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Free Markets Work - by Larry Kudlow

The greatest story never told? It's still the booming American economy--spurred by lower tax rates, accommodative money, huge profits, big productivity, plentiful jobs and a general free-market capitalist resiliency.

Some folks are bellyaching and gnashing their teeth about oil and housing; but you know what? Housing is softer but is holding up just fine. Today's Wall Street Journal says its time to buy a home in Houston, Dallas and Atlanta, rather than the east and west coast. Good point. As for gas at the pump, it averaged about $2.40 in March and about $64 for crude oil. But this was not an economic impediment. Production, retail sales, and employment were all very strong in March. Very strong indeed.

Today's durable goods report was off the charts strong. Airplanes, transportation, metals, industrial machinery, computers, even motor vehicles and car parts. But wait. The key point: business investment in capital goods was unbelievable. New orders for core cap-ex, (ex defense and aircraft) have grown 9 percent at an annual rate and 12 percent over the past year. That is a leading indicator of future business spending.

And there's more. Backlogs of unfilled orders increased over 12 percent at an annual rate in the first quarter--the best in two years. This key measure is a leading indicator of the new orders leading indicator, a very important forecasting tool for business economists. With this kind of real world corporate activity in the pipeline, it shows that highly profitable businesses will be doing a lot of hiring in the months ahead in order to expand plant and equipment capacity. Just what the doctor ordered.

At these lower tax rates, capital is still relatively inexpensive and investment returns are unusually high. What's more, President Bush's mid course correction on energy policy is going to stabilize, or even reduce, upwards pressures on the price of oil and retail gasoline.

Regrettably, Mr. Bush included a lot of liberal-left greenie gobbledygook about price gouging inspections and oil company investments. But he may have included that to stop a windfall profits tax from coming out of Congress.

All this oil addiction stuff smacks of Jimmy Carter's malaise. But, according to Washington analyst James K. Glassman, over the past decade, big oil has invested roughly equal to their profits. In fact, according to Mr. Glassman, between 1991-2005, ExxonMobil's total investment totaled $210 billion (actually exceeding the company's earnings). So government should stop beating up on XOM and their brethren.

Confiscating Lee Raymond's bank account will not produce more energy. Nor will breaking up oil companies as per Sen. Chuck Schumer's goofy idea. And a windfall profits tax will only lower energy exploration and investment.

The point is free markets work. Rising prices from the global economic boom will lead to more conservation, less consumption, and more production. That is, if government steps out of the way, deregulates sufficiently, and finally allows drilling in ANWR, the Outer Continental Shelf, sets up LNG terminals, and creates nuclear power facilities. Just look at the deregulated boom in Canadian oil sands production.

On the positive side, Mr. Bush did suspend the ethanol tax mandate forcing gasoline distributors to participate in one of the great energy policy bungles of all time. Neither ethanol refiners nor transporters were anywhere near ready to implement this misguided policy mandate. Lee Raymond and other industry leaders warned Energy Secretary Sam Bodman about this. Bodman deserves a "F" for terrible execution and management.

No one's even sure if ethanol is worth the candle. Many believe the energy used in the production of corn based ethanol gasoline is actually greater than the energy produced by this stuff. This ethanol tax snafu is responsible for at least the last 50-cent increase in gas pump prices. Too bad Mr. Bush didn't abolish the ethanol tax altogether, rather than just suspending it for the driving season.

However, Bush's decision to finally stop the crude oil fill rate for the Strategic Petroleum Reserve is another good measure that will relieve upward pressure on oil prices. Missing though, is a total repeal of the 54-cent ethanol import tariff aimed largely at Brazil. This is the energy equivalent of the mistaken steel tariff a couple of years ago that protected producers at the expense of consumers. It's bad policy and it flies in the face of Mr. Bush's own stated principles of avoiding isolationism and protectionism. But at least some good in relieving the ethanol tax and the SPR fill rate will help economic growth.

All of which lead to some important fiscal policy decisions now confronting the White House:

First, it is essential that the tax cut extensions on job creating low tax rate dividends and cap gains be passed in the weeks ahead. This is a must. It will bolster and prolong the business capital investment boom that requires long lead times for planning purposes.

Second, the president must veto the budget busting emergency supplemental appropriations bill that is now before Congress. The Senate is overspending by $15 billion, including a $700 million Railroad to Nowhere in Mississippi. With new Bush White House staff, and a new budget director, now is the time for new toughness and resolve on spending. This kind of move will raise economic confidence and electrify a moribund Republican base.

As the Federal Reserve moves toward additional steps to remove excess money creation and bolster the dollar value relative to foreign currencies and commodities, inflation fighting money policy should be combined with lower tax rate incentives to promote long-term economic growth. This was the Reagan economic model twenty-five years ago, and it will work as well today as it did back then when it launched the long prosperity boom we continue to enjoy today.

To simplify matters, why not just repeal the ethanol tax, repeal the ethanol tariff, repeal the multiple taxation of dividends and cap gains, and get rid of the death tax while you're at it? Now there's a program of long run economic growth.