President Bush's speech tomorrow to the Economic Club of Chicago, billed as his most important economic talk since 9/11, will be anticlimactic. Details of his $600 billion, 10-year stimulus plan have been leaking for a week.
Not surprisingly for an administration that has no coherent economic plan, Bush's new policies are a grab bag, everything from cutting the taxes shareholders pay on dividends to increasing unemployment benefits, from accelerating marginal tax-rate reductions to shipping cash to financially strapped states.
Shrewdly, the Bushies aren't calling it a stimulus package—it's a jobs bill or "growth insurance" (the same silly moniker they used for Bush's 2001 tax cut, which did not ensure growth). As always with Bush's economic policy, it's a mixture of good intentions ineffectively executed, and dubious theory presented as gospel truth.
For starters, if our economy needs short-term stimulus as badly as everyone seems to agree it does, why does the plan offer so little of it? The Wall Street Journal estimates that the Bush package could inject $80 billion-$100 billion into the economy in the first year—less than 1 percent of GNP. That's nice, but on its own it hardly makes the difference between a job-losing economy like the one we have today and a job-creating economy like the one we had in the '90s. (Bush does not even contemplate the one act that would put cash into virtually every consumer's hand immediately—a payroll tax holiday.)
Besides, the states will be taking almost as much out of the economy over the next 12 months as President Bush puts in. Governors, unlike the president, must balance their budgets every year. According to the Center on Budget and Policy Priorities, the states are facing a collective deficit of $60 billion-$80 billion for the upcoming fiscal year, which starts in June 2003.
In other words, governors must act like Herbert Hoovers precisely when we need them to act like Keynesians. Confronted with staggering deficits, state chief executives, many of whom ran down reserves during this past election year, are slashing spending; cutting jobs; raising income, sales, and sin taxes; and boosting tuition at public institutions.
The Bush plan would deliver up to $10 billion for struggling states—a pebble compared to their yawning hole. (Ten billion is only enough to close the deficit of New York State.)
Administration policies are contributing to these state gaps. Federal mandates created by Bush-supported legislation—for education testing, homeland defense, smallpox inoculation, and election reform—are increasing the shortfalls.
As for the dividends measure, it won't help much, it won't help soon, and it's aimed at the wrong target.
The theory of cutting dividend taxes is that if companies pay higher dividends—the indicated dividend yield of the S&P 500 is less than 2 percent—investors would be willing to pay more for stocks. That would reinflate the stock market and create positive collateral effects ranging from higher capital-gains tax payments to the resuscitation of the value of CEO option packages.
Council of Economic Advisers Chairman Glenn Hubbard, the Bush administration's one-man-economic-policy-band, apparently believes that this move will boost the market by 20 percent. "This will provide a lot of juice to the market," said Kevin Hassett, a co-author of Dow 36,000, told the New York Times. But if they believe that this proposal will achieve such results, then I've got some calls on Dow 36,000 to sell them.
A great deal of stock is held in tax-favored accounts like 401(k)s, IRAs, and pension funds—whose holders aren't paying taxes on the dividends they receive anyway. A giant chunk of the investor class thus won't benefit directly from the dividend tax elimination and hence have no incentive to pay significantly more for dividend-yielding stocks. And those who will see a tax savings won't feel it until at least a year from now, when they start to file their 2003 tax returns. By that time, presumably, the economy won't need the stimulus that newly discovered spare change will provide.
The other problem of cutting dividends for individuals is that it gives the carrot to the wrong person. Today, corporate interest payments on debt are deductible from taxable income while dividend payments are not. (The bondholders pay income tax on the interest they receive.) Companies bulk up on debt and eschew dividends in part because the interest payments reduce tax liability. But corporations get no tax benefits for paying dividends—and they won't under Bush's proposal.
If Bush really wants to encourage corporations to pay out dividends—and quickly—he could erase that inconsistency. Make dividends deductible for corporations, but let recipients continue to pay taxes on them—just as they do with bond interest. In theory, shareholders, who would receive Bush's dividend tax break, will clamor for companies to pay dividends. In practice, shareholder power is too diffuse. At times when profit margins are under pressure, as they are today, executives tend to make decisions that boost the bottom line. And the incentives in the tax code favor taking on debt and disfavor paying out dividends. The Bush plan would require lots of shareholder activism and lots of time to get more companies to start paying dividends.
But if the administration declared all dividend payments to be deductible, companies eager to reduce their tax liability would have a huge incentive to start paying dividends immediately. So, if you think expanding dividends rapidly would be a boon to the economy—and that's an open question—it would be more effective to give companies the greatest incentives to start paying them.
Of course, making dividends deductible for corporations—rather than cutting dividend taxes for individuals—would have opened Bush up to charges that the stimulus plan was a reward to corporate backers. But this is a rare instance when Bush might have been better off following his instincts to favor corporate insiders over masses of shareholders.