It's the economy stupid. Those were the sentiments of Bill Clinton the first time he ran for President and the title of Phyllis Schafly's latest column. Politics sometimes comes down to a catchphrase and may get you elected. Bill used the feeling about the economy back in '92 to beat Bush the elder out of a second term. Schafly ask whether the same thing might happen this election cycle. After all we have all been hit over the head with economic talk from talking heads that have been predicting disaster on a daily basis. We even have another Clinton running for office, but no Bush although you would not no it from the Democratic candidates campaign rhetoric. Mantra seems to be what we hear from both sides of the aisle and Schafly ask if it will be nothing more then the same. Both sides seem to have their answers that can be pulled out of their pockets are read off at a moment's notice. The column points out that it has been certain U.S. policies that have created much of our current problems. This would include our dealings with immigration which has been minimal or pathetically inept. In Schafly's mind Free Trade has not lived up to its monikor, and the U.S. worker has payed the price. A debate over Free Trade can take place at another time. I agree that many are looking for those who can restore jobs and are looking at the candidates for answers.
http://www.eagleforum.org/column/2008/jan08/08-01-23.html
Courtesy of www.eagleforum.org
Showing posts with label economy. Show all posts
Showing posts with label economy. Show all posts
Tuesday, January 22, 2008
Friday, January 18, 2008
Why Tax Rate Reductions Are More Stimulative Than Rebates: Lessons from 2001 and 2003
January 18, 2008
by Brian M. Riedl
WebMemo #1776
With slower economic growth raising fears of a recession, Washington is abuzz with economic stimulus proposals centered on tax rebates. Tax rebates, however, don't stimulate the economy. Lawmakers currently examining economic stimulus proposals should reject rebates in favor of tax rate reductions.
Tax Rebates Don't Stimulate
By definition, an economy grows when it produces more goods and services than it did the year before. In 2007, Americans produced $13 trillion worth of goods and services, up 3 percent over 2006.
Economic growth requires four main factors: (1) an educated, trained, and motivated workforce; (2) sufficient levels of capital equipment and technology; (3) a solid infrastructure; and (4) a legal system and rule of law sufficient to enforce contracts and contain a functioning price system.
High tax rates reduce economic growth, because they make it less profitable to work, save, and invest. This translates into less work, saving, investment, and capital--and ultimately fewer goods and services. Reducing marginal income tax rates has been shown to motivate people to work more. Lower corporate and investment taxes encourage the savings and investment vital to producing more and better plants, equipment, and technology.
By contrast, tax rebates fail, because they do not encourage productivity or wealth creation. To receive a rebate, nobody has to work, save, invest, or create any new wealth.
Supporters of rebates argue that they "inject" new money into the economy, increasing demand and therefore production. But every dollar that government rebates "inject" into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It is merely redistributed from one group of people to another. (Even money borrowed from foreigners brings a reduction in net exports.)
Supporters of rebates respond that redistributing money from "savers" to "spenders" will lead to additional spending. That assumes that savers store their savings in mattresses, thereby removing it from the economy. In reality, nearly all Americans either invest their savings (which finances business investment) or deposit it in banks (which quickly lend it to others to spend). Therefore, the money is spent whether it is initially consumed or saved. Given that reality it is more responsible to let the savers keep that money for a new home or their children's education, rather than to have Washington redistribute it to someone else to spend at Best Buy.
Simply put, low tax rates encourage working, saving, and investing, which in turn encourages job creation and wage growth. Tax rebates merely redistribute existing wealth.
The Failed 2001 Tax Rebates
While the 2001 tax cuts reduced some marginal tax rates, the centerpiece was tax rebates. These rebates were rationalized as a pre-payment of the reduction of the lowest marginal income tax bracket from 15 percent to 10 percent. Yet because they were not based on encouraging productive behavior, the rebates had little economic impact.
In the spring and summer of 2001, Washington borrowed billions from the capital/investment markets, and then mailed it to families in the form of $600 checks. In the fourth quarter of that year, consumer spending responded with 7 percent annualized growth, and investment spending correspondingly decreased by 23 percent. The economy grew at a sluggish 1.6 percent annualized rate.[1] The simple redistribution from investment to consumption did not create new wealth.
All traces of the rebate policy effectively disappeared by the next quarter. Consumer spending retreated to 1.4 percent annualized growth, and investment spending partially recovered from its steep decline with a 13.6 percent annual growth. The economy remained stagnant through much of 2002.
