A number of pro-growth tax initiatives have been proposed and signed into law by President Bush since 2001. The initiatives enacted include provisions aimed at reducing the double taxation of corporate profits by lowering the tax rate on dividends and capital gains; temporary bonus depreciation; expansion of deductibility of higher education costs; and several smaller provisions aimed at encouraging investment. Taken together, these reforms reduced the effect of taxes on investment decisions.

   Reducing the Double Tax on Corporate Profits.

   The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), proposed and signed by President Bush, reduced the double tax on corporate profits by lowering the top individual tax rate on dividends and capital gains to 15 percent through 2008. These changes promoted economic growth by increasing capital in the corporate sector and improving the allocation of capital throughout the economy. In the 9 quarters preceding JGTRRA, real private nonresidential investment fell at an average annual rate of about 7.5 percent and annual real GDP growth averaged 1.1 percent. In the 13 quarters after JGTRRA was enacted, real private nonresidential investment grew at an average annual rate of about 6.9 percent, with annual real GDP growth averaging 3.6 percent. While it is too early to estimate the full effect of pro-growth tax policy on GDP, recent estimates suggest that without the tax cuts the economy would have had as many as 3 million fewer jobs and real GDP would have been as much as 3.5 to 4 percent lower by the end of 2004.

   Several studies indicate that prior to JGTRRA, corporations had been steadily reducing dividend payments. The reason is that the tax system resulted in a strong tax bias in favor of retained earnings and capital gains. Since passage of JGTRRA, there has been an increase both in the average amount of corporate dividend payments and in the percent of firms paying dividends. Reducing the double tax on corporate profits also slightly reduced tax-motivated incentives for debt finance because it reduced the effective marginal tax rate on equity finance. As seen in Chart 3-2, the effective marginal tax rate on equity-financed corporate investment is now about 40 percent, a drop of about 12 percent from the pre-2001 effective tax rate. While this rate is still substantially higher than the effective tax rate on debt-financed corporate investment, the relative reduction reduced the distortion between debt and equity finance.

   A major challenge facing this pro-growth change is the impermanence of the capital gains and dividend tax reductions. Originally scheduled to expire at the end of 2008, both provisions were recently extended until the end of 2010 in the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). For these changes to have lasting effects on investment and economic growth, these pro-growth policies should be made permanent.