23 May 2003 “It’s the Economy”
Today, assuming the Senate does as expected and passes the $350 billion tax cut bill, the campaign for theU.S.presidency in 2004 unofficially begins today. The health of this economy will make or break Mr. Bush’s re-election bid for the presidency. His father learned just how fast his huge popularity after the Gulf War dissipated when voters were made to feel that their pocketbooks were threatened by a weakening economy.
The tax cut bill passed the House by 231-200 in favor of the bill, largely on party lines. The legislation goes to the Senate for a vote scheduled at9:30this morning, where Republicans say they will pass it with a single-vote majority. President George W. Bush embraced the compromise measure even though it is half the $726 billion, 10-year plan he sought. He focused the objectives of his bill on jobs, aware that the economy has lost two million jobs since he took office. Yesterday, he said that passing the economic plan “is good for American workers, it is good for American families, it is good for American investors.” Bush believes that lower taxes will stimulate investment, job growth, and increased spending by consumers, thereby speeding economic growth and increasing the tax rolls. He better be right and soon, as Democrats are already staking their positions on the harm that potential deficits caused by the tax cuts will do to the long-term economy.
The bill came as a result of significant White House pressure to enact the legislation this week. The plan is a compromise on the elimination of the double taxation of dividends, but it still ranks as the third largest tax cut in the nation’s history. This cut represents the third during President Bush’s presidency and highlights how much is riding on the theory that lower taxes are needed to stimulate this lethargic economy.
Among the key components of the bill are; the acceleration of earlier tax reductions that were scheduled to occur later this decade, capital gains rates reduced to 15% from 20%, dividend taxes cut to 15% from the top rate of 38.6%, an increase from $25,000 to $100,000, the equipment investment that small businesses can write off, reduce taxes for some married couples, and expands the child tax credit for 2003 and 2004 to $1,000. It may be possible for the Treasury to put the refund in the hands of 25 million households by mid-August, further boosting spending. The bill drops to 25, 28, 33, and 35% the current 27, 30, 35, and 38.6% rates, respectively. The bill also sends $20 billion in aid to the states, which are suffering from the slow economy and increased spending requirements for homeland security. Time will tell just how much stimulus will be provided by the reductions in taxes.
On the monetary policy front, Mr. Greenspan spoke before the joint Congressional Economic Committee on Wednesday. At that session, the Chairman expressed optimism that a forecast for faster economic growth was “not unreasonable.” He also repeated comments from the May 6th meeting that a “substantial fall” in inflation was “unwelcome” and that the Fed has “the capability, should that be necessary, of moving long-term rates down and expanding the monetary base.” Greenspan reiterated that deflation is not an “imminent” threat to theU.S., but the Fed maintained a vigilant watch for that possibility.
Mr. Greenspan also noted yesterday that layoffs and a reluctance to hire are maintaining employment as one of the weakest parts of the economy. According to the Wall Street Journal, the number of new jobless claims in the U.S. last week was higher than expected and rose for the first time in four weeks, by a seasonally adjusted 7,000 to 428,000 claims, as announced by the Labor Department today. The Wall Street Journal further points out, that while much of that rise was blamed on the effects of tornadoes that caused severe damage in several areas in the Midwest, today’s report also marks the 14th consecutive week that new claims have topped 400,000.
The validity of this economic recovery lies in its ability to create jobs. That is not expected to happen for some months to come as employers generally hire only when they have exhausted most other forms of productivity enhancement. And it appears we still have a ways to go in the non-job creation phase. According to an article onBloomberg,U.S.companies are extending the lifespan of their office computers at the economy’s expense. “In the late 1990s, computers lasted as little as three years as companies rushed to keep up with changes in technology. Between 1995 and 2000, spending on information technology rose by 19% a year, in 2000 reaching $583 billion, or 6% of the economy. In 2002, such spending dropped to $563 billion. Information technology accounts for more than half of business fixed investment.”
“The central question about the outlook remains whether business firms will quicken the pace of investment,” Greenspan said on Wednesday. Firms still appear hesitant to spend and hire, and we need to remain mindful of the possibility that lingering business caution could be an impediment to improved economic performance,” according to Mr. Greenspan.
The Bloomberg article goes on to point out that companies are sticking with the PCs they bought at the turn of the century to hold down costs and because new software applications aren’t straining the power and memory of their equipment. Replacement cycles have risen to four years from three in the mid-1990s. This is holding down business investment at the same time that technology gains from the last decade enable companies to operate with fewer workers, economists said. “Business spending is going to make or break the economy in the second half of the year,” said Sung Won Sohn, chief economist at Wells Fargo & Co. “A lot of businesses are saying they don’t need new equipment and software.”
But, that may be starting to turn around, according to Synopsys Inc., which makes software for designing computer chips. The company, based in Mountain View,California, said third-quarter profit will exceed analysts’ estimates, and its stock rose 16% yesterday. Shares of other software companies are seeing their sales and stock prices pick up as well. And PC and software sales were among the growth leaders in the last report ofU.S.gross domestic product.
Finally, the stock market, the best leading indicator, is throwing its weight behind the recovery scenario. Since March 12th, the beginning of the post-Iraq war rally the Dow is up 14% and the S&P and the NASDAQ are each up 16%. While there remain numerous hurdles to clear, such as the declining dollar,North Korea, SARS, andIraq reconstruction, this economy has demonstrated its ability to withstand much greater shocks. As Greenspan said on Wednesday, this economy has withstood significant declines in equity prices, a substantial fall in capital spending, the terrorist attacks of 9/11, “confidence debilitating revelations of corporate malfeasance, and wars in Afganistan andIraq. Any combination of these shocks would have arguably induced severe economic shocks two or three decades ago, yet remarkably over the past two or three years activity has expanded on balance.” Those major shocks are behind us now and the same fundamentals are in place. Maybe the growth forecasts aren’t so “unreasonable” after all.