The Successful 2003 Tax Rate Cuts
By contrast, the 2003 tax cuts lowered income, capital gains, and dividend tax rates. These policies were designed to increase market incentives to work, save, and invest, thus creating jobs and increasing economic growth. An analysis of the six quarters before and after the 2003 tax cuts (a short enough time frame to exclude the 2001 recession) shows that the policies worked:
by Brian M. Riedl
WebMemo #1776
With slower economic growth raising fears of a recession, Washington is abuzz with economic stimulus proposals centered on tax rebates. Tax rebates, however, don't stimulate the economy. Lawmakers currently examining economic stimulus proposals should reject rebates in favor of tax rate reductions.
Tax Rebates Don't Stimulate
By definition, an economy grows when it produces more goods and services than it did the year before. In 2007, Americans produced $13 trillion worth of goods and services, up 3 percent over 2006.
Economic growth requires four main factors: (1) an educated, trained, and motivated workforce; (2) sufficient levels of capital equipment and technology; (3) a solid infrastructure; and (4) a legal system and rule of law sufficient to enforce contracts and contain a functioning price system.
High tax rates reduce economic growth, because they make it less profitable to work, save, and invest. This translates into less work, saving, investment, and capital--and ultimately fewer goods and services. Reducing marginal income tax rates has been shown to motivate people to work more. Lower corporate and investment taxes encourage the savings and investment vital to producing more and better plants, equipment, and technology.
By contrast, tax rebates fail, because they do not encourage productivity or wealth creation. To receive a rebate, nobody has to work, save, invest, or create any new wealth.
Supporters of rebates argue that they "inject" new money into the economy, increasing demand and therefore production. But every dollar that government rebates "inject" into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It is merely redistributed from one group of people to another. (Even money borrowed from foreigners brings a reduction in net exports.)
Supporters of rebates respond that redistributing money from "savers" to "spenders" will lead to additional spending. That assumes that savers store their savings in mattresses, thereby removing it from the economy. In reality, nearly all Americans either invest their savings (which finances business investment) or deposit it in banks (which quickly lend it to others to spend). Therefore, the money is spent whether it is initially consumed or saved. Given that reality it is more responsible to let the savers keep that money for a new home or their children's education, rather than to have Washington redistribute it to someone else to spend at Best Buy.
Simply put, low tax rates encourage working, saving, and investing, which in turn encourages job creation and wage growth. Tax rebates merely redistribute existing wealth.
The Failed 2001 Tax Rebates
While the 2001 tax cuts reduced some marginal tax rates, the centerpiece was tax rebates. These rebates were rationalized as a pre-payment of the reduction of the lowest marginal income tax bracket from 15 percent to 10 percent. Yet because they were not based on encouraging productive behavior, the rebates had little economic impact.
In the spring and summer of 2001, Washington borrowed billions from the capital/investment markets, and then mailed it to families in the form of $600 checks. In the fourth quarter of that year, consumer spending responded with 7 percent annualized growth, and investment spending correspondingly decreased by 23 percent. The economy grew at a sluggish 1.6 percent annualized rate.[1] The simple redistribution from investment to consumption did not create new wealth.
All traces of the rebate policy effectively disappeared by the next quarter. Consumer spending retreated to 1.4 percent annualized growth, and investment spending partially recovered from its steep decline with a 13.6 percent annual growth. The economy remained stagnant through much of 2002.
The Successful 2003 Tax Rate Cuts
By contrast, the 2003 tax cuts lowered income, capital gains, and dividend tax rates. These policies were designed to increase market incentives to work, save, and invest, thus creating jobs and increasing economic growth. An analysis of the six quarters before and after the 2003 tax cuts (a short enough time frame to exclude the 2001 recession) shows that the policies worked:
- GDP grew at an annual rate of just 1.7 percent in the six quarters before the 2003 tax cuts. In the six quarters following the tax cuts, the growth rate was 4.1 percent.
- Non-residential fixed investment declined for 13 consecutive quarters before the 2003 tax cuts. Since then, it has expanded for 13 consecutive quarters.
- The S&P 500 dropped 18 percent in the six quarters before the 2003 tax cuts but increased by 32 percent over the next six quarters. Dividend payouts increased as well.
- The economy lost 267,000 jobs in the six quarters before the 2003 tax cuts. In the next six quarters, it added 307,000 jobs--and 5.3 million jobs over 13 quarters.[2]
Critics contend that the economy was already recovering and that this strong expansion would have occurred even without the tax cuts. While some growth was occurring naturally, critics do not explain why such a sudden and dramatic turnaround began at the exact moment that these pro-growth policies were enacted. They do not explain why business investment, the stock market, and job numbers suddenly turned around in spring 2003. It is no coincidence that the expansion was powered by strong investment growth, exactly as the tax cuts intended.
