Friday, January 11, 2008

Are We All Democrats Now?

Peace and prosperity are age-old winning campaign issues. Reduced marginal tax rates have stood the test of time. They are an effective economic stimulant, creating permanent incentives to work and invest and sufficient fire power to expand the economy’s long-run potential to grow.

And yet the estimable David Brooks, writing in today’s New York Times, says the Republicans need a new economic model. He writes, “Supply-side economics had a good run, but continual tax cuts can no longer be the centerpiece of Republican economic policy.”

With respect, I do not agree. Deserting the 100-million-plus investor class, as Brooks suggests, would be economic and political folly.

In today’s innovative high-tech world economy, where the global spread of free-market capitalism is the single biggest growth factor, saying “the entrepreneur is no longer king” is just plain wrong. New technologies and new companies are springing up everywhere, and it is precisely this Schumpeterian process that is the single-biggest driver of jobs, incomes, prosperity, and wealth creation.

The targeted tax credits that David Brooks supports have no impact on incentives or economic growth. However, slashing marginal tax rates (as Rudy Giuliani and Fred Thompson propose) has the maximum economic-growth impact.

Incentives matter. We have learned that economic behavior responds quickly to changing tax rates. Practically all of Eastern Europe has moved to a flat tax. This Reaganesque trend has spread to Asia. If the U.S. switches to small-ball tax credits to subsidize workers, we will become increasingly uncompetitive and will lose the global race for capital and growth.

Without new capital to finance new businesses, job creation and consumers will lag further and further behind. It must pay, after-tax, to take risks and invest. New capital is essential for technology and productivity. This is the source of real wage gains. And this is why tax penalties on capital should be eliminated.

Unwittingly, however, many in the GOP fold are drifting toward a Keynesian demand-side model that ignores incentives and will reduce economic growth in the decades ahead. If the GOP abandons supply-side tax reform and instead opts for targeted tax credits or subsidies, Republicans will sound just like Democrats. Meanwhile, the Chinese, Indians, and Eastern Europeans will forge ahead with dynamic growth and capitalism that will leave us in the dust.

The current White House will have a hand in this, too. President Bush’s new tax proposal to “pre-fund” temporary income-tax cuts is nothing more than an ineffectual demand-side nostrum. In fact, there is very little difference between Bush’s tax-rebate plan and the plans proposed by senators Clinton and Obama.

Are we all Keynesians now? Are we all Democrats now?