretary of State Condoleezza Rice reacting to Iran's claims this week that it has enriched uranium for the first time--an advance necessary to produce a nuclear weapon. The news came just a day after President Bush dismissed reports of U.S. plans for a military strike on Iran as wild speculation. Bret, after this week, there is any doubt in your mind that Iran intends to build a nuclear weapon and is making real progress in doing so?

Stephens: The key point is the progress. I think we've known for quite a while that their intention is to build a bomb. What they've done now is really a very significant technological breakthrough. It's kind of like inventing the wheel for the first time. The trick was, they've run centrifuges at 80,000 rotations per minute.

Gigot: Not easy to do.

Stephens: Not easy to do. And once you master that kind of technology, it's only a matter of replicating it over and over again to get sufficient quantities of bomb-grade enriched uranium. And it shows that our estimates that the Iranians are 10 years or five years away from making a bomb were wildly exaggerated. They're going to be able to enrich uranium in the next year or two. So it adds urgency to the crisis.

Gigot: All right. You saw Secretary Rice say, let's go to the Security Council--must act. Any confidence that it will act, and will it make a difference?

Riley: Well you've still got a problem with China and Russia, who don't want to--they're members of the Security Council. They have veto power. And they're still--

Gigot: They're not going to do anything about this really. I mean, is there any evidence they'll do something about it?

Riley: No, there isn't, and it's a shame. Because Iran's nuclear ambitions are about the worst-kept secret in the world. I mean, what was interesting was not only what the president of Iran said this week, but it was who he was addressing. He wasn't talking to urban planners and social engineers in Tehran. It was a speech given to military commanders and clerics.

Henninger: Well, you know, we have to start somewhere. I think what we're talking about with the Security Council is a Chapter 7 resolution, which requires member nations to comply with Security Council resolutions. You start first with something like economic sanctions, and you move all the way up to the possibility of a military action. What we're talking about here is making our side credible in any kind of diplomacy that we engage in with these people. If there's not a credible threat, you're simply going to default to the kind of wild statements that were coming out of Iran. Yesterday, President Ahmadinejad said, "Today, thank God, the Iranian nation is a powerful one. Everyone we have is from God, and a few weaklings cannot stand against the Iranian people." He sounds like the guys on Flight 93.

Riley: But when are we going to give up this diplomatic solution? We've tried it. We tried it under Carter. We tried it under Reagan. We tried it under Clinton. We've tried the diplomacy tack. We tried it unilaterally. We tried it multilaterally.

Stephens: Jason, the name of the game--

Riley: Either they are going to show us what they're doing, or they're not. And there has to be consequences if they're not.

Stephens: The name of game for the Iranians is how long can they keep the international community at bay. And they know perfectly well that if you go to the U.N., the U.N. is not exactly known as the expediency council. If you go to the U.N., you're going to be engaged in a very long process. Even if Russia and China were on board, there'd be no question that the U.N. would first vote for some limited sanctions, then gradual sanctions--and it comes back to the question of a timetable. If the Iranians are going to be able to get a bomb or some kind of device in the next year or two, there is no way the U.N. is going to have any kind of effective action.

Gigot: But let's talk about those consequences, because we had another kind of bomb scare this week, which is a bomb scare about Washington maybe having military contingent plans, and this was in several papers. Do you think those are serious, and should President Bush have said, this is wild speculation, which maybe has reassured Tehran that we're not serious?

Stephens: Well, it's funny. I mean, I hope they're serious. You know, the Pentagon always plans for every kind of contingency against every kind of adversary. And one would assume that they're planning very hard and thinking very hard about how you deal with the Iran nuclear problem. Because unlike, say, dealing with Saddam, our periodic bombings of some of his facilities during the 1990s, we're dealing with a much more difficult military target than we've ever dealt with before. And it's going to require a kind of military response, if it comes to that--and of course we hope it doesn't--than anything we've seen previously.

Gigot: But Bret, I have to tell you, my reporting suggests that this administration really doesn't want to--I mean, they're petrified of having to use military force. The military is against it. Far from being bomb-happy, they're going to try to do everything they possibly can not to, which of course is prudential. But the question is, I'm not even so sure that they have given a lot of serious thought of the kind you talk about of what to do about this.

Henninger: Well, they have a lot on their plate in Iraq. I mean, it stands to reason. But in the absence of any credible threat, you have to put in the minds of Iranian leadership--which is essentially a kind of a dictatorship--that you are willing to do something like that. They're simply going to grind forward to the day of reckoning.

Stephens: Well, this is something--I mean, Richard Nixon was famous for saying, you know, in order to keep the peace of the world, the Russians have to think I'm crazy.

Gigot: Right.

Stephens: And in a way, that's the same with Bush. And this has to do with some of the debate that's come out about the possibility that the U.S. might use nuclear bunker-busters. It's important to get those bunker-busters precisely for the Iranians to think that we just might be crazy enough to use them.

Gigot: Jason, I'm sorry, we've got to go. But we'll come back to this issue many times I'm sure. Thank you. We have to take one more break. When we come back, our "Hits and Misses" of the week.

Gigot: Winners and losers, picks and pans, "Hits and Misses"--it's our way of calling attention to the best and the worst of the week. Item one, the city of San Francisco prepares to mark the 100th anniversary of one of the most devastating natural disasters ever to strike the United States. Dan?

Henninger: Yeah, I was in San Francisco this week, Paul, and they are in fact celebrating--if that's the word--the 100th anniversary of the famous 1906 earthquake and fire. And the TV and the newspapers out there have been having these eye-popping series about what happened back then. And according to the best estimates, the U.S. Geological Survey holds that sometime--as they were putting it out there, in the next three minutes or 30 years--there is a 62% chance of having an earthquake the size of the one in 1906. I'm taking all of this in from the 18th floor of my hotel out there. And I'll tell you, either the people in San Francisco are the bravest people in this country, or they're the biggest fools in paradise.

Gigot: OK, Dan. Next, Jason Riley gives a hit to this week's immigration protesters. Jason, why?

Riley: Well, as someone who sort of sympathizes with the argument that our immigration laws are broken and need to be fixed, I was initially skeptical to the protests. You know, why go out and agitate against the bill that the ;president doesn't even support? But I think I'm being won over. I think the American people are also being won over by these protests in the sense that they've sort of put a human face on what's going on. And I think that's largely because these protests have by and large been peaceful. And given the size of them, that is a pretty impressive accomplishment. And I think that they're making a point, and for all those who say the Latin American immigrants don't assimilate, in this case, they certainly seem to be behaving in the best American tradition of peaceful protest.

Gigot: All right, Jason, thanks. Finally, Oprah Winfrey any makes no apologies for her good fortune. Bret?

Stephens: Yeah. The story is that Oprah took a trip to Africa with some well-to-do friends, and on the way back, one of those friends said, Don't you just feel guilty? Don't you just feel terrible? And Oprah's response, I think, was very telling. She said, No, I don't feel guilty. How is my being destitute going to help these people? I'm going to go home to my Pratesi sheets, and I'm going to have a very comfortable night.

And I think this kind of story reminds us of why Oprah is really America's darling. She's not a limousine liberal. She comes from a working-class background. She made it to where she is with her smarts and determination, and I think she is proof that--she is a one-woman demonstration of the power of the American Dream, and why none of us should really feel guilty about that.

Gigot: All right, Bret. That's it for this week's edition of "The Journal Editorial Report". Thanks to Dan Henninger, Jason Riley and Bret Stephens. I'm Paul Gigot. Thank you for watching. We hope to see you next week.

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