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Today's Commentary: 11.30.06
Worth the Risk?
How Undoing the Bush Tax Cuts could affect the Economy
Should we worry about the current conversation concerning taxes the new congressional majority is having? They don't seem to have many options available to them as they inherit an economy that is doing well by some standards and worse by others. The question facing the new Democratic leadership is clear: Is the economic risk worth undoing the Bush tax cuts?
The Bush tax cuts as a stand alone idea were not such a bad idea and you can see how the fundamental principle of giving Americans more money to spend would appeal to the public at large. Unfortunately, the dark side of those cuts manifested itself with increased borrowing on the federal level.
Those tax cuts without any accompanying fiscal austerity brought the problem front and center for the Democrats. Raising taxes now when most Americans are feeling their own economic slowdown might seem counterintuitive.
So, what effect will it have on the economy? As many of you know, I am an economic doubter. I am not seeing the economic strength so often touted by the administration as proof that current fiscal policy is working.
Instead, I see an alarming dependence on historically low rates to continue to borrow without any significant increase in savings. Sure, you may say, spending keeps the economy moving along and if that entails forking over $1.22 for every dollar we earn; so be it.
Granted, there is more to the economy than just spending. Most will point to low unemployment rate as a good sign that the economy is moving in the right direction. Perhaps, but it is debatable whether those jobs areas good as they say or are the direct result of any tax cuts.
Inflation is under control you might add as further proof the economy is doing well. Fed chairman Ben Bernanke¹s comments on Tuesday to the National Italian American Foundation in New York might suggest otherwise. His intimations that the slow down in the economy may be the result of "a failure of inflation to moderate as expected" left open possibility of yet another rate hike. He also seems convinced that his policies would bring the desired effect of both stimulating growth and curbing rampant fuel and food prices. A dramatic drop in durable goods orders in October added to the confusion.
While his speech on Tuesday could have found the Fed chief suggesting that the administration restrict spending to avoid any increase in taxes, which is the only alternative left to the incoming senators and representatives, any mention of pay-go was conspicuously absent. You¹ll recall, his predecessor suggested just such a policy of tax cuts linked to spending cuts before he left his post.
No. Tax increases are just about the only thing left. But are they worth the risk of bringing the economy to a screeching halt as some economists predict? Bernanke could raise interest rates to modify any tax increases. Interest rates can take up to six months to work their way through the system but tax hikes for the upper income bracket would be felt immediately.
Many of the tax cuts were aimed at increasing business activity, which would lead to stronger growth. The tax breaks for capital gains only made old investments worth cashing in but did little to spur new ones. Income credits in the guise of tax cuts offered no real incentives.
Additional proof of the disparity of those cuts surfaced when a released by the IRS showed just how few people benefited. Those cuts deprived the government of $140 billion in revenues. Perhaps a better metric of just how divided American incomes are as a result of the cuts is illustrated in who kept the most after earnings.
The portion of the American populace that kept 95 cents on each dollar reported in 2004,the latest year for available statistics, as compared to 1979 increased to 60%. The income gains increased slightly for the remaining population during the same period. That is, until you reach the upper tier wage earners. Their income increased over 53%. More telling: they kept $3.94 for each inflation adjusted dollar as compared to 1979.
Repatriation of taxes gave corporations the ability to bring home profits generated overseas with the hope that the additional cash would find its way into capital spending had the opposite effect. Companies tightened their bottom lines and despite restrictions stated otherwise, used the tax break to buyback stock and/or offer increased dividends.
The burgeoning deficits have made business borrowing more difficult and that can create growth restrictions on the economy. Deficit reduction would hamper growth but only for a period of six months. Eventually, businesses would step-in once the government got out of the vicious borrowing cycle it currently employs.
While recession is a concern in the short-term should Congress take any action, the long-term possibilities show more promise.
We will be left to grapple with the problems of Medicare and Social Security long after Mr. Bush has taken his leave from office and the newly elected may find the task of undoing this administration's efforts at policy truly daunting. But undoing the tax cuts is a good first step in becoming a nation that can pay its own way. And that makes it worth the risk.
The Blue Money Report
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