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| October 13, 2001, Saturday
The challenge for government policy is to temporarily stimulate the economy without jeopardizing the long-term budget outlook.
The Federal Reserve can control short-term interest rates, but long-term rates, which determine mortgage costs, depend largely on bond traders' expectations of the government's future borrowing needs. For the last year, long-term interest rates remained stubbornly high because of fears that this year's big tax cut package went too far and that budget deficits would reappear. A stimulus package that worsens the government's budget position after economic growth resumes will hurt because long-term rates will rise, choking off investment.
To maintain long-term budget discipline the stimulus package should be temporary. Further, a temporary sales tax cut or investment tax credit will deliver more bang for the buck than a permanent one because consumers and businesses will rush to take advantage of the tax incentives while they last.
President Bush is seeking to speed up tax cuts that he previously won largely for wealthy families. That was the wrong medicine before Sept. 11 -- and it is worse medicine now. Because low-income families have a higher propensity to spend additional income, even brief windfalls, aiming at low-income workers, would stimulate the economy more.
Traditionally, unemployment insurance is the first line of defense in a recession -- and for good reason because it expands only temporarily and aims at those most in need. Mr. Bush proposed extending benefits for an extra 13 weeks to people who lost their jobs after Sept. 11.
But the greater need is to expand eligibility, especially for workers who left welfare for work and are ineligible for support because they seek part-time work. And don't forget that people who lost a job before Sept. 11 are affected by the fallout from the attacks. They deserve government help as much as those who lost their jobs after the attacks.
Sacrifices during a recession are not evenly shared: they fall mainly on disadvantaged workers. This asymmetry makes it even more critical to shore up the safety net.
---- Alan B. Krueger
Sept. 11, in turn, greatly raised the danger of a deep and prolonged recession as consumers and business, plagued by unprecedented uncertainties, cut back on spending.
For these reasons, significant economic stimulus is necessary. But tax cuts -- any tax cuts -- are the wrong way to go. Worse than a mere policy mistake, they are irresponsible now that the attacks on the World Trade Center and the Pentagon have made it impossible to know the minimal financial needs of a nation whose options had already been sharply narrowed because of deep cuts in future federal revenues.
Moreover, tax cuts won't work. Reductions in taxes, especially for the wealthy, will mostly be saved rather than spent. Capital gains tax cuts should be viewed with particular skepticism. Claims that such a cut produced the stock market boom of the late 1990's are obviously misleading. We all know what caused the boom. A dramatic drop in the cost of computer power, exciting new opportunities like the Internet, and a more expansive Federal Reserve policy were the main factors.
What is needed now is $100 billion to $150 billion of additional federal spending. After rebuilding New York City and buttressing the nation's security, expanded and more generous unemployment insurance should be the first priority. The newly unemployed are on the front line of suffering, especially when corporations are so quick to fire these days. These Americans will also spend the money quickly. The second priority should be additional revenue sharing with state and local governments, which are now reducing their social programs for lack of money.
If we are to entertain ideas about contributing to the long-term health of the American economy, public investment rather than more permanent tax cuts for business and the wealthy should have the priority. The nation has crying needs -- for school buildings, quality child care, greater computer access, and more -- that have been neglected for too long.
Tax cuts are designed not to stimulate the economy, but to reduce government in the long run. That's the wrong policy at a time when the need for government has never been made more clear.
The worst approach is a combination of dithering and one-shot stimulus attempts. The dithering fosters uncertainty, and one-shot rebates won't work. Both historical evidence and economic theory suggest people make their spending decisions based on long-term earnings expectations and save unexpected windfalls. In today's anxious environment, saving is all the more likely.
One way to remove uncertainty is to accelerate the Bush tax cuts, possibly reducing their total size. No one can trust a 10-year tax bill. A stretched-out schedule of tax cuts invites continuous tinkering. A bill with cuts focused over two or three years would be more trustworthy.
To stimulate employment and spending, especially by low-income Americans, the best policy would be a permanent cut in the payroll tax rate, not a quickie rebate. A payroll tax cut would make hiring less expensive and raise long-term take-home pay for all wage earners.
The retreat to the present cannot be addressed only through fiscal policy. Regulations create just as great a burden and just as much uncertainty. Congress may have handed the airlines $15 billion, but new security policies of dubious value will cost far more by deterring travel through frustrations and delays.
Meanwhile, the antitrust suit against Microsoft continues to roil the technology industry, and telecommunications regulations hamper the rollout of broadband capacity. The Consumer Product Safety Commission is about to decree that every bottle of sunscreen and baby oil must be redesigned. Complying with new mandates means not planning for productive investment.
The boldest move Congress could make would be to end the Postal Service's monopoly. On Sept. 11, it requested a 9 percent rate increase -- an extraordinary rise in the midst of a recession -- that acts as a new tax on every business and individual who must use the mail. Only a monopoly could get away with such an increase. Allowing competition would provide relief, and it would spur a new wave of innovation.
After Sept. 11 both consumer and business spending came to an abrupt halt. Though this halt is likely to be temporary, there are fears that reduced spending will lead to more layoffs, which reduce income, causing further reductions in spending.
The priority should be to prevent this downward spiral into a deep recession from gaining momentum.
Monetary policy can be adjusted more rapidly than fiscal policy, but it has its limits. Short-term interest rates are now about as low as they can go. Further attempts to cut rates by pumping money into the economy risk unnecessary future inflation.
This leaves us with fiscal policy. There are two basic tools: cut taxes so as to increase spending by consumers and companies, and increase government expenditures. Though there are certainly worthwhile government projects to pursue, the debate about which to pay for will be lengthy and contentious. And even after such decisions, it takes many months for government spending to work its way through the system.
Consequently, the best fiscal policies now are an investment tax credit and a personal tax rebate. Both the credit and the rebate should be temporary.
A temporary investment tax credit gives businesses a strong incentive to invest now, rather than wait until later. It would make sense to base the personal tax rebate on last year's Social Security payroll tax since it would then reach low-income workers who didn't quality for the earlier income tax rebates. Tax rebates to low-income families and unemployment payments to laid-off workers will be spent quickly, not saved, helping to short-circuit the recessionary spiral.
Permanent tax cuts, cuts in capital gains taxes, reductions in the corporate income tax, direct industry subsidies, and pork barrel public spending are bad ideas. They are economically dubious, indirect, prone to abuse, and slow acting. Our focus should be on policies that are temporary, direct, simple, and can be carried out quickly.