Fears of a "double dip" recession are overblown, but the market's got a long way to go before it returns to pre-Sept. 11 levels, and we'll be lucky if growth climbs above 2% or 3% by year's end. It didn't have to be this way.

In a closed-door session of the House Ways and Means Committee last October, three Democrats and three Republicans testified on appropriate fiscal policy responses to Sept. 11. All three Republicans--Allen Sinai, Kevin Hassett, and I--argued strongly in favor of tax cuts, preferably permanent tax reductions targeted to stimulate fixed capital investment.

We argued that temporary tax cuts, in contrast, would have little effect in stimulating investment, that the risk of low fixed capital investment producing a sustained economic decline was real, and that concerns over deficit-driven increases in interest rates were contradicted both by theory and fact. John Makin, an economist at the American Enterprise Institute, made similar arguments in simultaneous Senate hearings.

But the Democrats who spoke to the House Ways and Means Committee had a very different point of view. They argued for a wait-and-see approach, viewed the risk of severe recession as remote, and saw the risk from expanded deficits (that is, of high interest rates) as too high a price to pay for effective fiscal stimulus. Since then the Democrats, and their economic "experts," most notably Senator Jon Corzine and Citigroup Vice Chairman Robert Rubin, have consistently opposed fiscal stimulus. Yet the basis for that opposition has never been supportable by facts, as the recent decline in interest rates attests. Indeed, on Aug. 13, the 10-year U.S. Treasury note's yield reached a 40-year low of 4.08%.

Given the reasonable expectation that the Fed will maintain low (say, 2.5%) inflation on average over the next 10 years, the current long-term yields imply an extremely low real long-term interest rate (the nominal yield less expected inflation over the next 10 years) of roughly 1.5%.

Perhaps the most noteworthy fact here is that the only argument against tax cuts last fall, made by Messrs. Corzine and Rubin, has been refuted again by the data. They and others argued that increased deficits would crowd out private debt, drive up interest rates and thereby harm the economy, despite the pervasive economic research showing no link between moderate increases in deficits (i.e., increases that don't force future money growth) and increases in interest rates. In fact, despite the surging deficits and deficit forecasts of the past year, long-term rates have fallen by nearly a full point since Messrs. Corzine and Rubin warned of the threat of rising, deficit-driven interest rates last October.

The fact is, long-term interest rate changes have virtually nothing to do with fluctuations in deficits; they are driven by three main forces: expected inflation, inflation risk, and the private supply and demand for investment funds (which depends on private incentives for saving and investment).

Remarkably, many Democratic leaders are still opposing tax cuts on the grounds that deficits will drive up interest rates. Some cynical politicians, no doubt, are simply using that argument as an excuse to oppose tax cuts, in order to leave room for ambitious proposed increases in government expenditures, despite the fact that economic research consistently finds that government expenditures exert a negative influence on economic growth. Others simply may have deferred to the expertise of Messrs. Corzine and Rubin. In any event, it is high time for someone of stature in the Democratic party to declare that these Wall Street emperors have no clothes, and for cynical Democratic politicians to put the health of the economy above partisan strategizing. Congress should surprise us all by proposing a bipartisan fiscal package to spur economic growth.

Is the needed fiscal stimulus politically impossible? Perhaps, but it is worth a try. A promising approach--from both political and economic perspectives--would be to combine incentives for new capital investment with incentives for job creation. At this crucial juncture, to avoid a double dip, it is important to maintain both capital investment and consumer confidence. Substantial reductions in corporate profit tax rates (lasting at least five years) and permanent increases in equipment depreciation rates would go a long way toward stimulating increased investment, and would deliver a very large effect on equipment investment and economic growth per dollar of government tax receipts forgone. Short-term investment tax breaks, in contrast, have little effect on decisions to undertake long-term investments, and often waste resources by benefiting investments that were already in the pipeline.

To further stimulate immediate job creation, which is crucial for consumer confidence, the government could declare a temporary (say, six-month) payroll-tax holiday beginning two months in the future (to maximize its effect on corporate hiring plans). In contrast to the meager effect of a temporary corporate profits tax cut, a temporary reduction in the payroll tax would discourage layoffs by making it substantially cheaper to employ workers now rather than wait to hire them six months from now.

The payroll tax holiday would have a "static score" revenue loss of roughly $350 billion, and a corporate tax rate cut from 35% to 25% over five years would have a similar static score. These tax cuts would have no effect on interest rates, even if they actually produced $700 billion in new government debt lasting five years. In fact, more than half of that amount would be recaptured by increased tax revenues resulting from the tax cut. As Kevin Hassett and I explain in a recent study published in the National Tax Journal, an expansion in deficits also helps to keep growth-reducing government expenditure in check, which translates into lower debt. Even deficit worry warts have little to fear from this proposal.

The reaction of the stock market to an announcement of such a package no doubt would be an immediate, substantial increase in prices. That itself would go a long way to encourage investment (by reducing the cost of financing investment), and restore flagging consumer confidence.