NCPA - National Center for Policy Analysis

Long-Term Growth and Short-Term Stimulus

February 21, 2003

Economists predict the U.S. economy will grow 3.1 percent this year, after adjusting for inflation. However, that projection is predicated on the passage of the president's tax-cuts, according to Council of Economic Advisers Chairman Glenn R. Hubbard.

The president's plan has been criticized for not providing enough short-term stimulus -- which critics define as putting money in consumers' pockets. However, says Hubbard, it is tax cuts that lower the tax burden on capital that will stimulate investment and job growth in both the short and long term.

The president's plan includes such tax cuts. Specifically, he proposes increasing the amount of small business investment that can be deducted from taxable income, eliminating the double taxation of corporate dividends and lowering income tax rates now.

How will this stimulate the economy in the short term?

  • The effective federal tax rate on new investment is as much as 60 percent -- eliminating dividends taxes will reduce that tax burden, increase the long-term value of stocks and enlarge the stock of capital.
  • Stocks will quickly rise as markets anticipate the increase in dividends and lower cost of capital for equity-financed corporate investment -- which would fall by more than 10 percent for equipment and by a third for new construction.
  • Furthermore, according to a 1992 Treasury Department study, dividend tax relief will result in the reallocation of capital toward more efficient uses, permanently raise economic well-being by the equivalent of $36 billion worth of consumption annually in today's dollars.

As for the federal budget deficit and debt, because of the higher growth path, the president's plan would raise the ratio of debt to gross domestic product by less than one percentage point this year, and reduce the debt-to-GDP ratio in future years.

Source: Testimony of R. Glenn Hubbard, Chairman, Council of Economic Advisers, Joint Economic Committee of Congress, January 30, 2003.

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