Lack of Risk Taking in the Economy
The U.S. economy thrives due to courageous individuals willing to take economic risks. Unfortunately, economic growth has suffered since the middle of 2000 – almost three years now – due to a distinct lack of risk taking.
Let’s get some recent economic history straight. Coming out of the economic slowdown and recession of 1990 to 1991, the U.S. experienced an under-performing recovery. From 1992 to 1996, real gross domestic product (GDP) grew at an annual average rate of 3.2%.
Now that might not sound too bad. However, in the post-World War II era (1947 to 2002), annual real GDP growth averaged 3.4%, including expansions and recessions. For good measure, during years of economic recovery, the average annual rate of expansion was 4.4%.
It was not until 1997 that the economy really picked up steam. From 1997 through 2000, annual real GDP growth averaged a very respectable 4.2%.
Since the middle of 2000, though, the economy has grossly under-performed. Real GDP growth over the past 11 quarters (from the third quarter of 2000 to the first quarter of 2003) averaged only 1.4%.
What’s been the problem? Well, several factors come into the equation. For example, the Federal Reserve dramatically raised interest rates during 1999 and 2000. Starting in the late 1990s, federal tax revenues as a share of the economy crept up to dangerously high levels. Then, of course, there were the terrorist attacks of September 11, 2001, and subsequent wars in Afghanistan and Iraq.
These experiences raised costs and/or created uncertainty in the marketplace. As a result, risk taking – specifically, entrepreneurship and investment – took a major hit. News from the National Venture Capital Association on April 29 revealed that a long and dramatic decline in venture capital investment continued in the first quarter of this year. Venture capital is the lifeblood of entrepreneurial enterprises.
At its peak, venture capital investment registered almost $29 billion in the first quarter of 2000. That number declined by a staggering 87 percent to $3.8 billion in the first quarter of 2003. The number of venture capital deals reported by the association plummeted from 2,201 in the second quarter of 2000 to 623 in the first quarter of 2003 – a drop of 72%.
The decline in venture capital investment means less entrepreneurship, less innovation, less job creation and less economic growth. That’s exactly what we have been seeing over the past three years.
What would help to get risk taking back on track? The success of the wars in Afghanistan and Iraq should eliminate some uncertainty. In 2001, the Federal Reserve started to reverse its misguided policies of higher interest rates.
What about taxes? In 2001, President Bush and Congress passed a tax cut. However, the pro-growth aspects of the tax plan – specifically reductions in personal income tax rates and killing the death tax -- were substantially muted because they were phased in over many years and were not permanent. The President has now proposed accelerating the income tax cuts to January 1, 2003. That would be a big plus for economic growth, as would making the entire 2001 tax cut permanent.
Also, President Bush wants to boost expensing levels for capital expenditures made by small businesses from $25,000 annually to $75,000, and indexing that level for inflation going forward. This too should help investment and the economy.
In order to provide a major boost to the incentives for risk taking, though, more needs to be done. Specifically, it’s time to eliminate taxes on capital gains.
Capital gains taxes are direct levies on risk taking. Currently, the top capital gains tax rate paid by individuals is 20%, while corporations face a rate of 35%. However, since capital gains are not adjusted for inflation, the real tax rate can climb much higher. Of course, the more you tax something, the less of it you get. Capital gains taxes restrain entrepreneurship, investment, innovation, job creation and economic growth.
It’s worth noting that the last capital gains tax cut occurred in 1997, when the top rate was reduced from 28% to 20%. It’s no mere coincidence that economic growth stepped up considerably.
Eliminating the capital gains tax today – on both individuals and corporations – would jump start risk taking and get the U.S. back on a robust path of economic growth.
