William R. Hawkins is Senior Fellow for National Security Studies at the U.S. Business and Industry Council.

IT’S THE ELECTION, STUPID!

In a rare show of bipartisanship, Republican President George W. Bush won almost instant support from House Democrats for his tax rebate stimulus package.  The bill was rushed through the lower house of Congress on January 29 by a vote of 385-35.  House Speaker Nancy Pelosi (D-CA), Minority Leader John Boehner (R-OH) and Treasury Secretary Henry Paulson had unveiled the deal at a joint press conference on Capitol Hill.  The package provides about $162 billion in tax rebates, mostly for individuals, though there is a 50 percent bonus depreciation allowance for business taxpayers who place equipment in service during 2008.

The income tax rebates would go to 111 million households, with most receiving refunds of $600 for individuals, $1,200 for couples and those with children an additional $300 per child.  The package also includes a Democratic-backed refund of $300 per individual and $600 per couple for 35 million working families whose wages are too low to pay income taxes.  The rebates would phase out quickly for individuals whose income exceeds $75,000, and couples with incomes above $150,000.  

So even though the rhetoric of a national emergency has been used to speed passage, the bill was still structured like a welfare program, the first clue that this action is more about politics than economics.  The Senate is likely to make the legislation even broader and more expensive.   Finance Committee chairman Sen. Max Baucus (D-MT) wants to add an extension of unemployment benefits, checks for retirees, and the removal of the income caps on tax rebates, raising the package to $196 billion.  Meanwhile, a front page story January 29 in the Capitol Hill newspaper The Hill opened with the warning, “K Street lobbyists sense a major opportunity with the upcoming stimulus package and are hoping to attach some of their own priorities this week to the moving legislation.”

Not only did the House pass the stimulus package without the normal round of committee hearings, but it embraced the White House notion of an economic crisis despite the forecast of its own staff at the Congressional Budget Office.  On January 23, CBO Director Peter Orszag presented a budget and economic outlook for fiscal years 2008 to 2018 before the House Committee on the Budget.  The forecast assumed the status quo, with no changes in current law, nor enactment of any stimulus package.  The CBO acknowledged that there was uncertainty in the economy, but CBO did “not expect the slowdown in economic growth to be large enough to register as a recession.” Economic growth would continue, but at a slower pace, running at 1.7 percent in 2008 compared to 2.2 percent in 2007.  America will still be growing faster than the other mature economies of Japan and the EU.  Then the CBO believes the economy will recover in 2009, rebounding to 2.9 percent growth.  So why the panic?

It’s the election, stupid!

President Bush does not want to leave office with the economy in recession, as it was when he came into office.  Every member of the House will be up for reelection this year, and an economic downturn is bad for incumbents.  The Democrats signed on fast because they are the majority, and were roundly criticized for leading a “do nothing Congress” last year.  From the political perspective, it is better to overstimulate the economy in an election year than risk a recession.  The political (as opposed to the fiscal cost) of a larger budget deficit due to the tax rebates will be minimal since both parties signed onto the policy.

The stimulus package is just a larger, more expensive version of the practice I witnessed decades ago as a student poll watcher in Chicago.  Campaign workers would slip a few bucks into the hands of voters to get then into the booth to pull the lever for the local political machine.  The new checks won’t go out to the public until summer, well past the time for immediate action if the economy is in trouble, but closer to election day.

The Commerce Department's report on GDP, released January 30, indicated that the economy slowed to a 0.6 percent annual growth rate in the fourth quarter of 2007, as the housing and credit bubble burst.  There will be residual effects from the decline in home prices and the need for lenders to improve their risk assessments before committing funds.  Reforms are needed in the wake of the financial crisis, which is where the focus should be.  The stimulus package is not, however, targeted on the sources of the economy’s problems.  It may even serve as a diversion that will slow reform, masking the symptoms as the underlying disease continues in the Federal Reserve’s easy money environment.

The tax rebates will also mask another core problem which has weakened the economy, making it more vulnerable to collateral damage from bubbles in key sectors.  The largest imbalance in the economy is the trade deficit, which hit $759 billion in 2006.  This sum dwarfs the $200 billion downward revision in GDP between the CBO’s August 2007 and January 2008 projections.  The stimulus may well make the trade deficit worse.  

Tax rebates were enacted in 2001.  At that time, Franco Modigliani and Robert Solow, both Nobel Prize-winning economists at the Massachusetts Institute of Technology, warned in a New York Times op-ed (April 9, 2001) that the stimulus would be weakened because consumers would spend part of the tax rebates on imports rather than on goods produced in the domestic economy by American workers.  By May 23, 2003, Business Week was reporting that the economists had been right, “The fiscal and monetary stimulus of the past two years has helped global producers as much as U.S. companies.” Earlier (Feb. 3, 2003), Business Week had noted, “Real GDP, after all, is a tally of domestic output, so when a bigger chunk of spending is satisfied by foreign suppliers, it's a drag on economic growth, especially in the manufacturing sector.” The current stimulus package is destined to repeat the mistake of the last tax rebate program – because no limitations on imports are in place.

Repeating mistakes is bad enough, but heralding mistakes as successful policy is even worse.  Republicans have been propagating the simple-minded myth that tax cuts to boost consumption demand is the engine of economic growth, even if financed by debt and fulfilled by production overseas.  Now the Democrats have signed on as well.

The GOP has gotten away with calling its program “supply-side economics” when it is nothing of the kind.  A true supply side program would be aimed at increasing domestic production and improving the income of Americans.  It would build infrastructure, and develop new technology and energy sources.  It would help business firms become more productive, and more competitive against overseas rivals.  It would boost consumption by helping the private sector create better paying jobs, rather than allow good jobs to be poached by foreigners.  But the need for major changes in economic policy will not become a campaign issue if the American people are pacified by nothing more than a government handout in an election year.

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