Wall St. And Business Wednesdays: The Laws of Capital Taxation by Jude Wanniski

For President Bush to succeed in getting $550 billion out of Congress for his tax-cutting growth package, he should be making better arguments for its centerpiece: ending the double-taxation of corporate dividends. If he gets only the $350 billion being offered grudgingly by the Senate, there will likely be no room at all for this desperately needed cut in the taxation of capital.

The biggest reason for the near-total Democratic opposition is the argument that ending the double tax on dividends benefits the rich. In announcing his intent to campaign for the higher number (spread over ten years), the president used the demand-side pitch that it would put more money into the hands of "investors."

The more accurate supply-side argument is that by taxing dividends once instead of twice, far more capital will be created. And it is not "the rich" who benefit most when capital is in surplus, but labor. It is an argument that is easy to understand - the only kind that will resonate with the electorate in a way that will break the ranks of Democratic opponents and perhaps win back the four GOP senators who balk at the idea.

When capital is taxed less, it becomes more plentiful relative to labor. It is only when labor is scarce relative to capital that it can demand and get higher wages, because the capital is there to make labor more productive.

This has been true since the dawn of civilization, when workers had little or no capital. When a man digs a hole with a stick, the capital/labor ratio is 1-to-1. When he digs with a shovel, the capital/labor ratio is 5-to-1. The ratio shoots to 100-to-1 when he digs with a backhoe and 1000-to- 1 when he digs with a giant power shovel. His wages do not rise in exact proportions because there is a cost to capital that must be paid. But it should be clear the worker is worth more and is paid more when capital is plentiful.

In brief, national standards of living only rise when the governing authorities encourage the formation of capital.

That's what the Bush tax cuts failed to do in 2001. They were not designed at all to increase capital formation, but simply to give money to labor to spur consumer demand. The president may have thought he could spur the economy by "putting money into people's pockets," the phrase he and his advisors used countless times in promoting the plan. The concept, though, is the primary growth mechanism of the demand-side school of economics and does nothing for capital formation.

Treasury Secretary John Snow is surely correct in arguing that an end to one of the two taxes on dividends would add at least $1 trillion to the $11 trillion value of traded equities. It is true all Americans benefit directly or indirectly when the value of the nation's capital stock grows, but the argument still sounds as if it primarily benefits the rich.

Not so, says Gary Robbins of Fiscal Policy Associates, arguably the most respected of all supply-side tax experts. When the national economy over time adjusts to a 100 percent exclusion, he says, it would eventually add 3 percent annually to the gross domestic product in perpetuity. For every $1 in foregone revenue, society as a whole would gain $2. The private sector, keeping that $1, would gain $3. Within all of the economic sphere, investors with this surplus capital would bid down marginal returns on capital through competition - and thereby gain least of all.

It is not fantasy but fact that we cannot solve our myriad financial problems with a marginal cost of corporate capital now exceeding 70 percent. There is universal agreement that by 2020 we will have only two workers to support one retiree, where we now have three. The problem can be solved only by giving each of the two workers 50 percent more capital.

This is not economics. It is arithmetic. Social Security and Medicare cannot be financed when dividends are taxed twice and capital gains are taxed at 15 percent. Nor can the soaring budget deficits at all levels of government be managed unless the economy can return to high levels of non-inflationary growth. None of the primary objectives of government finance can be met unless capital can form at a much higher rate than it is now.

The greatest gains in real wages for labor in the last half-century came following the lowering of tax rates on capital during the Kennedy-Johnson administrations, during the Reagan years, and in the second term of the Clinton administration. Democratic Party leaders and presidential contenders who are uniformly ridiculing Mr. Bush's tax proposals should rethink them in this light. The president and his team should do the same.

This article first appeared in The Washington Times

Wednesday, May 14, 2003