It's All About Risk-Taking, Not Rebates
Sheryl Gay Stolberg of the New York Times reported Thursday morning that a serious debate is taking place inside the Bush Administration over whether the President should seek to compromise with the Democratic Congress on a temporary tax relief package, or remain vigilant in the fight to make his 2003 tax cuts permanent. By Thursday afternoon, rumors spread that the White House was planning to propose a $1600 tax rebate and new accelerated depreciation rules for small businesses. This, instead of an effort to push through permanent tax reductions on capital gains and dividends.
Without a doubt, the White House should abandon any tax rebate idea. As the 2001 tax relief package proved, Keynesian proposals to put money back into people's pockets do nothing to spur risk-taking and production. On the other hand, as the 2003 tax cuts proved, tax cuts on capital can be massively powerful and ignite economic growth because incentives are enhanced to take risks and produce. How could Washington not have learned anything by the juxtaposition of these starkly different tax relief packages and their subsequent track-records?
The underlying economic problem today is economic participants are less willing to take risks to produce. The S&P 500 has lost 15% since its October 9th high. Meanwhile, the spread between selected junk yields and the 10-year Treasury has widened from 310 basis points to 542 basis points. Widening credit spreads indicate a reluctance to take risk; the last time we witnessed such a sharp widening amidst an equity market pullback was 2000 through 2002. Not surprisingly, the 2001 tax rebates did little to improve market and risk-taking sentiment. But the 2003 tax cuts did, as credit spreads finally narrowed to more normal levels - and stocks soared.
Today’s aversion to risk has been arguably caused by the increasingly negative and uncertain fiscal, regulatory and monetary outlooks.
On the fiscal front, the tax outlook worsens by the day. House Ways & Means Chairman Charlie Rangel has not followed through on Nancy Pelosi's promise in October 2006 to keep the cap gains and dividend tax cuts. At this point, the tendency of the Democratic Party at large is to either allow the sunsetting of these tax cuts or at the very least rescind them from the highest income earners. Rangel is also failing to permanently correct the increasing burdens of the AMT. All the while, the weak dollar marked by rising gold is, in my estimation, doubling effective tax rates on capital; and marginal income tax rates are being under-adjusted by 4%, causing a real bracket creep akin to the 1970s, albeit to a lesser degree.
The unintended consequences of Sarbanes-Oxley also remain, such as capital flight to foreign markets and burdensome costs that coincidentally create barriers to entry for entrepreneurial start-ups. And the 2005 bankruptcy bill is arguably worsening today’s subprime crisis because it no longer allows households to wipe away credit card debt. As a result, households hanging by a thread are being forced to choose between which of their major debts to service: plastic or mortgage. Capital One Financial Chief Executive Richard Fairbank said on November 5 that households are deciding to "let the house go." This of course only worsens the crumbling housing market and reduces the values of the assets collateralizing mortgages and specifically subprime paper.
On the monetary front, the Federal Reserve's discretionary monetary policy of fed funds targeting is failing to restrain inflationary pressures for the second time since its original inception in 1974. The first time it failed (between 1977 and October of 1979 Paul Volcker abandoned it), it was abundantly clear that targeting the cost of credit to control money supply growth was utterly ineffectual. Today, Ben Bernanke and his FOMC colleagues are attempting to control both the price level and economic growth with this same lever based on Phillips Curve principles that run contrary to classical economic theory. But today's weak dollar and slowing growth problems require two distinct policy prescriptions: a gold-price policy target to directly and efficiently control the monetary spigot combined with tax relief and simplification to ignite risk-taking. Undoing Sarbanes Oxley and bankruptcy regulation would help, too.
Jude Wanniski often said, "There is no growth without risk, not only in economics but politics and daily living." Our fiscal, regulatory and monetary problems need repair. The question facing President Bush and his Administration is: will they increase the economy's appetite for risk to reinvigorate growth, win the electorate, and solidify a proud economic legacy?
