Washington politicos may not be able to connect the dots, but stock-market prices on Wall Street have collapsed since the House passed its version of President Bush’s tax-cut bill.
Since last Thursday, when the bill passed with 230 votes (including 10 Democrats), both the Dow Jones and S&P 500 indexes have lost about 5% of their value. The broad S&P has now cumulatively declined more than 20% over the past 12 months, thereby qualifying for full-fledged bear-market definition. Over past cycles this sort of bear-market decline usually foreshadows economic recession. Meanwhile, the NASDAQ technology index has dropped another 10%, and this barometer of investment risk taking is now more than 60% below its year-ago peak.
Some of this carnage can be traced to timid Federal Reserve policies. Greenspan & Co. remain in denial about the stock-market message as they continue to delay much-needed liquidity additions and interest-rate cuts. Corporate earnings are falling everywhere. Manufacturing is already in recession, and services may not be far behind. Technology jobs are shrinking.
But the headline story is that investors are severely disappointed that there will be virtually no tax-cut stimulus this year. After hearing for many weeks from President Bush, Treasury Secretary O’Neill, and others that help is on the way, retroactively, it turns out that planned marginal-tax-rate reduction is being postponed until next year.
So, delaying lower tax rates delays economic recovery. Even worse, delayed tax relief may actually prolong the economic slump.
As the fine print of the House bill becomes available, investor disappointment grows at the five-year phase-in schedule for reduced tax rates. For example, the 39.6% top personal rate is projected to fall to 38% next year, then 37% in 2003, then 36% in 2004, 35% in 2005, and 33% in 2006. As I wrote last week, that’s one presidential and three congressional elections from now.
In fact, capital-supplying upper-end tax payers fear that they may never see the much-proclaimed reduction in tax rates — which, by the way, would still leave the top personal rate 5-percentage-points higher than Ronald Reagan left it.
Adding to the uncertainty, conventional inside-the-Beltway thinkers are now hinting at a possible compromise that will raise the final top tax-rate to 35% or 36%.
On the Sunday talk shows, both Senate Majority Leader Trent Lott and Texan Phil Gramm raised the possibility that Congress could make a “mid-course” adjustment to the tax bill if projected budget surpluses don’t materialize. Numerous others continue to insist on a trigger mechanism that would terminate tax cuts unless certain surplus targets are achieved. So, while George W. Bush is making the tax-cut case in the heartlands, congressional negotiators are making a complete hash of it in Washington.
Washington is obsessed with budget surpluses and income-redistribution tables, turning economics on its head. But who cares about budget surpluses during a recession? The budget should be running a deficit when investment, production, and growth are in retreat.
And then there’s Wall Street Journal editor Robert Bartley’s point from his column Monday. The problem isn’t maintaining budget surpluses in a downturn. Instead, the Reagan formula on incentive-oriented tax cuts to boost growth should be combined with Fed efforts to stabilize prices. Let me add that if the Fed pumps in more money while goods-producing tax incentives are left out, then a 1970′s-style stagflation could result.
Over the weekend, the only sensible voice was that of House Speaker Dennis Hastert. He said that capital-gains tax cuts and pension reform for expanded IRAs and 401Ks might still be part of the final tax-cut mix. This sentiment has been echoed by House Majority Leader Dick Armey. But these voices of economic sanity have been drowned out by the loud drumbeat of Hoooveresque withdrawal from urgently needed, retroactive tax-cut stimulus.
Prodded by faltering stocks and GDP decline, economically ignorant Washington knuckleheads may finally come to their senses. There may yet be an across-the-board, retroactive tax-rate cut combined with cap-gains and super-saver relief. This is a package the investor class clamors for. But thus far, there’s not one whiff of evidence from any of the major stock markets that any real help is on the way.