Taxes: Bush And Gore Are Both Wrong

Pardon us for laughing, but we've just toted up the list of proposed tax breaks from Presidential candidates Al Gore and George W. Bush. At last count, and in no particular order, there's talk of tax credits or tax cuts to eliminate the marriage penalty, promote long-term health care, help the richest 2,000 families in America pass on their inheritance, support household saving with matching government funds, encourage energy-efficient cars, pay for education, bolster child care, support farmers, and help small businesses. Wow, and we're not even counting all the breaks for specific industries, such as ethanol. Funny as this pandering to voting constituencies may be, the joke is really on America.

Even though the Gore and Bush tax proposals are miles apart ideologically, they have one thing in common: Both are in flagrant opposition to current Federal Reserve policy. At a time when the Fed is trying to temper consumer demand to bring a white-hot economy into a soft landing, the Democrats and the Republicans are offering tax credits and cuts that would hugely stimulate consumer spending. If either party's tax policies were to be instituted anytime soon, the Fed would have to tighten monetary policy. Even if they are phased in over ten years, market expectations would drive rates higher. It doesn't make sense.

Neither do most of the proposals. Tax policy at this point should be aimed at bolstering the transition from the Old to New Economy and promoting growth. The Bush and Gore tax proposals are designed instead to appeal to dozens of potential voting blocs and their political agendas.

What would a New Economy tax policy look like? Above all, it should be pro-investment and not favor increased consumer spending. Investment in information technology is driving the current expansion and will for years as new Internet companies arise and older, bigger corporations move into information-based processes and products. Low interest rates are the single most important factor in promoting investment. They make big capital expenditures more affordable and bolster the return on investment of startups, making them more attractive to venture capitalists. In this kind of economic environment, the most pro-growth tax policy may be no cuts or credits at all. Use the budget surplus to pay down the federal debt and lower interest rates.

A New Economy tax policy must also focus on keeping individual incentives high. If political pressure to change tax policy proves unstoppable in the face of huge budget surpluses, then lowering marginal income tax rates across the board to reward work is the way to go. The widespread use of stock options in the New Economy makes this all the more true. Employees increasingly are willing to accept options as a form of compensation, partly in lieu of higher wages. This has played a significant role in controlling inflation and increasing profit margins. But while options move in relation to stock prices, most are taxed as ordinary income. The top marginal income tax rate is, in effect, about 41%, among the highest in the world. Changes in tax policy should begin with lowering this top rate, or perhaps treating nonqualified stock options held for a year as long-term capital gains when exercised.

If government money is to be spent in the New Economy, it should go toward education and training. Fed Chairman Alan Greenspan recently pointed out that "the rapidity of innovation and the unpredictability of the directions it may take imply a need for considerable investment in human capital." People need much higher levels of analytical and conceptual workplace skills. A New Economy requires new ideas and policies. The U.S. electorate has yet to see either.