Cut payroll taxes temporarily in move to boost consumption

October 01, 2001|By David H. Feldman

WILLIAMSBURG, Va. -- Three months ago, the odds strongly favored the U.S. economy dodging a recession.

The wild cards were consumer confidence and unfortunate foreign events.

Little could we imagine how these two potential problems so appallingly would collide.

The odds of a more severe downturn have changed enough to warrant taking stock of where we now stand.

The shock to the nation's air transport system has led directly to 100,000 layoffs, and another 100,000 jobs in related firms (like Boeing) may go as well.

New York may lose a substantial number of jobs, at least temporarily, because of the devastation in Manhattan.

New security measures and public reluctance to fly may raise business costs somewhat, especially in the near term.

Sizeable declines in broad stock market indices raise the risk that consumers will postpone spending on a wide range of durable goods.

And although picking a market bottom is a fool's errand, a slew of bad profit reports likely will keep equity markets volatile for a while.

The Conference Board said that its Consumer Confidence Index sank by more in September than at any time since the Persian Gulf war more than a decade ago, and much of the survey was completed before Sept. 11.

A Roper poll after the air attacks confirmed this recessionary consumer sentiment, yet found more than 70 percent optimistic about their personal prospects. Only 3 percent were pessimistic.

A recession we've likely got, but consumer confidence surveys offer little information about its depth or duration.

In October or November, after the initial shock wears off, we'll get a better reading of the American consumer.

After all, the Federal Reserve has been ratcheting down short-term interest rates for more than a year, and much of the stimulus to short-term borrowing by consumers and businesses remains in the pipeline.

As bad as these events are, we need to measure them against the size and wealth of the U.S. economy.

An extra 200,000 unemployed workers adds a little over one-tenth of a percent to the unemployment rate. And the stock market has savaged equity prices back to where they stood in 1998, when Alan Greenspan so eloquently warned us of the perils of "irrational exuberance."

We do face one problem that has been developing since March.

At that time, long-term interest rates were only slightly higher than short-term rates.

The long-term rate is the market's best guess of where the short-term rate will be in the future. Because the federal budget showed healthy surpluses to pay down existing federal debt, the market could safely forecast that government borrowing needs for baby-boomer retirement could be financed at roughly today's interest rates.

As the administration's 10-year tax cut plan became a certainty, long-term rates on government securities moved up even as the Fed continued aggressively to reduce short-term rates.

The market clearly doesn't think those short-term rates can stay down for long.

The cloudier long-term federal budget picture bodes ill for business investment in plant and equipment since future government deficits reduce the pool of savings available for businesses to borrow.

Higher rates on long-term bonds also may end the recent dip in mortgage rates for households.

And so as Congress debates its own $100 billion package to shore up consumption, Mr. Greenspan has cautioned against any ill-conceived rush to action.

His target are those in the Republican leadership who favor permanent cuts in capital gains taxes and corporate taxes, since these changes would further complicate the government's long run budget picture.

If Congress must act, any tax cuts or spending increases should be temporary and targeted to raise consumption immediately.

A one-year reduction in the payroll tax rate for social security would reach all working Americans in ways the Bush tax cut does not.

Better yet, couple this with an agreement to revoke parts of the tax cut that are concentrated in the "out-years" and whose benefits accrue primarily to the wealthiest 1 percent. Good candidates include the repeal of the estate tax and the reduction in gift taxes.

David H. Feldman is a professor in the Department of Economics at the College of William & Mary.

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