The Quiet Entrenchment of Our Investment Class
By James K. Glassman

On a glorious day in mid May on the South Lawn of the White House, President Bush signed a bill that extended two of his tax initiatives from 2008 into 2010. That may appear a small thing, but it was a manifestation of a much larger political, economic, and social change: Most Americans are now investors.

During the President's first term, Congress passed laws that reduced personal income tax rates across the board, phased out the estate tax, cut the top rate on dividend payments from 35 percent to 15 percent, and trimmed the top rate on capital gains from 20 percent to 15 percent.

The personal and estate tax changes expire at the end of 2010--at which time Cinderella's coach turns into a pumpkin, and rates revert to what they were in 2000. The dividend and capital gains changes had been set to expire at the end of 2008, but thanks to the May bill signing they too will now end in 2010.

With less than six months before a critical election, it's remarkable that such a bill would pass. The forestalled tax rise comes after three years in which the federal budget deficit has totaled more than $1.1 trillion, making both parties itchy to appear "fiscally responsible." The New York Times characterized the action as "almost $70 billion in tax cuts, mostly for the nation's wealthiest taxpayers." I would have described the congressional action as preventing $70 billion in tax increases, but it's true America's wealthiest will benefit the most because they do the vast bulk of our investing and taxpaying.

There are two reasons the bill passed despite the easy openings for demagoguery. The first is that more members of Congress have come to understand that reducing taxes on invested capital spurs economic growth. The second is that 57 million American households (out of a total of 113 million) owned stocks in 2005. That's up from just 16 million in 1983. Stock ownership has grown 15 percent just since 1999, despite the dot-com/9-11 stock market contraction, the worst since the Great Depression.

Senate Minority Leader Harry Reid (D-NV) couldn't have been more wrong during the May signing, when he argued that the bill "sealed the fate of those trying to get ahead," and that "today's a great day to be a millionaire, but it's a bad day if you want to be a millionaire." The only question is whether he was being disingenuous or simply did not understand how America has changed.

Obviously, someone who owns $1 million in stock will benefit more from shrinkage of capital gains and dividend taxes, in dollar terms, than someone owning $10,000 in stock. But over a lifetime, the smaller shareholder has a greater chance of becoming a millionaire if he's able to pocket or reinvest more of what he earns.

Far from condemning anyone to penury, May's lower tax rates on capital will boost stock prices (by an estimated 6 percent according to economist James Poterba), improve the economy, and reduce the bite on American incomes. Businesses will also be encouraged to increase their dividend payments. Thankfully, average Americans are now aware that taxes on capital directly affect their well-being, and not just the well-being of the rich. That's a huge shift with vast political implications.

Hey, but what about the deficit?

The strong economy, which has undeniably been helped by five years of reduced taxes, has pared deficit levels of late. As I write, the deficit for the current fiscal year, first forecast at $423 billion, has been repegged by the Congressional Budget Office as "perhaps as low as $300 billion." That's about 2.5 percent of the nation's GDP--not a disturbing number, historically.

What is disturbing is the growth of spending, especially on Social Security, Medicare, and Medicaid. Those entitlements threaten to overwhelm the federal budget beginning in a decade. But remedies to the entitlement explosion may also be found in our new, increasingly self-reliant, investment class.

Is it so far-fetched to expect people to be responsible for more of their own retirement and health-care funding? Not if we heed the President's call on the South Lawn: "Let Americans keep more of their own money, and live a better life."