There is an increasing risk that the negative effects of the Hurricane Katrina catastrophe could be compounded by an inexplicable series of policy blunders in Washington. Over the last week, calls have emerged for excess profits taxes on oil companies, gas caps at the pump, and higher tax rates on investment and business in order to fund the recovery effort. A rainbow coalition of Republicans and Democrats has simultaneously stepped up calls for the Fed to respond to Katrina with an easier liquidity policy.
#ad#Apparently policymakers in Washington fell asleep during Price Theory 101. Natural disasters are supply shocks — they temporarily reduce the supply of goods and services (production). Higher tax rates, restrictions on energy company profits, and price caps at the pumps would result in an additional supply shock by permanently reducing the efficiency, flexibility, and productivity of the U.S. economy. At the same time, a printing-press policy at the Fed would allow more money to chase a reduced supply of goods — i.e., inflation. This witch’s brew of ad hoc neo-Keynesianism won’t rebuild homes, fix highways, bring refineries back on line, or reemploy displaced workers.
With booming tax receipts at all levels of government, policymakers in Washington should not be bullied into sidelining a pro-growth agenda because of an utterly confused and increasingly vociferous band of no-growth neo-Malthusian nabobs on Capitol Hill. With the 10-year Treasury yield just north of 4 percent, it will cost about $8 billion in additional annual debt service to fund the highest estimates of the recovery effort. This expense could be covered 20 times over by the $162 billion increase in gross private savings that has accrued since 2003 (the year the supply-side tax cuts were made retroactive). Moreover, making the tax cuts permanent is critical to preserving and protecting long-term growth and the size of the future tax base. A one-percentage-point rise in the growth rate would be worth about $1.7 trillion in cumulative tax receipts during the next decade. Growth matters.
The good news is that it is becoming increasingly apparent that Hurricane Katrina hit a robust economy with strong fundamentals. The ISM non-manufacturing business activity index for August rose to 65, a level consistent with 4.8 percent real GDP growth. The employment sub index rose to 59.6, matching its previous all-time high reached in February 2005. The unemployment rate has dropped to 4.9 percent and real hourly compensation is up 3.5 percent on a year-over-year basis, the fastest since September 2000. Lower tax rates on investment have helped boost the capital-to-labor ratio — the raw fuel for productivity and income growth — to record levels. Non-financial productivity is up 6.4 percent year-over-year, the fastest annual growth rate since 1959.
The U.S. economy is dynamic and its fundamentals are sound. Hurricane Katrina will not change this unless policymakers in Washington respond with totally unnecessary and destructive policies that turn a temporary supply shock into a permanent outage.
— Michael T. Darda is the chief economist and director of research for MKM Partners, an equity execution and research boutique located in Greenwich, Conn. He welcomes your comments here.