- The Washington Times - Tuesday, January 7, 2003

How do you make an exhausted horse run? Feed it carrots and whip it? How do you make a broken car race? Pour in gasoline and floor the accelerator?

A confident-looking U.S. President George W. Bush announced his "growth and jobs" economic stimulus package in a speech to the Economics Club of Chicago on Tuesday. Bush emphasized the need to cut taxes in order to drive the U.S. economy toward recovery.

"The need for this plan is urgent," Bush said, "and I urge the Congress to act swiftly and pass the bill."

Most of the details of the package had already been revealed in the last several days by the administration. The opposition Democratic Party has already made criticisms and come up with proposals of its own. Their proposals, Democrats say, favor the rich less and ordinary Americans, growth and employment more.

The makeup of an economic stimulus package will always give the politicians plenty to argue about. But the problem now with economic stimulus is not really its makeup but whether the carrots and the whip are timely and useful at all.

Nobody — neither the administration, nor its opponents, nor academic economists, nor Wall Street, nor Federal Reserve Chairman Alan Greenspan — seems to want to remember that the U.S. economy is a horse that galloped in the 1990s, or, to take our other image, an engine that ran for a decade at full speed. Yet that is the reason why the economy is weak now, even when Greenspan is whipping it on with 40-year low interest rates, and Bush is pouring the gasoline of tax cuts into it. The economy is just not ready to run.

It is not that Tuesday's carrots and gasoline are not good things. Some of Bush's proposals make sense by themselves, though they may not make the best sense now.

The central proposals in Bush's package are the elimination of effective double taxation of company dividends and acceleration of the tax cuts previously proposed by Bush and passed by the Congress.

At present, U.S. corporations pay taxes on their profits and investors pay taxes on the dividends that corporations pay to them out of profits. This double taxation of dividends does not make sense. The administration proposes to remove the taxation of dividends and estimates that this change will have a cost of $364 billion over 10 years. This, then, is the biggest proposal in a package to which the administration ascribes a total fiscal cost (in forgone tax revenues) over 10 years of $674 billion.

Is cutting dividend tax the best way to stimulate growth? Bush defended the proposal Tuesday by arguing that half of the dividends paid by U.S. corporations go to senior citizens. But the senior citizens who receive dividends, Bush's critics will point out, are not among America's poor.

Professor Christopher Carroll, who teaches economics at Johns Hopkins University, told United Press International that "proposing a dividend tax cut as the centerpiece of a 'stimulus' plan is like telling someone who is having a heart attack to drink herbal tea: It might or might not be a good idea in the long run, but it does nothing to address the immediate problem."

The second major proposal moves forward previously promised tax cuts. Tax cuts and an increase in the child tax credit, due to be enacted in 2004 and 2006, would be brought forward to this year. As a result, marginal tax rates would come down, with the 27 percent tax bracket reduced to 25 percent, the 30 percent bracket to 28 percent, the 35 percent bracket to 33 percent and the top 38.6 percent bracket to 35 percent. In addition, in a progressive measure, millions of taxpayers would be moved to the lowest rate of tax of 10 percent this year rather than in 2008. This change benefits the lowly paid.

Americans are likely to welcome these tax cuts, which increase disposable income. The administration estimated in a release that a typical family of four with two wage earners earning a combined income of $39,000 would pay $1,100 less in tax this year as a result of the package. Bush put the average level of tax relief for 92 million taxpayers at a similar level: $1,083 in 2003.

A further important and no doubt popular measure is the retroactive reinstatement of unemployment benefits that expired Dec. 28. The expiration of these benefits had left almost 800,000 workers without benefits.

All of these measures must give some stimulus to economic growth. The Council of Economic Advisers to the president estimated the package would create an additional 2.1 million jobs over the next 3 years.

What, then, is wrong with stimulating a weak economy in this way? Does it hurt to whip on the horse or pour gas into the slowing engine?

The answer depends on what is wrong with the horse and the engine.

U.S. economic growth has been weak since the final quarter of 2000 but not because of a lack of consumer spending. Automobile sales and retail sales have been robust until recent months. And the current account balance — the broadest measure of trade — shows a record deficit. This is normally a sign not of inadequate consumption but of excessive consumption.

What needs to be recognized and is not recognized is that the U.S. stock market boom of the second half of the 1990s triggered a boom in consumption that has not really ended, though it shows some signs of coming to an end. The U.S. economy is unbalanced, with investment spending having fallen steadily and deeply for two years while consumption has been firm — and house prices have rocketed. Is that combination a healthy and balanced one?

By cutting interest rates so drastically, Greenspan has tended to offset the natural corrective slowdown in the economy — and has triggered a house price boom that is itself dangerous. By slashing taxes and pouring money into the economy Bush, too, is tending to prevent that needed, albeit unpleasant, slowdown — and is pushing up the fiscal deficit.

Nobody in the U.S. policy debate, in the government or outside it, wants to acknowledge an uncomfortable truth of the dismal science of economics: that there is a limit to growth; that having galloped for some years, on the false energy of stock market inflation, a slowdown is not just inevitable but necessary.

The stimulative policies of Bush and Greenspan are acting as palliatives, averting a deeper slowdown, but may eventually prove counter-productive. As, through a combination of tax cuts and war, Bush drives up the fiscal deficit, the U.S. Treasury's issuance of bonds is going to have to increase. If long interest rates are driven up, then mortgage rates will rise and house prices will fall, leaving many Americans with mortgages of higher value than their homes. That is dangerous: a recipe for slump. It is a danger that could be avoided entirely if U.S. economic policy-making were not so pro-active.

The excessive stock prices that stimulated the boom in U.S. economic growth in the late 1990s are now the source of its bust. Trying to counter that bust, Greenspan is fostering a new asset price boom, in house prices.

Neither Greenspan nor Bush is leaving himself room to adjust policy in years to come. The carrots will all have been fed to the weary horse, the whip will have whipped to little avail, the fiscal gasoline will have been poured into a sputtering engine.

Patience is the treatment the U.S. economy needs, a recognition of its limits, of its need for a slowdown, of higher savings and a smaller trade deficit. After the slowdown has rebalanced the economy, it will be ready to run again.

But that is a policy line neither Bush, nor the Democrats, nor Greenspan, nor Wall Street, nor probably Americans as a whole would welcome.

Bush, a popular and active president, a man who said Tuesday that "there are warning signs I won't ignore," is seeking to avoid the accusation leveled at his father, President George H.W. Bush, that he did not do enough to counter slow growth, and is giving Americans what they want.

Whether they will thank him in years to come is another question.

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