Although much of the excitement over Bush's State of the Union address yesterday was over foreign policy issues, rights to privacy, and mistimed applause from the Democrats, key declarations about tax cuts created enough buzz for Market-Racket to want to review them in more detail.

About half way through his speech, the President urged Congress to make permanent the tax cuts that he instituted in 2001. In brief, these tax cuts included sweeping changes to individual income taxes (including an overall reduction in rates, doubling of the child tax credit and other reductions), a lowering of capital gains and dividend taxes, and a repeal of the estate tax. The goal of the policy was to catalyze an economic growth spurt and provide more jobs for Americans. To these ends, the cuts provided the Invisible Hand an extra $800 billion to play with since the policy was implemented.

In principle, this is a good policy when well-timed. Money in the hands of consumers, who are pressured by competitive forces to allocate resources to society's best rewarded uses, is better than money in the hands of the government, which is generally viewed by economists as less intelligent than the marketplace for this role.

The problem is that today's government still accounts for a great deal of transactions in our economy, and its expenditures of late have gotten out of control. The U.S. Budget Office estimates that the federal government spent $477 billion more than it earned in 2005.

In addition to this unfortunate timing, the tax cut report card is far from stellar. The unemployment rate, which started out at 4.7% in the year the tax cuts were implemented, finished at 5.1% at the end of 2005. Growth rates of sectors affected by the cuts have not surpassed historical averages, and in many cases, linger far below years where there were no cuts.

Of course, it is impossible to tell what the rates would have looked like if the cuts had not been implemented. Perhaps, due to other economic events, the growth rates would have absolutely tanked, and the tax cuts are the only thing that are keeping them afloat near the surface of normality. Indeed, considering the extra cash in people's pockets comes out to only $2,700 per person over the last 5 years, it may not be shocking that this measure wasn't going to be the winning lotto ticket for our economy.

So what now? It appears that the question remains the same: is it worth stretching the deficit to put the cash in America's pockets? Perhaps a compromise can be met. Greenspan has supported financing the tax cuts purely through a reduction in government spending. The Bush administration seems to acknowledge and agree with this in principle, having cut discretionary spending slightly each year, and promising to cut the deficit in half before 2009.

But we Americans should be mindful that it's going to take a lot more than meeting these specific goals to fix the problem. The "discretionary spending" and "deficit" Bush refers to in his promises ignores the huge impacts of expenditures in Afghanistan, possible reforms in Social Security, continuation of tax cuts, and many other big-dollar items. Regardless of the political nature of any of these items, dollars remain dollars, and one cannot talk about the deficit problem going away unless they are referring to the full picture. If we're truly going to have it both ways we're going to have to strap the full budget within the deficit-reducing limits.

UPDATE: The Wall Street Journal had a great article today describing the full picture of our budget problem. Check it out here.

Posted by Michelle Smith on February 1, 2006 08:11 PM