Whatever emerges from the current tax cut debate in Washington, you can be sure that politicians will call it a stimulus package. But the tax cuts the Bush administration is promoting would fail miserably as stimulus. Some of them could make things worse.
Fortunately, there is a simple way to boost the economy now and improve future prospects as well.
We have had record amounts of stimulus in the last two years. The Federal Reserve has cut interest rates by 500 basis points, to the lowest level in several decades. Federal spending increased by 6%, and tax revenue fell by 13% as a share of the economy.
Although most economists believe that tax cuts are a poor way to boost the economy in the short run, the administration claimed that its $1.35-trillion tax cut in 2001 was an insurance policy against stagnation. Of course, the economic fallout from the Sept. 11 terrorist attacks could not have been forecast. Nevertheless, a mere two years later, we are left with only a sputtering economy and a vastly increased budget deficit. Now we are being asked to drink more tax-cut snake oil.
A new subsidy for business investment would generate little new activity; it would just pay companies to do things they would have done anyway. The cost of investing has already fallen dramatically because of the generous depreciation rules enacted this year and steep declines in interest rates and inflation. But investment has been flat or falling. Businesses already have more excess capacity than at any time in the last 20 years; why should they buy new plants and equipment when they are not even using what they own?
Likewise, tax cuts aimed at promoting saving work in the wrong direction. Raising the contribution limit on retirement savings accounts might boost saving a little, but it also would reduce spending. Expanding deductions for capital losses would encourage people to unload their losing stocks, generate a wave of selling and push the market down.
Cutting dividend taxes makes sense as part of a broader deficit-neutral effort to clean up loopholes and problems in the corporate tax, but not as stimulus. The stock market effect would be muted because half of dividends already escape income taxes. The stimulus would be even smaller because dividends go mainly to high-income households that probably would save the money.
