Can the tax cuts jumpstart economy?
Deal for a $330 billion tax cut will provide a short-term stimulus, but bigger deficits could hurt long-term growth.
President Bush has scored a major political victory on tax cuts, but a central question still looms over his signature domestic initiative: Will those cuts boost a flagging economy?
Unlike the first round of Bush tax cuts, this one "front-loads" reductions in income-tax rates, rather than having them kick in gradually. Its $330 billion in 10-year tax cuts is bolstered by $20 billion in aid to state and city governments. Republicans are counting on the package, which could start affecting worker paychecks by July, to improve a job climate that remains stubbornly weak.
Economists agree that the $330 billion deal over 10 years, worked out by House and Senate Republican leaders this week, will provide at least some economic stimulus. But they are more skeptical of the long-term benefits of a package that will also likely boost the federal budget deficit dramatically.
Moreover, even the short-term impact isn't expected to be large. In a $10.6 trillion economy, the question is whether the amount of tax relief scheduled for this year will be "enough to matter," says Bruce Bartlett, a senior fellow at the conservative National Center for Policy Analysis.
President Bush has himself called an earlier $350 billion Senate version "itty-bitty."
Still, Sen. Charles Grassley of Iowa, chairman of the Senate Finance Committee, maintains the package will "pump up our consumer-driven economy. It'll put more money in individuals' and families' pockets. It'll encourage small businesses to invest in equipment and create jobs."
Possibly the economy will gain speed without the help of the extra fiscal stimulus. Most private economic forecasters see a modest pickup in activity in the months ahead. A sizable fall in the value of the dollar, apparently welcomed by Treasury Secretary John Snow, should encourage exports and discourage imports, lifting American production.
But in congressional testimony Wednesday, Federal Reserve Chairman Alan Greenspan said there was insufficient information on economic activity to make "a firm judgment about the current underlying strength of the real economy."
Already Democrats are warming up charges that President Bush has squandered prosperity, allowing the number of jobs to decline at a monthly rate of 69,000 since he took office.
The Democrats have been proposing tax cuts aimed more at lower- and middle-income Americans. The Republican package, though providing some tax breaks for those of modest income, aims more at business and the well-to-do on the basis that they will create more jobs.
In economic theory, almost any tax cut or extra government spending can give the economy a short-term boost. But the Fed must make room for extra growth with an expansionary monetary policy. Wall Street expects the Fed to make another cut in interest rates when it meets June 23-24.
Republican moderates in the closely divided Senate are concerned that larger tax cuts would excessively swell the federal deficit. Seven months into fiscal 2003, which began last October, the deficit stands at $201.61 billion, up from $64.75 billion at the same point in 2002.
Some Wall Street experts see a $400 billion deficit before this fiscal year runs out. Such deficits must be financed by federal borrowing, a process that takes money out of the hands of those buying the Treasury securities.
But to many economists, such a deficit is not immediately threatening to the economy, amounting to not quite 4 percent of gross domestic product. The issue is whether the deficits make the nation less prepared for dealing with the imminent retirement of the populous baby boom generation, with their Social Security and Medicare needs.
Some provisions in the bill expire - or "sunset" - later in the decade to reduce the 10-year cost of the package. Republicans count on renewing these provisions before their expiry. Democrats call them dishonest "gimmicks" that could damage the fiscal scene for baby boomers.
"The price tag is fake," said Rep. Charles Rangel, ranking Democrat in the House Ways and Means Committee. He charges that in the long run the package will cost Uncle Sam a trillion dollars or more in lost revenue.
From a content standpoint, conservative analyst Mr. Bartlett finds the latest package "better than what the president proposed and what the Senate passed."
It includes a cut in both capital gains taxes and the tax on corporate dividends to a 15 percent rate for upper-income taxpayers, and to 5 percent for taxpayers in 10 and 15 percent brackets, through 2007. It eliminates these taxes for lower-bracket taxpayers in 2008. But then the entire tax break expires after 2008.
Dividends are now taxed at the same rate as earned income. That amounts to 38.6 percent for the wealthiest investors. Few lower-income taxpayers get dividends.
Republicans hope the tax cut for dividends will boost the stock market, thereby encouraging investors to spend more on goods and services. But economists predict such an impact will be tiny.
The bill, which was to get House approval Thursday and come before the Senate Friday, also provides a bonus depreciation tax break to 50 percent for business investment, through 2004. The amount that small businesses can expense rises from $25,000 to $100,000.
The package speeds up the personal income tax cuts legislated in the first Bush tax-cut bill, passed in 2001, from 2006 to Jan. 1, 2003. It increases the child tax credit from $600 to $1,000 only through 2004. Marriage penalty relief is provided from 2003 through 2004. A provision eliminating a tax break for Americans abroad was dropped.