Conclusion
The 2003 tax rate cuts succeeded, because they increased incentives to work, save, and invest, thereby creating new wealth. The 2001 tax cuts, based more on demand-side tax rebates and redistribution, did not significantly increase economic growth. Lawmakers currently examining economic stimulus proposals should reject rebates in favor of tax rate reductions.
Brian M. Riedl is Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.
[1]U.S. Commerce Department, Bureau of Economic Analysis, NIPA Tables, Table 1.1.1, at www.bea.gov/bea/dn/nipaweb/SelectTable.asp (January 18, 2008).
[2]U.S. Commerce Department, Bureau of Economic Analysis, NIPA Tables, Table 1.1.1, revised, at www.bea.gov/bea/dn/nipaweb/SelectTable.asp (January 16, 2007); Yahoo Finance, "S&P 500 Index," at www.finance.yahoo.com/q/hp?s=%5EGSPC (January 16, 2007); and U.S. Department of Labor, Bureau of Labor Statistics, "Employment, Hours, and Earnings from the Current Employment Statistics survey (National)," at http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=CES0000000001&output_view=net_1mth (January 16, 2007).
Courtesy of The Heritage Foundation, find more articles at http://www.heritage.org/
Friday, September 21, 2007
Tough Love: Why the Federal Reserve Should NOT Cut Interest Rates
by Robert M. Clinger III
With the real estate bubble having burst and the financial system in a tizzy over the attending fallout in the mortgage markets, bankers, investors, homeowners, and CEOs are calling on the Federal Reserve's Federal Open Market Committee (FOMC) to cut the federal funds rate in an effort to avert a financial meltdown. However, the Federal Reserve should see through these self-serving calls and hold rates steady for the time being.
A cut in the federal funds rate, or several cuts as the futures markets are predicting, may well spur growth in GDP from the tepid rate of the first half of the year. With this, however, comes the risk of increasing inflationary pressures at a time when inflation is likely to remain above a comfortable level for maximum economic output. In addition, increased economic activity resulting from lower interest rates at a time of sustained higher energy prices could result in inflationary pressures spiraling out of control.
A cut in the federal funds rate would also likely result in a long-term strengthening in the dollar. With the dollar currently weak in the foreign exchange markets, consumers here in America may find domestic-made goods less expensive than imported foreign goods. Likewise, foreign trading partners would find American produced goods relatively less expensive than their own domestic goods. Thus, the weaker dollar may well lead to a shrinking of the current account deficit. Cutting rates and strengthening the dollar could lead to an increased current account deficit which could have adverse economic consequences.
Further, a cut in rates now may well lead to increased spending by consumers, many of whom have already spent beyond their means. Higher rates have reduced the proclivity of consumers to make purchases on credit and have prompted repayment of debt and increased savings. This increased savings comes at a time when America has become a nation of dissavers in recent years.
More importantly, cutting rates now is not going to stem the much needed cooling of the housing market. Highly accommodative monetary policy that saw the federal funds rate cut to 1% was what the economy needed in the aftermath of September 11, 2001 and likely helped to avert a potentially deep recession. However, the FOMC, as is so often the case, overshot on the downside by cutting rates so aggressively. The environment of virtually free money, credit, and mortgages from 2002 to 2004 created a moral hazard--mortgage companies and banks loaned money for real estate purchases to many individuals who otherwise would not have been able to afford such investments. At one point, exotic mortgages (reverse amortization for example) and interest only mortgages accounted for over half of those underwritten.
Cheap money could not last forever, and, ultimately, the time would come to pay the piper when rates began to rise. Little heed, evidently, was given by lenders to the ability to service the debt obligation when rates increased down the road. By then, the underwriters would have packaged and resold those loans to other investors. Consumers also failed to consider the consequences of when the music stopped and they were unable to pay for purchases made on credit that had been and were still beyond their means. The irrational exuberance that surrounded the noble desire to achieve the American dream of home ownership clouded some consumer's and lender's judgment.
