About | HeinOnline Law Journal Library | HeinOnline Law Journal Library | HeinOnline
LOG IN
LOG IN

139 IRET Congressional Advisory 1 (2002)

handle is hein.taxfoundation/iretcgadv0136 and id is 1 raw text is: INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION IRET is a non-profit 501 (c)(3) economic policy research and educational organization devoted to informing the public about policies that will promote growth and efficient operation of the market economy. October 23, 2002 Advisory No. 139 DEFICITS, TAX CUTS, INTEREST RATES AND INVESTMENT (PART 1) DO LARGE DEFICITS RAISE INTEREST RATES? Two competing policy prescriptions have been offered to combat the sluggishness of the economic recovery: a deficit reduction strategy favored by Democrats and a tax reduction strategy favored by Republicans. The question is which would best stimulate business fixed investment. Weakness in business investment was the cause of the 2000-2001 economic downturn and the continued economic sluggishness. A difference of opinion on how best to address the investment slump is at the heart of the competing proposals. Deficit reduction approach. Former Secretary of the Treasury Robert Rubin and some Congressional Democrats have recommended freezing the remaining steps in the 2001 tax rate reductions (at least for the top brackets) to reduce projected budget deficits. They assert that higher deficits due to the tax cuts have boosted interest rates and depressed investment, and that freezing the tax cuts would lower deficits, reduce interest rates and spur business investment. Tax reduction approach. President Bush and most Congressional Republicans believe that the 2001 tax cuts and the bonus depreciation added in the subsequent 2002 stimulus package boosted the economy and investment. They oppose any freeze of the 2001 tax cuts and, if anything, would accelerate them and make them permanent. Others would enact new tax cuts reducing the double taxation of dividends and easing taxation of capital gains. They contend that lower taxation of capital income would spur investment. An empirical question, not a rhetorical one. Taken separately, each policy sounds reasonable, but they cannot both be right. One cannot choose between them based on the wording of the arguments. It is an empirical question whether tax cuts indirectly do more harm to investment by raising deficits and interest rates or do more good by directly increasing the after-tax returns on investment. In this paper, we shall look at the historical evidence concerning how much deficits affect interest rates. In the next paper, we shall look at more recent data and consider some of the world capital market conditions and economic factors and behaviors that might account for the observed results. Later, we shall discuss how businesses decide whether or not to undertake investment, and how taxes and interest rates affect the decisions. In that way, we can decide which is of greater magnitude, the assumed negative effect of higher interest rates on investment or the assumed positive incentive effect of tax reductions on investment. The historical record. Professor Paul Evans of Ohio State researched the relationship between deficits and interest rates in a number of published studies. Evans assumed that, if a relationship exists, it might be most obvious during those periods when budget deficits were very large relative to the size of the economy. The largest budget deficits as a share of GDP in U.S. history occurred during three major wars. The e~em kI A * * gg~ g ~gg

What Is HeinOnline?

HeinOnline is a subscription-based resource containing thousands of academic and legal journals from inception; complete coverage of government documents such as U.S. Statutes at Large, U.S. Code, Federal Register, Code of Federal Regulations, U.S. Reports, and much more. Documents are image-based, fully searchable PDFs with the authority of print combined with the accessibility of a user-friendly and powerful database. For more information, request a quote or trial for your organization below.



Contact us for annual subscription options:

Contact Us

Already a HeinOnline Subscriber?

Log In

profiles profiles most