Magazine

The Kick the Economy Needs


It's time for Washington to take out an insurance policy on the economic recovery. The economy is growing below its potential, consumer confidence is falling, leading indicators are fading, corporate profits are still weak, and there is growing talk of deflation. CEOs are focused on reforming business practices, not investing for the future. On top of all this, geopolitical risks are rising again in the global economy. Al Qaeda has launched a series of terrorist acts, the bombing in Indonesia being just the latest. And a probable invasion of Iraq weighs heavily on the minds of most Americans. Signs of some life in the stock market give hope that a double-dip recession will not take place. But a little help from Washington right now could go a long way toward ensuring that outcome.

We would start with the Federal Reserve cutting interest rates by 50 basis points. When a bubble bursts, demand plummets. The major risk to today's economy is low demand; cutting rates is the easiest, fastest way to stimulate it. The deflation specter haunting America, as it does Japan, is not easily dismissed. Falling prices for most goods and many services is a major reason corporate profits are so weak, even with an average 3% growth in gross domestic product in the past four quarters. The Fed should act at its next meeting on Nov. 6.

That may not be enough. Washington has to increase fiscal stimulus as well. To its credit, Congress moved quickly last year to cut taxes. It has to do more now. The tax rebate and cut in marginal tax rates in fiscal 2002 lifted real disposable income 1 1/4% and added 1.3% to GDP growth. But 2003 is an "off year" in the multiyear tax cut, and U.S. consumers will receive no extra boost in their disposable income. GDP will likely suffer. Moving forward the scheduled 2004 personal income-tax cut, as most Republicans and some Democrats suggest, would help--but it would pump only about $10 billion extra into the economy. Accelerating both the 2004 and 2006 income-tax cuts to 2003 adds a total of $40 billion--a real chunk of change. Most Democrats oppose an acceleration of tax cuts on grounds that it would favor the rich. Actually, the cuts would benefit both the middle class and the rich: The top four tax brackets would drop to 35%, 33%, 28%, and 25%.

Democrats prefer suspending the payroll tax. (Nearly half of all taxpayers don't pay income taxes and so receive no benefit from rate cuts.) There is merit to their proposition. Companies and employees split the 15.3% payroll tax. A three-month hiatus would pump $180 billion into the economy, divided evenly between employees and corporations.

The economy needs a kick in the pants--but the price is a growing budget deficit. The recession, bubble, and military spending have erased the $5.6 trillion surplus projection behind the 10-year, $1.3 trillion tax cut. Policymakers may want to rethink costly out-year income-tax cuts and the decision to end estate taxes by 2010. New uncertainties require that all policy options be kept open. That includes the policy of taking out economic insurance right now.


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