- The Washington Times - Tuesday, January 7, 2003

Stocks rocketed yesterday amid hopes for an economic revival spurred by President Bush's plan to provide tax cuts for American families averaging more than $1,000 and to eliminate the tax on dividends.
The $600 billion in tax cuts over 10 years are aimed at improving the economy's sluggish growth rate by putting money in people's pockets while easing the burden on consumer spending and business investment caused by the depressed stock market.
Jubilation over the potential dividend tax break, which would increase the after-tax return of stocks by as much as 74 percent, in particular boosted the Dow Jones Industrial Average by 172 points, or 2 percent, to 8,774. The Nasdaq Composite Index rose 2.5 percent to 1,421.
"President Bush is making it clear that he is going to do everything in his power to avoid the mistake that his father made with regards to the economy," said Edward Yardeni, chief investment strategist with Prudential Securities.
"He is going to gun it, step on the accelerator, and provide as much stimulus as he can," he said, noting that about half of Mr. Bush's package would go toward ending the taxes that shareholders pay on dividends.
"The tilt toward the investor class is extremely important and probably the first time you have ever seen our administration propose a tax plan so focused on the stock market."
Many economists question whether the dividend tax cut would provide much immediate stimulus to the economy, but Mr. Yardeni noted that it is improving business on Wall Street, where stocks have been down for three straight years.
"What is good for Prudential is good for the country, of course," he joked.
Economists say the dividend tax cut should spur the economy eventually, but its effect in the short run is not clear. During the late 1990s, the rapid accumulation of stock market wealth added as much as one percentage point to economic growth each year by spawning increased consumer spending.
Since 2000, the down market's dampening effect on consumers has been substantial, partly accounting for the economy's recent diminished growth rates. But no one knows how much the proposal will lift stocks in the long term and, therefore, how much it would relieve the so-called "negative wealth effect" from the market in recent years.
"It is a plus for the long-term health of the stock market. Whether it boosts growth in the short run, that's very iffy. But even if it jump-starts growth a year later, that is good enough," said Rajeev Dhawan, an economics forecaster at Georgia State University.
"The reform is needed to bring back the confidence of the small investor in the market, which is totally shattered at this moment," he said, adding that senior citizens living off investment income would especially benefit from the proposal.
Dividends, because they are paid out in cash, unlike earnings, cannot be fabricated by engineering a company's books. The tax proposal, thus, should cause a sweeping redirection of the market toward more reliable sources of profit and growth, he said.
"Dividends are the most clear indicator of the financial health of a firm. WorldCom and Enron were able to fudge their books. But this is an observable guarantee to a small investor. He can say, 'I've got the dividends, so things should be OK,'" he said.
The most powerful boost to the economy would come not from Mr. Bush's dividend proposal but from accelerated income-tax cuts and rebates that the White House said yesterday would average more than $1,000 per taxpayer this year, Mr. Dhawan said.
"Putting the money into one lump sum makes a big difference," he said.
The tax cut for 2003 would average $1,083 for each of 92 million U.S. income tax filers, $1,716 for each of 46 million married couples, and $1,473 for each of 34 million families with children, the White House said.
A plan offered by House Democratic leaders yesterday, by contrast, would provide American households with one-time rebates of $300, though those rebates would go to a greater number of low- and middle-income households compared with the Bush plan.
Mr. Dhawan said that the Democratic plan probably would not do as much to pump up the economy since consumers tend to put aside and save one-time rebates rather than spend them.
The rival stimulus plan is more modest, totaling $100 billion over 10 years, with the goal of preventing the federal budget deficit from soaring. But Mr. Dhawan said that unless the plan permanently increases growth, it will not do much to stem the hemorrhaging of tax revenue that has ballooned the deficit.
That plan provides more funds for unemployment benefits and one-time aid to the states than the Bush plan. Economists said such aid would help counteract the contractionary effects of lingering joblessness from the recession and planned state budget cuts and tax increases.
The Democratic plan provides a one-time doubling of the tax write-off for equipment purchases by small businesses and other business investment tax breaks, but contains no cut in dividend taxes.
Nariman Behravesh, economist with Global Insight, estimated that eliminating the dividend tax and accelerating some of Mr. Bush's 2001 tax cuts would add about 0.3 percentage points to economic growth in 2003 and 2004.
"The fiscal stimulus does not come without a cost," he said. "The higher federal deficit, along with the stronger demand for funds that comes with better growth, results in higher interest rates. Housing is hurt, but the loss there is more than offset by increased spending on other goods and services."
Sung Won Sohn, chief economist with Wells Fargo & Co., said that the president's proposal would boost the after-tax return on stocks from 6.8 percent to 11.8 percent and improve the tax code by ending the favorable treatment of debt that has encouraged corporations to become overleveraged.
However, "A dividend tax change is not the best tool to stimulate the economy in the short run," he said, adding, "Joe Sixpack does not have much in the way of dividends. The tax change won't affect the personal spending habits of billionaire Warren Buffett, either."

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