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Fiscal Policy Redux

Proposals for managing the sagging economy will abound in the next few months.

November 13, 2002|Peter G. Gosselin | Times Staff Writer

WASHINGTON — Listen to the post-election hubbub about more tax cuts and you can hear the ghost of a long-dismissed government strategy: fiscal policy.

Sure, politicians talk about "fiscal stimulus" whenever the economy sags, and sometimes even pass the requisite tax cuts and spending increases as they did this year and last. But for two decades, the White House and Congress have been little more than bit players in an economic drama dominated by the Federal Reserve.

No more. With short-term interest rates near zero, the era of Fed ascendancy is over. A new age of fiscal policy is about to begin.

"We're going to get a big new dose of fiscal policy, come hell or high water," predicted Brookings Institution economist Robert E. Litan.

Talk of more tax cuts is one measure of the uneasiness people feel about an economy that, while no longer shrinking, seems unable to grow strongly. It also is a gauge of people's surprise -- even shock -- at the idea that Fed Chairman Alan Greenspan may be running out of tricks to cushion economic blows and manage growth.

"The Federal Reserve has given you the impression it can fine-tune the economy," said Bank of America chief economist Mickey D. Levy. "Guess what? It can't."

And neither can the White House and Congress, so the conventional wisdom has been. Indeed, the conviction that fiscal policy doesn't work has been a staple of Republican orthodoxy since the boom of the 1960s turned into the inflation of the 1970s, helping to pave the way for Ronald Reagan, the country's rightward shift and the election of the current president.

But if the economy continues to perform poorly, the president and the new congressional Republican majority probably will respond -- particularly because of what happened to the first President Bush, whose 1992 re-election bid foundered when a mild recession similar to last year's gave way to an anemic recovery like this year's. Whatever doubts they may still harbor about fiscal policy, they can comfort themselves with the knowledge that it once worked brilliantly, if only briefly.

The moment was 1963. The president was John Kennedy. The problem was an economy stuck in low gear with unemployment at about 7%. Kennedy's advisors argued for what was at the time the largest income tax cut ever approved. Within a year of its passage, unemployment had dropped to 4% and the country was roaring forward.

"It was fiscal policy's shining moment, one it has never been able to repeat," said UC San Diego historian Michael A. Bernstein. Within a few years, Kennedy's successor, Lyndon Johnson, was forced to seek a tax increase in an unsuccessful attempt to slow growth and dampen inflation.

Despite this checkered past, fiscal policy proposals will abound in the next few months largely because fiscal policy is the only game left in town. That being so, here is a brief viewer's guide to the coming debate:

* What counts as fiscal policy and what doesn't?

White House officials already have signaled they generally favor renewing a 13-week extension of unemployment compensation benefits due to expire in December, and are interested in new tax breaks for investors who lost large sums in the stock market. Both would count as fiscal policy because they would prop up the economy by helping people continue to spend.

But the president has said that one of his biggest priorities will be to make his 10-year, $1.35- trillion tax-cut package permanent. That wouldn't count. "It's not going to make a bit of difference to the economy in the next year or two," said David Hale, chief economist at Zurich Financial Services in Chicago.

* What is "discretionary" and what is "automatic"?

Critics of fiscal policy argue that Congress and the White House take so long to settle on specific measures that the economic problems they are designed to solve usually have disappeared.

When they do get the timing right -- as they did with last year's installment of the president's tax-cut package -- it's generally dumb luck.

But such criticism -- which will inevitably be heard in the coming debate -- focuses on only one kind of fiscal policy, the kind that is discretionary and requires votes by Congress and approvals by the president to turn on or off.

But there is another kind of fiscal policy that is generally less controversial, the "automatic" programs that kick in when the economy is in trouble and bolster it, and turn off when the problem is over. Examples are unemployment compensation and, surprisingly, corporate income taxes, which plummet along with profits in a downturn, relieving companies of the burden of paying them, and then come back during recoveries.

Watch for whether proposals fall into the discretionary or automatic category.

* Which fiscal policy measures do Republicans favor and which do Democrats favor?

In general, Republicans want to help business and investors, arguing that savings and investment are the economy's weakest links. The Democrats favor proposals that help low- and moderate-income Americans such as suspending Social Security and Medicare taxes for six months.

The divisions could stall action as they have so many times before. But if the economy continues stumbling, watch for the differences to be quickly bridged.

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