From the January 13, 2008 Sunday Times
January 15, 2008
by Irwin Stelzer
"What is to be done?" asked Lenin in 1902. He couldn't have been thinking of capitalism's problems circa 2008, but he was asking a question that is on the lips of America's policymakers as the U.S. economy slows. Indeed, more than slows if economists at Goldman Sachs, Morgan Stanley, and Merrill Lynch are to be believed. Economists at those august institutions agree that the United States is tipping into recession. Indeed, like 60 percent of Americans, Merrill Lynch's economy-watchers believe a recession has already started.
The answers to Lenin's question, like sorrows, come not single spies, but in battalions. Wall Street wants the Federal Reserve's monetary policy committee to cut interest rates, now and not by a measly quarter point. Last week, Chairman Ben Bernanke signaled a change in position: he is now prepared to give the baying investment bankers what they want. Food and energy prices (corn up 122 percent and energy 77 percent last year) might be driving the inflation rate a bit above the Fed's comfort zone, but that is nowhere near as terrifying as the prospect of a major, protracted recession. At least, from Bernanke's point of view: others warn that it was just such a reaction to past downturns that created the too-easy-credit that led to the problem we now face in financial markets
That prospect now looms larger than even a few months ago. The unemployment rate has jumped to 5 percent and new jobless claims are rising, the manufacturing sector is slowing, forecasts of auto sales are being revised downward, house sales are down and foreclosure and delinquency rates are up, banks are being forced to write-off more billions in bad loans than even pessimists had anticipated and to cut back on lending, and profits are falling (Thomson Financial, which in October predicted profits would rise in the last quarter of 2007 by 11.5 percent, now guesses that the final tally will show a drop of 10.7 percent). If that isn't enough to rattle the powers-that-be, Moody's added the prospect of a loss of America's triple-A credit rating, granted to U.S. debt ever since it was assessed in 1917, if the nation's politicians didn't soon fix the health care and pension systems.
Bernanke promised congress and the markets that he would do his part to stave off a recession. But easier monetary policy alone can't stave off recession, not according to two famous economists, one from each side of the political aisle. They are calling for the president and congress to deploy another weapon: fiscal policy. Larry Summers, who served as treasury secretary in the Clinton administration, favors a $50 billion-$75 billion stimulus lest a recession and its "adverse impacts . . . be felt for the rest of the decade and beyond." Marty Feldstein, the Harvard professor who served as chairman of Ronald Reagan's Council of Economic Advisers, agrees with that concept. "What's really needed is a fiscal stimulus, enacted now and triggered to take effect if ... [there is] a three-month decline in payroll employment."
The president will undoubtedly propose a stimulus package in his State of the Union message. The last time Bush faced a sluggish economy, he did what Republicans love best: he cut taxes. In May of 2001 he announced plans to phase in over five years a reduction in the highest marginal income tax rate from 39.6 percent to 33 percent, reduced taxes on the lowest earners from 15 percent to 10 percent, increased the child tax credit from $500 to $1,000, and mailed checks of $300 to every single taxpayer, and $600 to couples. This was followed one year later by an increase in depreciation allowances, and in 2003 by accelerating the phase-in of marginal-rate reductions and a cut in taxes on capital gains and dividend.
In that history lies a clue to future actions. It is generally agreed that the 2002 increase in depreciation rates had very little stimulative effect on the economy. But the cut in marginal rates and taxes on dividends and capital gains in May of 2003 had the desired effect: every economic indicator headed up in July.
But for some observers that was then and this is now. Alice Rivlin, who served as Clinton's budget director says, "It is not clear that we need the stimulus yet," a position supported by the Institute of International Finance's prediction that the United States will avoid a recession, and even by those forecasting a recession: some expect it to be short and mild enough to allow the economy to grow over the entire current year. Others note that the decline in tax receipts incident to the current slow-down will naturally increase the budget deficit, providing an automatic stimulus that makes further action unnecessary. And still others, mostly in the business community, worry that raising the issue of taxes in a Democratic congress and an election year will unleash a torrent of unwanted changes in the tax law having nothing to do with stimulating the economy.
If a package is to be put in place, it is likely that the President again will call for immediate rebates to taxpayers, to which the Democrats will want to add checks for low-income, non-taxpayers, and increases in unemployment compensation and food stamp allowances. Congress will also try to tilt the benefits of any reductions towards low earners, whom they deem more likely to spend these windfalls than richer folks. "You want to direct the tax cuts to people who are spending everything that's coming in," says Douglas Elmendorf, a Brookings Institution economist who once worked for the Clinton administration and who is not yet persuaded that a stimulus is needed.
The president can be expected to use the excuse of a stimulus to try for a permanent cut in personal and corporate income taxes, neither of which he is likely to get. But he might manage to wring a temporary increase in depreciation allowances from a reluctant Congress if he gives ground on the tilting of personal tax rebates away from what one Democrat calls "those hedge fund managers."
Serious analysts, such as Larry Lindsey and Marc Sumerlin, who fashioned the original Bush tax cuts and have just published the intriguingly titled, "What a President Should Know But Most Learn Too Late," are hoping that the need for a short-term stimulus does not result in Bush and the congress losing sight of the need for a tax regime that positions America to meet the long-term challenges it faces in an increasingly competitive globalized economy.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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