The Sad Legacy of the Bush Tax Cuts

Well, first the good news: The Bush tax cuts created jobs! Now for the bad news: Those jobs were not in the United States. --------------------------------------- The Bush tax cuts may have encouraged capital flight from the US because the dollar was weak and capital – including incremental funds in taxpayers’ pockets – tends to flow to stronger currencies. In a weak dollar environment, US... [more]

Well, first the good news: The Bush tax cuts created jobs! Now for the bad news: Those jobs were not in the United States. --------------------------------------- The Bush tax cuts may have encouraged capital flight from the US because the dollar was weak and capital – including incremental funds in taxpayers’ pockets – tends to flow to stronger currencies. In a weak dollar environment, US policymakers must consider whether a tax cut’s positive effects on the US economy might be muted relative to its collaterally positive effects on stronger-currency economies. Record flows to emerging market debt and equity funds, coupled with anaemic US investment spending, suggest that this might be an issue. If we are correct about the growing extraterritorial leakage of US monetary and fiscal policies, then an increase in the capital gains tax rate might have a larger negative effect on non-US investments such as emerging market funds and exchange-traded funds than on US investments. There probably are greater long-term capital gains to be made in non-US investments than in US investments simply because of the outperformance of non-US markets since the tax cuts were enacted. From December 2003 to August 2010, the MSCI Emerging Market Index appreciated 120 per cent versus a decline of 6 per cent for the S&P 500. Speculative assets that have appreciated, such as gold, might also suffer if the tax cuts were allowed to expire and investors rushed to cash in gains before the lower tax rate expires. Business investment data demonstrate that the Bush tax cuts failed to achieve their goal of spurring productive US investment and that this failure has contributed to the poor performance of US stocks. In a strong dollar environment, the cuts might have encouraged incremental taxpayer savings to flow into US companies, reducing their cost of capital, boosting their return on capital and driving their stock values higher. Instead, in the weak dollar environment of the times, the cuts leaked abroad and boosted return on capital outside the US. It is possible that allowing the Bush tax cuts to expire might damage non-US investment prospects more than those of the US. http://www.ft.com/cms/s/0/9e6a18ec-c019-11df-b77d-00144feab49a.html [less]