COP: The Road to Economic Demoralization

Larry Kudlow
Friday, July 10, 2009

There’s no question that current government policies for taxes, spending, and regulation are causing the U.S. to lose competitiveness in the global race for capital, prosperity, and growth. . Of course, China has been moving in the direction of free-market capitalism for years. To some extent, this shows the positive benefits of America’s free-trade policies and its open-mindedness in helping nurture not only China growth, but also middle-class prosperity worldwide.

But what’s particularly galling about Obamanomics is that we may well be losing our competitive edge with Europe. While Europe is ever so slightly moving toward Reagan and Thatcher, the U.S. is shifting toward an overtaxed and overregulated model that smacks of François Mitterrand. That’s something no one should want to tolerate.

Heavy government controls at home, along with an income-leveling social policy couched in economic-recovery terms, is no way to run a railroad. At the simple stroke of a computer key, world investment flows to its most hospitable destination. That includes a reliable currency. But in President Bush’s last year and President Obama’s first, the U.S. has become a less-hospitable destination for global capital. That should worry everybody.

But let’s first look to the China story.

We know that China is already our principal banker, to the tune of nearly $1 trillion. As President Obama’s record spending and borrowing continues -- he’ll be the greatest bond salesman in American history -- our financial reliance on China grows daily. But that’s not all.

Fortune magazine recently reported that the number of U.S. companies in the world’s top 500 fell to the lowest level ever, while more Chinese firms than ever made the list. Thirty-seven Chinese companies now rank in the top 500, including nine new entries. Meanwhile, the number of U.S. firms has fallen to 140, the lowest total since Fortune began the list in 1995. This is not good.

China also surpassed the U.S. as the world’s biggest automaker in the first half of 2009, with June sales soaring 36.5 percent from a year earlier. The Chinese registered 6.1 million car sales for the first half of the year. That way outpaced American sales, which were only 4.8 million.

And China has no capital-gains tax. It only has a 15-to-20 percent corporate tax. The U.S., on the other hand, is raising its cap-gains tax rate to 20 percent. It’s also increasing its top personal tax rates.

In fact, the scheduled income-tax hike along with a much-discussed 4 percent health-care surtax will balloon the top U.S. tax rate all the way to 51 percent. And there’s more. In order to finance so-called health-care reform, congressional Democrats are now talking about raising the tax rate on capital gains and dividends by another 1.5 percent while installing a value-added tax (VAT) that would begin at 1.5 percent.

So top tax rates in the U.S. may edge into the mid-50 percent range. Compare that to the OECD average of only 42 percent. And when those tax-hikes kick in, the top U.S. tax rate will rank above that of France, Germany, and Italy. That can’t be good.

Incidentally, our 40 percent corporate tax rate is already almost 15 percentage points higher than the corporate rates in most of Europe.

Washington’s enormous expansion of the state-, local-, and federal-government spending share of GDP to over 40 percent -- including Bailout Nation, TARP, and takeovers in numerous industries -- is eerily reminiscent of Old Europe’s old policies. And in an ironic twist, Europe seems to be moving toward a lower-tax-and-spend-and-regulate, Ronald Reagan–type approach, while the U.S. is regressing to the failed socialist model of Old Europe. This makes no sense.

Higher tax rates undermine the incentive model of growth. At the margin, investment risk and work effort become less rewarding. On top of this, Obama’s regulatory moves toward greater government control of the economy will further drown animal spirits in a sea of red tape born of bureaucratic officialdom.

Think about this in terms of the threat to nationalize heath care, which is over 15 percent of the economy. Additionally, Washington’s cap-and-trade proposals will essentially nationalize the entire energy sector -- another 15 percent of the economy -- sending long tentacles into every nook of the economy that’s impacted by energy, which is virtually everything.

And all this comes on top of the U.S. government’s takeover of auto companies, banks, AIG, Fannie, and Freddie. Instead of Schumpeterian gales of creative destruction, we’re on the road to economic demoralization.

Here’s the clincher: Year-to-date, Dow Jones stocks are off 8 percent, while China stocks are up 71 percent. The world index is up 4 percent. Emerging markets are up 25 percent. They’re all beating us. None of this is good.

We’re going the wrong way. That’s why stock markets are not voting for the United States anymore.



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