http://www.investors.com/editorial/issues.asp?v=5/7INVESTOR'S BUSINESS DAILY
Tax Policy: You can't always get what you want, someone once said (or sang). But if you try sometime, you just might find — you get what you need. And so it is with President Bush and his tax-cut plan.
The president is this far away from getting the plan he and the country need to spur economic growth and generate enough jobs for all Americans who need them. But it's not the $726 billion plan he wants, the one that's built around ending the double tax on stock dividends and which has hit a wall in Congress.
Rather, it's the new plan set out by Rep. Bill Thomas, chairman of the House Ways and Means Committee, and which we hope will be endorsed by the full House later this week.
Thomas' $550 billion alternative (we got the cost wrong here Monday) would keep the key elements of Bush's package, including the important acceleration of income-tax cuts that the president got through Congress last year.
These include reductions for all taxpayers, including those in the top bracket. Their rate would drop to 35% from 39.6% — significant, we believe, because the owners of many small businesses — America's real job-generators — would then pay the same rate on income as the biggest corporations, many of which are slashing payrolls.
But Thomas stops short of getting rid of the dividend tax altogether. Instead, he puts dividends, now treated as ordinary income, in the same category as capital gains. Capital gains are taxed at a top rate of 20%. Thomas' plan would lower that to 15% for both cap gains and dividends.
Thomas is to be commended for putting cap-gains cuts on the table while also preserving a major reduction (to 15% from 39.6%) in the tax on dividends. This rebalances a Bush package that puts too much emphasis on tax reform and too little on economic stimulus and job creation.
How does a cut in cap-gains taxes help create jobs?
By giving innovative entrepreneurs enough reason to start and build new businesses. Simply put: The bigger the difference between the rates on income and capital gains, the more compelling it becomes for ambitious men and women to strike out on their own. Otherwise, the risk is too great in relation to the payoff when part or all of the business is sold.
Note in the table that a widening of the capital gains differential in the late 1970s, followed by a sizable cut in cap gains in 1981, set the stage for the 1980s boom that produced millions of new jobs and thousands of new companies. These included the Microsofts, Dells and Ciscos that carried the economy and led the stock market for most of the last two decades.
Note also how the differential widened as the economy reached warp speed in the late-1990s. By contrast, the narrowing of the differential in the late 1980s and early 1990s coincided with a period of lackluster activity.
The economy needs just as stiff a jolt today. The recovery remains sluggish, as we predicted more than a year ago based on similar periods, like the 1930s and 1970s, that followed severe stock-market declines.
We'd go so far as to say the economy needs even more help than provided in Thomas' praiseworthy plan. We'd take his 15% cap-gains tax and halve it again for any American who starts a brand-new business and hires at least three employees. The 7.5% would be applied to any stock or business interest sold by founders or employees in the first 10 years.
The nearly fivefold differential created by a new top income-tax rate of 35% and a 7.5% cap-gains tax rate for new small-business owners would be a powerful incentive. Otherwise, with a 15% cap-gains rate (under Thomas) and a top rate of 35%, the differential wouldn't be much different from what's in place now.
We estimate that this incentive would result in 100,000 new small businesses each year. Not all the new enterprises would survive, of course. But using the historical average of 5.3 employees per new small business for those that do, plus some future growth, we reckon that a half-million new jobs would be created over the next year and 2.8 million over the next five. That would more than offset those lost since Bush took office 27 months ago.
The kicker would be that this small-business incentive would cost the government . . . nothing. New income from these additional new businesses and their jobholders would result in a $28 billion net increase in tax revenues. And if the holding period for realizing cap gains were rolled back to six months from a year, the government would get its future capital gains that much sooner.
Bush's plan to speed up income-tax cuts and address the dividend-tax inequity is terrific.
But with a less-expensive plan that includes cap-gains relief, Thomas has gone one better. If the cap-gains rate were cut even further for the most ambitious, inventive and innovative risk-takers among us, the economy could be up to speed — and millions of Americans back to work — sooner than anyone thinks.
