One of the first tasks for President Bush's new economic team next year will be selling a package of tax cuts as a quick "stimulus" to a lackluster economy. But a number of analysts question whether any boost is needed at all, and whether the ideas under consideration would have much of an effect until 2004, when Bush is seeking reelection.
Treasury Secretary-designate John W. Snow and economic adviser Stephen Friedman would shepherd though Congress what administration sources say are plans to reduce the "double taxation" of dividend income, a speedup of the 2004 personal income tax cuts to next year and additional incentives for capital spending. Other possible cuts would allow individuals to deduct more than the current $3,000 in losses on stocks and other assets, accelerate increases in the child tax credit, and even eliminate the "marriage penalty."
Administration officials have been struggling to fit as much in the package as possible while holding down its total cost in lost revenue. Estimates are for cuts worth about $300 billion over 10 years, much of it next year.
Most of the impact of any new round of tax cuts would come in 2004, not by specific political design, but simply because it will take until roughly the middle of 2003 before they could be enacted, implemented, and begin to affect consumer or business spending behavior, analysts said.
Some Federal Reserve officials noted as much at a meeting of top Fed policymakers last month. Some in the group "observed that further federal tax cuts, should they be enacted, would likely take effect too late to foster much added spending over the year ahead," according to minutes of the meeting released last week.
Economists are divided over whether any stimulus is needed, even though the economy is expected to grow at only about a 1 percent or so annual rate in the last three months of this year. Many analysts and economists -- and Fed officials -- regard the uncertainty caused by the possibility of war with Iraq as the single most important force restraining economic growth, and there is considerable doubt among most of them that a stimulus package would relieve much of that uncertainty.
Many firms, both large and small, are concerned about how war with Iraq might affect them and, as a consequence, are postponing many decisions to avoid risks, said economist Robert V. DiClemente of Salomon Smith Barney in New York.
"A strengthening in business activity awaits a decline in risk aversion and a fading of geopolitical uncertainties," he told his firm's clients last week. "A resolution to the Iraq situation would do much to raise business and [financial] market sentiment."
Furthermore, most forecasters predict -- with the Bush administration likely to join them when its 2003 forecast is made public next month -- that growth will strengthen to a 3.5 to 4 percent annual rate in the second half of the year without any new stimulus.
"Regardless of what the administration does, they are going to call it stimulus," said economist William G. Gale, a Brookings Institution tax expert. "They have a tax-cut agenda, and they will fashion it to the moment." Two years ago, during the presidential campaign, "with a booming economy, that was the right answer, and now that it is sputtering, the right answer is still tax cuts."
Charles L. Schultze of the Brookings Institution, an economic adviser to President Jimmy Carter, said he is not sure whether any additional stimulus is needed, because he expects growth to accelerate.
"I would say that after another couple of quarters, we will get back on track," Schultze said. What is certain is that the package of tax moves being discussed would increase the government's long-term budget deficit, both through making permanent some cuts enacted last year that have not yet taken effect and by adding some new ones, he said.
"Please wait," Schultze urged. "Don't do it now."
However, some administration officials regard quick action on a tax cut package early next year as insurance against the possibility that a second-half rebound does not occur or that war with Iraq could also provide a shock that derails growth, at least temporarily.
And some analysts agree. "Why do we need this?" said economist Chris Varvares of Macroeconomic Advisers, a St. Louis forecasting firm. "There are two reasons." First, economic growth might not pick up as expected, and second, "who knows what kind of shock the economy would take if we go to war in Iraq."
Economist M. Cary Leahey of Deutsche Bank Securities in New York faults the proposals under discussion because he doubts they would provide the stimulus proponents are seeking.
"Ironically, the stimulus package may have very little old-fashioned stimulus in it," Leahey said. Advancing the tax rate cuts by a year or reducing taxes on dividends would have little impact on households with incomes under $50,000, he said. Instead, both actions would primarily benefit higher-income individuals.
Allowing firms to write off the costs of buying new equipment more rapidly also would have little impact, he added.
"Additional tax breaks for capital spending might work on the margin, but the costs of capital are already quite low. Firms are hesitant to invest, not because they need another tax break . . . but because they are worried" that the added production capacity may not be needed, Leahey said.
In contrast, Jerry J. Jasinowski, president of the National Association of Manufacturers, is pushing to extend and enhance the new first-year write-off of equipment purchases put in place earlier this year. "People who argue that we have so much excess capacity that the [write-off] is not needed just don't understand," Jasinowski said. Many industrial firms have unused production capacity, but much of it is "outmoded and obsolete." With the added tax benefit, some firms would begin to replace that older equipment, he said.
R. Glenn Hubbard, chairman of the president's Council of Economic Advisers and a tax expert, didn't respond to interview requests. But he has argued that the reduction or perhaps elimination of taxes on dividends paid to individuals could have a substantial positive impact on economic activity by generating significant increases in stock prices.
By some private estimates, eliminating taxes on dividends would reduce federal revenue by about $25 billion to $30 billion a year. The figure would be much higher except that the bulk of dividends are already exempt from tax. Most aren't paid directly to individuals. Many go to tax-exempt pension funds. Others go to corporations. Yet others are paid on stocks held in individual retirement plans, such as IRAs, which are tax exempt.
It is hard to predict the effect on the economy cutting the tax on dividends, Varvares said. "We have queried a lot of smart people on this and the answers are all over the lot."
He agreed that cutting dividend taxes would give stock prices a boost, but not necessarily a lot. For instance, if many investors switched money from bonds to stocks to get tax-free dividends, stock prices would rise. But it is also likely that interest rates would have to rise to attract new bond buyers, offsetting some of the positive effect of higher stock prices, he said.