Economic Growth the Right Way

Whenever Congress assembles an economic “stimulus” package during a campaign year, the election season quickly degenerates into silly season.

Spooked by a sudden up-tick in the nation’s unemployment rate, jittery stock and home mortgage markets, and record-high energy prices, liberal Democrats returned to Washington determined to throw up to $125 billion of your tax dollars at the problem. Like dollar bills tossed out of a helicopter, they would land on everything from health care and highways to home mortgages and home heating oil. $250 tax rebates would arrive in your mailbox, whether you paid taxes or not. Unemployment checks would flow far into the future. State governments would also share in the bounty.

Republican Leader John Boehner (R-Ohio) laid down a very different marker. House Republicans, he explained, would propose legislation “that truly is stimulative — not for the federal government, but for our nation’s increasingly sluggish economy.” An acceptable stimulus “must not raise taxes and must not increase unrelated federal spending on the backs of families and employers struggling to make ends meet,” he said.

President Bush, too, is expected to back a stimulus program — one that reportedly will shun more spending and focus instead on incentives for businesses to invest in new equipment and tax relief for wage earners.

Sensing an enormous chasm between these two camps? You’re right. In fact, it’s hard to envision any bipartisan consensus emerging that would satisfy both pro-growth economic conservatives and their liberal colleagues.

But there are other, outside-the-box ways to skin the stimulus cat. What, specifically, can the president do unilaterally to spur real, and permanent, economic growth?

The answer lies in a 1992 legal memorandum that resurfaced recently. In it, three prominent legal scholars addressed the question of whether the tax code gives the president the authority to instruct the Treasury Department to index capital gains for inflation.

After examining the legislative history and relevant Supreme Court precedents, the scholars discovered that Congress left the term “cost” undefined in the cap-gains section of the tax code. For eight decades, Treasury has calculated capital gains by comparing cost at the time a capital asset was purchased to the cost at the point of sale, no matter how long the investor held on to it. But this approach taxes investors unfairly on gains attributable solely to inflation, especially those who hold their assets for many years, as often happens with homes.

A far better way would be to exclude the effect of inflation entirely when calculating capital gains. Such an approach would lower the tax assessed on the sale of stocks, homes, real property and other capital assets, in some cases dramatically so. Supreme Court decisions, the scholars also concluded, indicate that federal officials have broad discretion to fill gaps left by Congress, provided this discretion is exercised reasonably.

Noted economist Richard Rahn believes such a change would “[produce] more short-term revenue to the Treasury as long-term gains are unlocked, [lower] the cost of capital … stimulate investment and the stock markets, and … increase the fairness of the tax system by not taxing phantom gains for people at all income levels.”

One of the scholars challenged the president to “correct this serious deficiency.” If Congress objects, he observed, “it can pass a law outlawing indexing.”

But, enacting legislation to put the indexing toothpaste back into the capital-gains tube may prove impossible in light of the new Democratic majority’s strength in our wealthiest states and congressional districts. Presuming taxpayers would welcome this form of tax relief, any attempt to rescind it could inspire a tax rebellion in Democratic strongholds old and new — i.e., states represented by Democrats in the Senate, and House districts represented by the politically vulnerable class of freshmen Democrats.

Consider the following, drawn from the latest (2005) IRS income tax data:

• Taxpayers in the 18 states with two Democratic senators reported $280 billion in capital gains, more than half the national total. Those in the 15 states with one Democratic senator accounted for an additional $159 billion (29% of the total).

• In the 2006 House elections, Democrats did quite well in traditionally Republican areas with many high-income households. In fact, 14 of the House Democratic class of 2006 represent districts where total capital gains exceeded $1 billion. Altogether, 21 hail from the wealthiest one-half of districts, where the gains were $800 million or more.

This is one of those rare times when a policy change would not only create jobs and raise incomes, but simultaneously impose a political checkmate on the class warriors.

So, what are we waiting for?

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