The Tax Relief Program Worked: Make the Tax Cuts Permanent

Tax relief worked. It put the federal tax burden on track toward its historic norm. Combined with an aggressive monetary policy, tax relief helped to restore robust economic growth following the Clinton reces sion and subsequent shocks early in the decade. It pro duced a more growth-oriented tax policy for the long term, helping the economy to weather current storms arising in the housing and capital markets. And it made important strides toward fundamental tax reform.

The 2001 and 2003 tax cuts will expire at the end of 2010 unless Congress acts. Congress should act quickly, making the tax cuts permanent, and then pur sue additional pro-growth tax policies. Many major trading partners, including France, Germany, and other countries throughout Europe, are looking to lower tax rates and reform their tax systems to become stronger competitors, while other economic power houses such as China and India are bursting onto the scene. Standing still is not an option unless the United States is willing to lose ground consistently and persis tently in the international economy.

Tax Relief as Economic Stimulus

The economic boom of the late 1990s was driven by many factors, one of which was a major bubble in the equity values of information technology compa nies. This was clearly reflected, for example, in the tech-heavy NASDAQ stock index that averaged 1570 in January of 1998; peaked more than three times higher at 5049 on March 24, 2000; and averaged only 2577 in all of 2007. The popped bubble led to a con tracting economy in the third quarter of 2000 and again in the first quarter of 2001. The Clinton reces sion greeted the new President.

The correct policy response involved stimulative monetary and fiscal policies. The Federal Reserve lowered the federal funds rate from 6.5 percent at the start of 2001 to 1 percent by late spring of 2003. President Bush campaigned in 1999 and 2000 on a well-crafted program of individual income tax relief. Congress responded quickly, allowing the President to sign the Economic Growth and Tax Reform and Relief Act of 2001 (EGTRRA) on June 7, 2001.

The 2001 tax relief bill was supposed to strengthen the economy partly through the simple expedient of lowering tax burdens. A contributing factor to the 2001 recession was the oppressively high levels of federal tax extracted from the econ­omy. In the 40 years prior to 2000, federal tax receipts averaged about 18.2 percent of gross domestic product (GDP). In 1998 and 1999, the tax share stood at 20.0 percent, and in 2000, it shot up to tie the previous record of 20.9 percent set in 1944.

Regrettably, Congress chose to phase in much of the tax relief over the ensuing years, depriving the economy of a much-needed immediate tax stimu lus. Tax relief in 2001 amounted to only about 0.8 percent of GDP, leaving the tax share at a still heavy 19.8 percent. Even by 2002, the tax share remained just below the modern norm at 18.2 percent despite the drop in tax receipts from a weakened economy. Furthermore, little of the tax relief that really would have helped, such as cutting individual income tax rates, had yet taken effect. Not surprisingly, espe cially in light of the September 11 terrorist attacks and subsequent corporate scandals, the economy struggled into 2002.

See more of this article from the Heritage Foundation.