The blame for the current situation has to be shared by all parties. Consumers thirsted for the American dream but spent beyond their means with mortgages and credit cards. Lenders made the American dream sound possible with sales pitches that seemed too good to be true. Investors bought speculative properties and flipped them for quick gains with what was perceived to be no risk, driving up prices in some places and further fueling the exuberance. The FOMC failed to take the punch bowl away whilst the party was still going strong by opting for a measured removal of accommodative monetary policy in twenty-five basis point increments. Whereas their rate cuts had, at times been in fifty basis point increments, their reaction in removing accommodation was weak and timid.
Through all of this, did no one--lenders, consumers, investors, the Federal Reserve policymakers--recall the old adage, "If it seems too good to be true, it probably isn't true?"
Now that the party is over and everyone has a bad hangover, these same partygoers are turning to the Fed to bail them out of the problems that they have created. During the Greenspan era at the Fed, investors and financial market participants manifested in their minds the existence of a protective "Greenspan put"-the notion that the Fed would aggressively cut interest rates to avoid a steep decline in the markets. Indeed, the Fed cut rates in the early 1990s following the savings and loan crisis and again in the late 1990s following the Asian contagion and bailed out the markets following the collapse of Long-Term Capital Management.
The mandate of the Federal Reserve, however, is not to protect the markets from sharp declines. The mandate of the Fed is, as defined by the Federal Reserve Act, to "maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." Whilst working to ensure the stability in the overall financial system is important, this should in no way imply that the Fed should bail investors out of bad investment decisions. Declines in markets (a.k.a. corrections) are a perfectly natural part of a well-functioning, orderly financial system and serve to adjust asset prices towards more fundamental valuations.
To be sure, the Fed should not cut interest rates now. Yes, credit conditions did deteriorate considerably in mid- to late August. The injection of over $69 billion into the system coupled with a cut in the discount rate helped shore up confidence amongst lending institutions. But cutting the federal funds rate (leading to lower interest rates overall) will not stop the pain the real estate market is feeling and the further pain that is to come. To stop the default on loans and subsequent foreclosure on properties with adjustable rate mortgages would require a cut in rates to levels of 2003 and 2004 when the federal funds rate was still under 2.25%. However, consumers who are already stretched too thin and who are buried under mountains of mortgage and credit card debt would still not likely be able to satisfy their debt obligations. Additionally, such a dramatic cut in rates again would start a vicious cycle of loose policy all over, further compounding the situation.
But more importantly, doing so would send a signal to the financial markets that this Fed will bail them out when they get into trouble as a result of bad investment decisions. Thus, the Fed would be obligated to bail out the next hedge fund that goes bust, and the next one, and the next publicly-traded mortgage lender that goes under, etc. Much like a spoiled child whose parents continue to bail him out of trouble without any consequences, the Fed would play this role well for unruly investors. And like the spoiled child, the investors would never learn their lessons. No, what we need is tough love from the Fed. Let the markets and investors sort this one out on their own. The Fed must hold rates steady. After all, the best lesson is a bought lesson, and it appears that investors and lenders may have bought and paid for this one to the tune of $50-$100 billion.
Robert M. Clinger III & Sebastian G. PereyCopyright 2007 Thinking Outside the Boxehttp://www.thinkingoutsidetheboxe.com/
Article Source: http://www.articlecube.com/
With the real estate bubble having burst and the financial system in a tizzy over the attending fallout in the mortgage markets, bankers, investors, homeowners, and CEOs are calling on the Federal Reserve's Federal Open Market Committee (FOMC) to cut the federal funds rate in an effort to avert a financial meltdown. However, the Federal Reserve should see through these self-serving calls and hold rates steady for the time being.
A cut in the federal funds rate, or several cuts as the futures markets are predicting, may well spur growth in GDP from the tepid rate of the first half of the year. With this, however, comes the risk of increasing inflationary pressures at a time when inflation is likely to remain above a comfortable level for maximum economic output. In addition, increased economic activity resulting from lower interest rates at a time of sustained higher energy prices could result in inflationary pressures spiraling out of control.
A cut in the federal funds rate would also likely result in a long-term strengthening in the dollar. With the dollar currently weak in the foreign exchange markets, consumers here in America may find domestic-made goods less expensive than imported foreign goods. Likewise, foreign trading partners would find American produced goods relatively less expensive than their own domestic goods. Thus, the weaker dollar may well lead to a shrinking of the current account deficit. Cutting rates and strengthening the dollar could lead to an increased current account deficit which could have adverse economic consequences.
Further, a cut in rates now may well lead to increased spending by consumers, many of whom have already spent beyond their means. Higher rates have reduced the proclivity of consumers to make purchases on credit and have prompted repayment of debt and increased savings. This increased savings comes at a time when America has become a nation of dissavers in recent years.
