- The Washington Times - Thursday, May 8, 2003


   As the various factions in Washington maneuver to fashion this year’s tax-relief bill, it’s worth taking a moment to compare today’s economic circumstances with those prevailing when Congress passed President Bush’s 10-year, $1.35 trillion tax cut on May 26, 2001. At that time, there were great fears about the bill’s impact on the deficit if the various tax cuts in the legislation were allowed to take effect immediately. So, most of the tax cuts were scheduled to be incrementally implemented during the 10-year period, including the income-tax-rate cuts, the child tax credit and the repeal of the marriage penalty.
   The result was that the short-term stimulus in the bill was significantly watered down. In hindsight, that was clearly a mistake. Hindsight also reveals that the economic conditions at the time Congress passed the bill — at least as contemporaneous economic data described those conditions — were far more encouraging, relatively speaking, than they were later proved to be. The upshot is this: Congress, knowing then what it now knows about the real condition of the economy in May 2001, would almost certainly have provided much more fiscal stimulus, especially over the short term. That is why accelerating the implementation of many of the tax cuts passed in May 2001 makes so much sense today.
   Consider what Congress knew in May 2001 and what it knows now.
    On April 27, 2001, the Commerce Department released its advance estimate of the growth rate of gross domestic product (GDP) during 2001’s first quarter. That report indicated the economy was expanding at an annual rate of 2 percent. It represented a significant slowdown from the 5 percent growth rate reported for all of 2000, a trend the Bush administration had earlier noted. However, subsequent revisions of GDP data revealed that the economy was in much worse shape at the time. In fact, as later data confirmed, GDP actually declined during 2001’s first quarter, and it declined during the two subsequent quarters as well. Indeed, as the National Bureau of Economic Research later determined, the economy had actually entered a recession during March 2001.
    Commerce also reported on April 27, 2001, that nonresidential fixed investment (i.e., business investment), measured at its annual rate, reached its all-time peak level of $1.44 trillion. However, GDP revisions later revealed that business investment actually began declining during 2000. Recently, Commerce reported that business investment resumed its decline during 2003’s first quarter, after having marginally expanded during the fourth quarter following eight successive quarters of falling investment.
    On the labor-market front, the data, as of May 26, 2001, reflected an unemployment rate of 4.5 percent for the previous month. To be sure, that rate was higher than its cyclical low of 3.9 percent, which prevailed six months earlier. But it was still extremely low by historical standards. Moreover, the average unemployment rate for men and women 20 years and older remained below 4 percent. In addition, nonagricultural employment of 132 million, having marginally declined from its February level, was still comfortably above the 2000 monthly average of 131.4 million. What was not known then was that the labor market was about to deteriorate in a big way.
   We now know that nonfarm employment peaked during the first quarter of 2001, before beginning a steep, precipitous decline that continues two years later. Today, nonfarm payrolls reflect 2.3 million fewer workers. Meanwhile, the unemployment rate has increased to 6 percent, fully one-third higher than the April 2001 rate of 4.5 percent. The unemployment rolls have increased by 2.4 million to 8.8 million, including an increase last month of 341,000, according to the Labor Department’s household survey. The average duration of unemployment has increased from 12.6 weeks in April 2001 to 19.6 weeks last month. During the same two-year period, the percentage of the unemployed who have been jobless for 27 weeks or longer has doubled from 11.5 percent to 21.8 percent.
    When Congress passed tax relief on May 26, 2001, the Dow Jones industrial average stood at 11005, about 2400 points and nearly 30 percent above its current level. The Standard & Poor’s 500-stock index was at 1278 on May 26, 2001, more than 35 percent higher than today. And the Nasdaq composite was above 2250 on May 26, 2001, nearly 750 points (and almost 50 percent) above today’s level.
   We now know that the economy was considerably weaker in May 2001 than it was believed to be at that time. In retrospect, it was clearly in need of more tax-relief stimulus than Congress implemented at the time. It should be no surprise that the rapidly deteriorating economy, manifestly illustrated by plunging payrolls, was generating significantly less revenues than projected. In addition, as the stock-market bubble further deflated after May 2001, stock-related tax revenues tanked. These factors caused the budget surplus to evaporate and subsequent deficits to rise.
   The second half of the 1990s demonstrated that a rapidly expanding economy will generate tax-revenue streams that consistently exceed projections and obliterate deficits in the process. Recent experience reveals that a weak economy will consistently fail to meet tax-revenue projections and exacerbate the budget deficit. In other words, the deficit problem cannot be solved without an acceleration of growth.
   As Washington maneuvers through the tax-relief process, the various players must learn from the mistakes of May 2001. While exquisitely timed in terms of the business cycle, the level of tax relief implemented then proved, in retrospect, to be too little and too late. Given what we now know about the path the economy has taken since May 2001, there really is no excuse not to get it right this time around.
   


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