The Phase-in of The Bush Vision
The benefits are being delayed. But the future is bright.


The strength of the economic expansion is being affected by the implementation of the Bush economic package. While the president has not been able to get a full implementation of his economic program, it is clear that he is a relentless man with a vision. He seems willing to implement his plan piecemeal. He will take what he can get and then come back for more later, and he will continue doing just that until he gets it all or his term runs out.

Under this scenario his re-election becomes very important; it will maximize his chances of implementing his agenda.

The long run benefits of President Bush’s economic vision — especially the elimination of double taxation, be it dividends or savings — are clear. The president’s economic plan will increase incentives to work, save, and invest, all of which will lead to an increase in asset values as well as an economic expansion.

However, many of these benefits are being delayed because of the way the president’s plan is being implemented. First, during the last go­-around, the president was not able to completely eliminate the double taxation of dividends. More, some of the gains realized are now only being phased-in.

The capital-gains and depreciation provisions are not retroactive to January of 2003; they are retroactive to May of 2003. That means that 4 months will be taxed at the old rate and 8 months will be taxed at the new rate. The phase-in will induce an incentive to delay recognition of capital gains as well as delaying the investment decisions of small businesses. This argument applies to a gradual implementation of the overall program.

However, the clear expectation is that the president will come back for more in the fall — be it for savings plans or more rate cuts. The more Congress slows down the president’s economic package, the slower the economic recovery and the weaker the market will be. Nonetheless, the long-run remains unchanged: It will be great.

One added complication is that the rate reduction is not permanent with the president’s package. But during the last 25 years we have never gone two presidential terms without changing the tax code in a significant way. Reagan lowered tax rates twice, Bush senior raised them once, and Clinton raised the personal income-tax rate and lowered the capital-gains tax rate. There is no reason to expect the rates to remain unchanged.

So, when you look at the long-term trend, the future is bullish. With a few minor bumps, the U.S. tax rates have been on a steady downward trend throughout the postwar period. This president seems bent on continuing the trend. Congress may be standing in his way and he me have to work around it. But that is why he is getting creative. A little now, a liitle later.

The downside to this is that uncertainty is increasing, and due to the changing laws, so are regulations. The uncertainty due to the lack of permanency of the tax bill will dampen the enthusiasms of investors, slow the economic expansion, and throttle down the rate of appreciation of asset values. The higher regulatory burden will tilt the balance in favor of smaller-cap stocks; the higher uncertainty will tilt the balance in favor of value stocks. The market has been moving this way in the recent quarter.

Any tax bill will have unintended consequences, and this one is no exception. Take, for instance, borrowed shares. The dividends received by shareowners when they lend the shares out is taxed at the ordinary income-tax rate, not at the preferential 15 percent rate. As shareholders learn about this they will switch their accounts, at least those with dividend-yielding stocks. That in turn will affect the amount of leverage/credit that brokerage houses may be able to accommodate.

That aside, the markets have reacted favorably to the portion of the Bush economic program that has been implemented. However, the path to the long-run outlook and the speed of adjustment is being regulated by Congress. Insofar as the Bush program is being “phased-in,” uncertainty will increase and the expansion will be slower and smaller than it would otherwise be. The higher uncertainty and regulation will tilt the investment choices to the smaller value-oriented stocks. And once the uncertainty is reduced and/or eliminated, the larger-capitalization stocks and cash-flow intensive stocks should do the best.

But count on this: The long-term outlook for the U.S. economy, in terms of real GDP growth and stock market performance, is a bullish one.


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