The U.S. economy will eventually rebound from its current recessed doldrums, but that resurgence will have little, if anything, to do with the economic stimulus package that is working its way through Congress.
The news last week that the economy contracted in the third quarter at a 0.4 percent annualized rate was anything but heartening. Consumer confidence is down, layoffs are coming in droves and business investment is slim. In this environment, a government effort to spur the economy is welcomed. The plan being tossed about, however, is flawed to no small degree.
The impetus from the beginning has been toward tax cuts, mostly for businesses, and away from spending programs. The business tax breaks include a retroactive rescinding of the Alternative Minimum Tax and long-term corporate tax reductions. For individuals, there is an acceleration of last May's tax cut and slashes in the capital gains tax, aimed primarily at wealthy Americans, mixed in with temporary cuts to benefit low-wage workers.
Why such a disdain for spending programs? The Economist offered evidence that spending is the way to go Oct. 27:
\The economic impact of a stimulus depends upon the mix of tax cuts and spending increases. Even the best-designed policy cannot prevent a recession, but it can ensure the biggest boost to demand at the least cost. A first rule is that government spending gives a bigger boost to the economy than income-tax cuts, part of which will be saved. The Federal Reserve estimates that a $1 increase in government spending on goods and services boosts gross domestic product after one year by three times as much as a $1 income-taxcut. The difficulty is finding enough sensible public projects on which to spend money quickly.""
The tax cuts are supply-side solutions. Unfortunately, the economic slide is more a problem of demand.
According to the Economic Policy Institute, consumer spending, which accounts for about two-thirds of GDP, dropped from 2.5 percent in the second quarter to 1.2 percent in the third quarter. Despite offerings of cut-rate car loans by many companies, growth in auto sales dropped from 7 percent to 1.7 percent. Business investment fell 11.9 percent. Faced with a deteriorating economic situation, private individuals increased their savings rate from 1.1 percent to 3.8 percent.
In other words, for the economy to rebound, people need a reason to be less frugal. The proposed stimuli, however, are more likely to promote savings than spending.
The Economist continues: ""A second rule is that tax cuts aimed at low-earners are more likely to be spent than handouts to the rich, who tend to save more. Income-tax cuts are more likely to be spent if they are permanent; temporary cuts tend to be saved.""
The economic stimulus package operates on the assumption that lower capital costs will spur investment, creating jobs and an economic revival.
Christian Weller of EPI, however, writes in an Oct. 4 policy memorandum that ""beginning with the work of noted economist Dale Jorgenson in the 1960s, economists have consistently found that the cost of capital plays a small role in determining investment'the much bigger player is sales growth. Without the prospects for increased growth of sales domestically and abroad, businesses have no reason to undertake risky investment, regardless of the cost of doing business.""
The Economists' final ""rule"" follows this line of reasoning. ""The rule for corporate taxes is the opposite. Permanent tax cuts are unlikely to boost investment, which is influenced more by profits, excess capacity and confidence. On the other hand, a temporary tax break for investment could well work, encouraging firms to bring forward capital spending.""
In an Op-Ed that ran in the Oct. 27 Boston Globe, Henry J. Aaron, a senior fellow in Economic Studies at the Brookings Institute, wrote that ""fiscal policy tax cuts and spending increases can boost spending, but they can do so only if personal tax cuts are aimed at people who spend most of what they receive and if business tax cuts are linked to investments put in place in the next 12 to 18 months.""
The tax cut, Aaron states, ""would provide business tax cuts that would encourage investment mostly after the current recession has ended. It would bestow windfalls on owners of capital.""
Rather than boosting investment and increasing consumer spending, the economic ""stimulus"" package threatens to increase rates of savings and line the pockets of people who need financial assistance least.
The EPI's Weller states, ""Corporate tax cuts and reductions in capital gains taxes will likely improve the bottom line for companies and boost the wealth of stock holders, but they will do little to stimulate the economy. ... Both tax cuts are likely to increase corporate and private savings, which means less spending'exactly the opposite of what the economy needs right now.""
