Economic moves fail to impress

Response muted to rate boost, bids to alter taxes, cut spending


WASHINGTON -- Rarely does a single day bring such news as a Federal Reserve interest-rate increase, a presidential panel's recommended overhaul of the income tax code and congressional consideration of Medicare and Medicaid spending cuts.

These developments yesterday all resulted from efforts to put the economy on a more even keel for the long run, keep inflation in check and deal with the fiscal time bomb that many economic analysts say awaits the country in the next decade.

And yet they failed to impress either financial markets or economic experts. All three major stock indexes declined.

Analysts said the spending reductions being discussed in Congress appear to be too small in relation to long-term budget problems facing the country. They said the tax-reform plan would encounter huge political difficulties because it would seek to tackle such sacred cows as tax deductions for housing and health-care costs.

The Federal Reserve did as expected, raising its benchmark short-term interest rate for a 12th straight time to 4 percent, the highest level in four years. But despite the Fed's gradual monetary tightening, inflationary pressures are building from higher energy costs. And so the Fed vowed to keep on raising interest rates, and two or three more rate increases are anticipated.

"We have sort of an unsettled world in both fiscal and monetary policy," John Silvia, an economist at Wachovia Bank in Charlotte, N.C., said in noting the day's events. "I think there is a much higher level of uncertainty in financial markets."

The U.S. economy is still strong, posting a 3.8 percent annual growth rate in the third quarter, but many analysts see trouble ahead if inflation takes hold and the nation fails to get its fiscal house in order as retiring baby boomers put greater pressure on the federal budget.

Both houses of Congress are struggling to limit spending, partly to offset higher government costs from the recent Gulf Coast hurricanes.

The Senate is debating a measure that would curtail federal entitlement spending by $39 billion over five years, and the House is preparing its own package of spending cuts, likely to be of an equivalent magnitude.

Brian Riedl, budget expert for the Heritage Foundation, said a spending reduction is highly desirable, but "the savings [of $39 billion] will consist of little more than a rounding error over the next five years. This amounts to one-half of 1 percent of entitlement spending projected over the next five years."

Budget analysts say federal spending will mushroom, particularly for such programs as Medicare and Social Security, as the first wave of the baby boom generation enters retirement. And these two big programs must be tapped to bring the deficit under control, and reduce the risk to the economy from soaring debt levels in the next decade, said Rudy Penner, former Congressional Budget Office director and now an Urban Institute scholar.

Yet, Riedl said, lawmakers are having a difficult time dealing with even modest changes in federal entitlement programs, which make up 55 percent of the budget.

The Medicare and Medicaid proposals in the Senate bill won't hit recipients, but produce savings at the expense of drug companies and pharmacies. A plan to cut food stamps was dropped in the Senate, but a controversial House proposal would cut food stamps by $844 million and drop 300,000 people from the program and cut free lunches for about 40,000 schoolchildren.

Democrats ridiculed the Senate plan yesterday, saying that the deficit will increase when a Republican tax-cut bill totaling $70 billion is passed. But Sen. Judd Gregg, the New Hampshire Republican who is chairman of the Senate Budget Committee, said, "We can act now, or we can just bury our heads in the sand. It is not good policy to pass this problem on to our children."

Uncertainty also hangs over the Bush administration's tax-reform effort. The president's advisory panel recommended two proposals to overhaul the tax code yesterday that would eliminate or sharply limit many tax deductions, credits and other tax breaks. Taxes on savings would be eased, so that the income tax system would be tilted more toward taxing consumption than income.

The panel recommended that the home mortgage-interest deduction be converted into a credit equal to 15 percent of mortgage interest paid. There now is a $1 million limit on mortgages qualifying for the tax break. The panel called for lowering the cap on the mortgages eligible for the tax break to between $227,000 in cheaper housing markets and $412,000 in the most expensive markets. This would help raise funds to offset a repeal of the alternative minimum tax, a levy originally aimed at wealthy Americans that will hit millions more over the next several years.

Rep. Steny H. Hoyer, who represents Southern Maryland and is the No. 2 Democrat in the House, criticized the commission's report, saying the suggestions would make things worse for middle-class families.

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