More importantly, cutting rates now is not going to stem the much needed cooling of the housing market. Highly accommodative monetary policy that saw the federal funds rate cut to 1% was what the economy needed in the aftermath of September 11, 2001 and likely helped to avert a potentially deep recession. However, the FOMC, as is so often the case, overshot on the downside by cutting rates so aggressively. The environment of virtually free money, credit, and mortgages from 2002 to 2004 created a moral hazard--mortgage companies and banks loaned money for real estate purchases to many individuals who otherwise would not have been able to afford such investments. At one point, exotic mortgages (reverse amortization for example) and interest only mortgages accounted for over half of those underwritten.
Cheap money could not last forever, and, ultimately, the time would come to pay the piper when rates began to rise. Little heed, evidently, was given by lenders to the ability to service the debt obligation when rates increased down the road. By then, the underwriters would have packaged and resold those loans to other investors. Consumers also failed to consider the consequences of when the music stopped and they were unable to pay for purchases made on credit that had been and were still beyond their means. The irrational exuberance that surrounded the noble desire to achieve the American dream of home ownership clouded some consumer's and lender's judgment.
The blame for the current situation has to be shared by all parties. Consumers thirsted for the American dream but spent beyond their means with mortgages and credit cards. Lenders made the American dream sound possible with sales pitches that seemed too good to be true. Investors bought speculative properties and flipped them for quick gains with what was perceived to be no risk, driving up prices in some places and further fueling the exuberance. The FOMC failed to take the punch bowl away whilst the party was still going strong by opting for a measured removal of accommodative monetary policy in twenty-five basis point increments. Whereas their rate cuts had, at times been in fifty basis point increments, their reaction in removing accommodation was weak and timid.
Through all of this, did no one--lenders, consumers, investors, the Federal Reserve policymakers--recall the old adage, "If it seems too good to be true, it probably isn't true?"
Now that the party is over and everyone has a bad hangover, these same partygoers are turning to the Fed to bail them out of the problems that they have created. During the Greenspan era at the Fed, investors and financial market participants manifested in their minds the existence of a protective "Greenspan put"-the notion that the Fed would aggressively cut interest rates to avoid a steep decline in the markets. Indeed, the Fed cut rates in the early 1990s following the savings and loan crisis and again in the late 1990s following the Asian contagion and bailed out the markets following the collapse of Long-Term Capital Management.
The mandate of the Federal Reserve, however, is not to protect the markets from sharp declines. The mandate of the Fed is, as defined by the Federal Reserve Act, to "maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." Whilst working to ensure the stability in the overall financial system is important, this should in no way imply that the Fed should bail investors out of bad investment decisions. Declines in markets (a.k.a. corrections) are a perfectly natural part of a well-functioning, orderly financial system and serve to adjust asset prices towards more fundamental valuations.
To be sure, the Fed should not cut interest rates now. Yes, credit conditions did deteriorate considerably in mid- to late August. The injection of over $69 billion into the system coupled with a cut in the discount rate helped shore up confidence amongst lending institutions. But cutting the federal funds rate (leading to lower interest rates overall) will not stop the pain the real estate market is feeling and the further pain that is to come. To stop the default on loans and subsequent foreclosure on properties with adjustable rate mortgages would require a cut in rates to levels of 2003 and 2004 when the federal funds rate was still under 2.25%. However, consumers who are already stretched too thin and who are buried under mountains of mortgage and credit card debt would still not likely be able to satisfy their debt obligations. Additionally, such a dramatic cut in rates again would start a vicious cycle of loose policy all over, further compounding the situation.
But more importantly, doing so would send a signal to the financial markets that this Fed will bail them out when they get into trouble as a result of bad investment decisions. Thus, the Fed would be obligated to bail out the next hedge fund that goes bust, and the next one, and the next publicly-traded mortgage lender that goes under, etc. Much like a spoiled child whose parents continue to bail him out of trouble without any consequences, the Fed would play this role well for unruly investors. And like the spoiled child, the investors would never learn their lessons. No, what we need is tough love from the Fed. Let the markets and investors sort this one out on their own. The Fed must hold rates steady. After all, the best lesson is a bought lesson, and it appears that investors and lenders may have bought and paid for this one to the tune of $50-$100 billion.
Robert M. Clinger III & Sebastian G. PereyCopyright 2007 Thinking Outside the Boxehttp://www.thinkingoutsidetheboxe.com/
Article Source: http://www.articlecube.com/
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