Friday, September 29, 2006
What distinguishes this period from the past is that recent large and unanticipated increases in energy prices have consumed much of the strong nominal wage growth. Workers� paychecks have gone up, but they have had to use a portion of that increase for higher costs of energy such as gasoline and heating fuel. The increase in the price of gasoline and oil products has been one of the most notable changes in our economy during the past year. The period from August of 2005 until August of 2006 witnessed a 22 percent increase in the price of crude oil, and a 32 percent rise in the price of gasoline. High energy prices strain family and business budgets, but throughout this period the economy exhibited resiliency and continued to grow at a rapid pace. Indeed, real growth for the first half of this year averaged about 4 percent on an annualized basis. Since the beginning of August, we have experienced substantial declines in the price of gasoline and crude oil. Gasoline prices have dropped 21 percent since early August, and the price of crude oil has gone from a high of $77 per barrel down to $61 now. This is positive news for two reasons. First, it suggests that inflation rates will moderate as we move forward, and so high nominal wage growth such as we have seen in the recent past will translate into real additional buying power for the typical American worker. Second, lower energy prices are a positive force in growing the economy.As I noted yesterday, GDP might be 3% higher today if we didn't have a tripling of the price of oil, which would increase the amount of money people earn.
How much of this growth can be ascribed to the Bush Administration? A new report from the Heritage Foundation report suggests that the Administration has made "two steps forward, one step back" in both cutting taxes and increasing the size of government. Two excerpts quantify that.
[T]ax cuts can promote growth if policymakers reduce mar�ginal tax rates on productive behav�ior. The 2003 tax cut was very successful in this regard, reducing tax rates on working, saving, and investing. Key provisions included:On balance the negative effects become more troubling if the tax cuts are not extended. The talk of balancing the budget you hear from Democratic challengers is little more than a call for tax increases, which would undo the one good thing the Bush administration has done with fiscal policy, while leaving the extra spending in place. New programs only would make matters worse.
- Immediately implementing the lower income tax rates that were approved in 2001 but were not scheduled to take effect until 2004 and 2006. This dropped the top tax rate from 38.6 percent to 35 percent and reduced other tax rates by similar amounts.
- Reducing the double taxation of dividends from a maximum of 38.6 percent to 15 percent. This provision significantly reduced the tax penalty on new investment and lowered the tax code�s bias in favor of debt-financed investment over equity-financed investment.
- Reducing the double taxation of capital gains from a maximum of 20 percent to 15 percent. Like the dividend provision, this reduced the tax penalty on new investment and lowered the tax code�s bias in favor of debt-financed investment.
Since 2001, the burden of government spending has increased by 2 percentage points of GDP. ...[T]his spending increase is hinder�ing economic performance. Small reductions in the rate of growth may make only a slight difference in the short run. For instance, the IMF study implies that recent spending increases since 2001 have reduced annual growth by 0.1 percent. However, the cumulative effect of even minor differences in growth can have a significant long-run impact on living standards. Indeed, if annual growth is 0.1 percent slower�e.g., 2.0 percent instead of 2.1 percent�total economic output after 30 years would be significantly lower, akin to a reduction in economic output today of $2,740 per household.