Keith Marsden: Bush tax cuts were good for business and the middle class

President Obama remains skeptical about the Bush tax cuts that were due to expire at the end of this year.

During his post Congressional election press conference, he said: “From 2001 to 2008 we cut taxes significantly, but didn’t see the results”. But “my goal is not to have a huge spike in taxes on middle class families”, he stressed.

Reluctantly, he has now struck a deal with Republican leaders in Congress to extend the Bush-era income tax cuts for two years for all Americans, including the wealthy earning over $250,000 a year.

This latter concession left some liberal lawmakers and activists seething. But the White House argues that this compromise was needed to win enough votes for a necessary measure – to avoid dampening the already sluggish recovery from recession.

Later on, Democrats will probably try to rally partisan support by arguing that Republicans insisted that the wealthy be included only because they are large contributors to Republican election campaigns.

This cynical view ignores strong independent evidence that the Bush tax cuts boosted equity investment in US business, that the “rich” were the largest contributors, and the “middle class” benefitted substantially in the form of more jobs and higher incomes.

The triennial Surveys of U.S Family Finances, undertaken by the Federal Reserve Board, show a large increase in equity investment in “privately held businesses” from 1998 (towards the end of the Clinton presidency) to 2007 (the latest year available). The forms of business in this category are sole proprietorships, limited partnerships, other types of partnerships, subchapter S corporations and other types of corporations that are not publically traded, limited liability companies, and other types of private businesses.

President Obama has often declared himself a fan of these forms of “small business”, and has urged an increased provision of financial resources for them.

The Fed surveys show that the percentage of the richest 10 percent of families (ranked by annual income) who had business equity investments, jumped from 34.2 percent in 1998 to 41.8 percent in 2001 (the first year of the Bush tax cuts). This percentage dropped slightly to 40.9 percent in 2007. But the average (mean) size of holding per investor more than doubled to $2.475 million (in inflation-adjusted 2007 dollars). There seems little doubt that tax cuts played a significant role in increasing both the incentives and availability of funds for these investments.

Business equity investment by the middle class also expanded. The proportion of families in the middle 40-59.9 percent income percentiles with holdings remained constant at 10.6 percent. But their average size went up to $240,000 in 2007 from $169,600 in 1998.

Even among families ranked among the poorest 20 percent, the mean value of business equity holdings shot up to $686,700 in 2007 from $158,100 in 1998. But only 3.3% percent of this group possessed holdings, probably in the form of start-ups or very small businesses that have yet to yield substantial income for their proprietors, but could have substantial growth prospects.

The significance of these findings does not only lie in the increased flow of investment funds to small private businesses. Most investors are not just passive providers of cash. The Federal Reserve studies show that of families with any business interest, 92% percenthad an active role as creative entrepreneurs and hands-on managers. Actively-managed interests accounted for 89 percent of privately-owned holdings in 2007.

The rich are also a significant source of inputs into the overall economy in other forms, and for varied purposes. They provide equity investments in non-residential property, including commercial property, farm and ranch land not operated through their own businesses. 21 percent of the richest 10% percent of families owned these assets in 2007, with a mean value per holding of $740,600, a 27 percent increase in real terms since 1998.

By investing in these properties, the more affluent families make office/factory/warehouse/space and farm land available for rental by other entrepreneurs.
They also help to fund investment in, and the operating costs of larger enterprises. They do so by buying and holding publically-traded shares. 91 percent of the richest 10% percent of families had stock holdings in 2007, a slight drop from 90.4% percent on 1998.

But the mean value (in 2007 dollars) of their holdings had risen by 26.8 percent over this period, reaching $863,300.

49.7 percent of the middle income group (40-59.9 percentiles) owned stock in 2007, up from 49.4 percent in 1998, and the mean value of their holdings rose to 5$8,900 from $49,000 dollars (in 2007 dollars). And even 13.6% of the poorest 20% were able to acquire stocks in 2007, up from 10.0% in 1998, with an increase in their average holding to $67,000 from $36,700 over this period.

Increased investment created more jobs. According to the U.S Bureau of Labor Statistics, total non-farm employment grew from 125.93 million in 1998 to 137.60 million in 2007, an increase of 9.3 percent.

This evidence contradicts the view, apparently held by President Obama and his administration, that the Bush tax cuts have benefited only the highest income group, and have fostered extravagant consumption at the expense of investment. On the contrary, the Federal Reserve studies show that all income groups enjoyed significant increases in real family incomes between 1998 and 2007. Rising productivity boosted wages.

The before-tax incomes (in 2007 dollars) of the poorest 20 percent of families went up by 21.8% from 1998 to 2007. The average rise for families in the middle 20 percent was 9.2 percent, while the richest 10 percent gained 42.3 percent on average, thus allowing the surges in investment noted above.

Minority ethnic groups also enjoyed increases in real income, according to the U.S. Census Bureau. It reports an increase in median (before tax) income for Black households from $33,315 in 1998 to $35,267 (in 2009 adjusted dollars) in 2007. While the median for Hispanic households went up to $40,013 in 2007 from $37,230 in 1998.

Except for the lowest income groups, whose members don’t pay federal income tax, the disposable (after-tax) income of most middle class families rose still faster as a result of the Bush tax cuts. Moreover, the cuts removed a further 5 million of families from the Federal tax roles.

The 10 percent of families in the highest income bracket remain by far the largest contributors of business equity. Even if the tax hike is confined to those with an income of $250,000 and above, as sometimes suggested, it could have a substantial negative impact on future equity investment flows to small business.

Post 2007 income trends are distorted by the recession that began at the end of that year. This recession stemmed from the collapse of the sub-prime mortgage market, provoked by an imprudent Democrat-led push for expanded home ownership among the lowest income groups. It was further accentuated by the repackaging of dubious home loans, supposedly “guaranteed” by Fannie Mae and Freddie Mac, into new-fangled derivatives promoted by the bonus-seeking staff of investment banks.

But this recession doesn’t invalidate the case for tax cuts as a means of stimulating the growth of output, employment and incomes. The new Republican-led House of Representatives should take the lead in promoting the indefinite extension of the Bush tax cuts for all income groups when it takes office in the New Year. These cuts should stimulate economic growth. But to accelerate reduction of the massive current and projected public debt, which acts as a drag on the whole economy, tax incentives will need to be accompanied by a pruning of wasteful and low priority government expenditure.
Keith Marsden is a member of the Council of the Centre for Policy Studies, and a former operations adviser at the World Bank.