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The economy and stock market have been slow to revive primarily because of errors in monetary and fiscal policies. The Federal Reserve’s failure to move more aggressively in cutting interest rates and supplying needed liquidity is well known. (Its most recent blunders came in June when it decided to cut the federal funds rate by only a quarter, instead of a half, point and then in July when it didn’t follow up with an interim rate cut.) Less appreciated, though, is the tremendous burden that federal taxation has placed on the economy. HIGHEST
IN U.S. HISTORY Moreover, even if Congress had adopted the Bush tax-cut plan in full, the White House didn’t foresee significant relief anytime soon. For the 2002 fiscal year begun Monday, Oct. 1, personal income taxes were expected to equal 9.9% of GDP, dropping to just 9.3% by 2004 and 8.9% by 2006. In the 1992 fiscal year ended just prior to Bill Clinton’s election, individual income taxes represented only 7.7% of GDP; when Ronald Reagan left office, they were 8.0% of GDP. Congress frustrated the effort to reduce the federal income-tax burden when it jettisoned much of the tax relief intended for middle-income households. The final bill was indeed a far cry from the president’s original plan. Congress ruined the best of the tax cuts that would have produced the largest increases in personal disposable income for millions of middle-income earners. Those cuts were, in fact, the very ones that would have supplied the most stimulus to the economy, and their loss is a primary reason why the stock market tanked as Congress readied the final bill for presidential signature and why business and investor confidence haven’t revived since. Specifically, President Bush’s original tax proposal called for a consolidation of income tax brackets and elimination of the 31% and 39.6% marginal rates. Single persons earning between $65,550 and $136,750 in taxable income and married couples making $109,250 to $166,500 would have seen their top marginal rate drop from 31% to 25% by 2006. As enrolled by Congress, however, the “Economic Growth and Tax Relief Reconciliation Act of 2001” (H.R. 1836) keeps these income brackets and gradually lowers the corresponding marginal tax rate from 31% to just 28% (rather than 25%) by 2006. Congress also retained the very top bracket on taxable incomes above $297,350, which President Bush had sought to scrap. The administration had hoped by 2006 to consolidate the 39.6% bracket with the next lowest one and reduce the top marginal tax rate to 33%. The new 33% rate would have kicked in on taxable incomes above $136,750 for single filers and $166,500 for married couples filing jointly. As amended, the 36% rate will be cut to 33% by 2006, but the existing bracket on taxable incomes above $297,350 will remain. The top marginal rate, covering incomes above that level, will be reduced from 39.6% to 35% (instead of 33%) by 2006. Sentiment on the stock market turned distinctly bearish as a congressional conference committee reconciled the differences between the Senate and House versions of the Bush tax cut. After rallying from their 2001 lows, set in late March and early April, stock prices peaked during the very week that the conferees reached a final tax compromise on May 25. Congress passed the $1.35 trillion measure a day later. (President Bush signed the bill into law on June 7.) The DJIA peaked on May 21 at 11,337.92. It then proceeded to drop 2,490.36 points through last Friday, a 22% decline. However, roughly seven-tenths of the falloff (or 1,732.41 points) occurred prior to Sept. 11. Similarly, the Nasdaq has lost 815.05 points, or 35%, from its May 22 high of 2,313.85; about three-quarters of the decline (or 618.47 points) took place before the attacks on the World Trade Center and the Pentagon.
Policymakers clearly were all too sanguine in believing the steps they had taken were adequate to help an economy in trouble. Wall Street didn’t buy Washington’s optimism. Short sales of stocks soared as the summer wore on. In the month to July 15, short interest in Nasdaq-listed stocks represented 2.36 days’ average daily volume, up from 2.19 days in the June period. By mid-August, short interest had risen to 2.56 times average daily volume. Then, in the period from Aug. 15 through Sept. 10, it climbed further to 2.99 times average daily volume. The market, in other words, kept pushing out its expectations for an economic and profits recovery. To revitalize the economy, Congress must not only address the uncertainty caused by the Sept. 11 attacks but also deal with the pre-existing economic risk that flowed from its evisceration of the middle- and upper-income tax reductions originally proposed by President Bush. The trouble is, few appreciate just how harmful Congress’s actions were. The significance of the congressional decision to deny middle- and upper-income earners substantial tax relief seems to have escaped even The Wall Street Journal Editorial Board, which last Wednesday wrote:
Mr. Bush needs a fiscal plan of his own, one that will actually fire the real engine of growth, which is private spending. And that means boosting incentives for people to work harder, invest more and resume risk taking. The cleanest, most effective way to do this would be to accelerate Mr. Bush’s cuts in marginal income tax rates. . . . This makes more sense than the current talk of targeting tax relief to businesses or to a certain class of workers favored by certain Members of Congress. Someday speeding up depreciation allowances or cutting the payroll tax would be nice. This is not that time.
— The payroll tax paid by both employees and employers should be reduced for six to nine months. This would immediately increase personal disposable income for all earners and not just those with taxable income. Companies would be able to retain more cash to keep personnel, hire extra employees, and fund new capital investment. A temporary reduction in the payroll tax — one that would apply equally to workers and their employers — would be of immediate help in reducing post-Sept. 11 uncertainty by increasing the amount of cash in hand available to consumers and businesses. It also would counterweigh the tendency that has emerged since the terrorist attacks to hoard cash and its equivalents. There has been talk of cutting the corporate income-tax rate, but that would probably do more harm than good. First of all, such a tax cut would be of little help to companies not earning profits. These include long-established firms that have been hard hit by this year’s economic downturn and upstarts in technology, biotechnology, and other emerging fields, where the prospects for profitability are still years away. Worse, a corporate income-tax cut could skew portfolio-investment decisions, favoring profitable blue-chip firms to the disadvantage of smaller and younger companies with distant profit horizons. The above tax measures, coupled with increased infrastructure spending, would countervail much of the uncertainty created by the threat of terrorism and also would add significant pro-growth incentives to rid the economy of the risk that plagued it even before the attacks of Sept. 11. They also would be equitable, increasing every worker’s take-home pay. Since the events of Sept. 11 affected every American, it is only right that everyone benefit from tax relief. Finally, such a fair and balanced plan would have a good chance of gaining public support and bipartisan approval.
— William
P. Kucewicz is editor of GeoInvestor.com
and a former editorial board member of The Wall Street Journal |
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counter the uncertainty and risk plaguing the economy, Washington needs
to cut taxes to increase disposable income and add pro-growth incentives.
The question is, which taxes should be cut? Various ideas already have
been floated — from speeding up the personal income tax cuts signed
into law in June to lowering corporate income, payroll, and capital-gains
taxes. Before answering the question, however, it’s worth looking at the
other problem weighing on the economy — i.e., the risk that had the
U.S. economy growing in the second quarter at its slowest rate in a decade
and that caused the stock market to backtrack even before the terrorist
attacks. 
