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CounterPunch
January
17, 2003
A Tax Cut That
Would Sink the Economy
by MARIA TOMCHICK
The U.S. media is expending a lot of ink and air
time evaluating the potential economic effects of George Bush's
new tax-cut proposal. So far, most of the discussion has centered
around how much economic stimulus the plan will provide and how
long it will take to work. No one, however, is discussing the
very real possibility that George Bush's tax-cut, especially
the elimination of taxes on dividends, could harm the U.S. economy
and drive it deeper into a recession.
To understand how this might happen,
let's look at consumer spending, the one thing that's kept the
U.S. economy afloat amidst massive layoffs and corporate bankruptcies.
Low interest rates are primarily responsible for keeping consumer
spending alive; big-ticket items -- like new homes and cars --
are a great bargain right now because of low rates on mortgages
and auto loans. Despite the worst Christmas shopping season for
retailers since 1970 (when the government began to keep track
of shopping patterns), consumer spending is still going strong.
The Bush plan could change that by raising
interest rates. Removing the tax on dividends would make dividend-paying
stocks more attractive to investors than interest-paying investments:
bonds, certificates of deposits (CDs), money market funds, treasury
bills, bank savings accounts, etc., which are all taxable. To
attract investors to those interest-bearing investments, interest
rates would have to rise to offset what people pay in taxes.
So banks and finance companies, corporations, and the federal
government would have to pay more interest on their debts.
To recoup some of that interest paid
out on CDs, bonds, savings accounts, etc., banks and finance
companies would have to raise the interest rates they charge
on home-equity loans, auto loans, credit lines, credit cards,
and business loans. Mortgage rates would rise, too. Rising interest
rates could stop the hot housing market in its tracks, just as
increased rates on auto loans would make people decide to drive
their old car a little while longer than they're inclined to
do today. As finance companies raise the rates on credit cards,
more Americans would spend less on new purchases and focus instead
on paying down their credit card debt. This would send consumer
spending into a tailspin.
Currently, low interest on corporate
bonds and bank loans to businesses have allowed many debt-ridden
companies to continue to make payments on their debts. Once interest
rates rise, however, companies that are just barely keeping their
heads above water could find themselves squeezed from both ends:
lower consumer spending would mean lower profits, while higher
interest rates would mean the companies would have to pay more
to banks or to investors on their debts. This could start a second
wave of corporate bankruptcies.
Meanwhile, another fallout of cutting
taxes on dividends would negatively effect state and local governments.
Currently state and local governments, which are required to
balance their budgets and not operate in at a deficit like the
federal government, are struggling to plug enormous gaps between
their incoming tax revenue and their increasing expenses. The
Bush tax-cut plan could make those gaps even wider.
Here's how: state and local governments,
including school districts, fire districts, and cities, have
the ability to issue municipal bonds to pay for special projects,
construction, and even operating costs. For example, the State
of California has just issued bonds to help it pay for the high
energy costs the state incurred during its recent energy crisis.
Municipal bonds are tax-free for the
investor, making them highly attractive investments -- there's
no shortage of people who want them. Because they are one of
the few tax-free investments available, municipal bonds carry
very low interest rates, and this helps state and local governments
keep a lid on their debt costs.
But once the tax on dividends is removed,
the picture changes. To attract investors and compete with dividend-paying
stocks, municipal bond interest rates would have to rise. State
and local governments would then have to pay higher interest
expenses to investors, putting even more of a pinch on their
budgets. Returning to our example, if the Bush tax-cut plan passes,
the State of California could face bankruptcy.
Notably, state and local governments
are major employers and major spenders in nearly every community
in America. Taking this into account, the Bush tax-cut plan could
have the effect of destroying jobs and curbing spending at levels
not seen since the Great Depression.
But it gets worse. When state and local
governments are pinched and forced to cut services to the poor,
homeless, and unemployed during an economic downturn, the nonprofit
sector usually steps in to help. Nonprofit groups -- from food
banks and homeless shelters to groups providing job training
and education services -- subsist on donations primarily from
wealthy people. But once dividends become tax-free, many wealthy
people will no longer have an incentive to make charitable contributions
to offset their taxable income. Nonprofits would suffer a severe
funding shortage at a time when their services are needed more
than ever.
The Bush administration argument for
this tax-cut plan has focused on its ability to boost the stock
market. Yet a jump in the stock market doesn't usually lead to
a recovery, it usually <I>reflects</I> a recovery
that's already in progress. Most economists agree that corporate
profits have to increase in order for a recovery to begin. And
an increase in consumer spending across all sectors would boost
corporate profits immensely.
The Bush plan, however, puts money into
the hands of people who simply can't spend it. According to the
Center on Budget Policies and Priorities, the richest 5% of Americans
would receive two-thirds of the tax cut. These are people who
have already reached their top limit on spending; they simply
can't spend all the money they earn in a year. Most of his tax-cut,
then, would have no effect whatsoever on consumer spending.
Any tax-cut, even one that was more equitable
and aimed at people who are lower on the socio-economic scale,
would have a minimal economic stimulus effect, because during
economic downturns people tend to either save or pay down their
debts when they get extra cash. Bush's 2001 tax cut proved that.
It was a $1.3 trillion tax break that gave back $300 to every
working American -- much more than most people will see from
his new plan -- yet it did nothing to stop the economic downturn
prior to September 11.
A better proposal would be to take a
portion of the current tax-cut plan, maybe half (or about $300
billion), and simply give it to state and local governments to
help them plug the holes in their budgets, pay wages to employees,
and build infrastructure like roads and schools. This would provide
far more economic stimulus than the current plan, which would
only exacerbate our current economic woes.
Maria Tomchick
is co-editor and contributing writer
for Eat The State!,
a biweekly anti-authoritarian newspaper of political
opinion, research and humor, based in Seattle, Washington. She
can be reached at: tomchick@drizzle.com
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