RateWatch #338 – Tax Cuts
January 11, 2003 By Dick Lepre
dicklepre@rpm-mortgage.com

What's Happening

The technicals still indicate high volatility - the possibility of a large move in either direction. The
next few weeks are prone to large swings.

The BLS Employment Situation Report showed 101,000 fewer jobs in December. Some of this is due to seasonal corrections which allowed for a surge in retail positions which did not occur. In any case, the economy still has the "blahs."

Tax Cuts?

I wrote a sizable check this week to the US Treasury Department for my 4thQ estimate taxes so the issue of taxes became more than academic.

On Tuesday Bush introduced his tax cut.  The Democrats have an alternative.  Neither is very imaginative.

Tax cuts will stimulate the economy in the short-term which, I guess, is all that politicians care about.

What would have been much better is investment tax credits geared to seed the growth of the economy of the future.  The problem may be two-fold:  1) no one has a good handle on what the growth industries of the future really are and 2) past efforts to target sectors for fiscal stimulus have proved spotty, at best. 

A few weeks ago I wrote about targeting a hydrogen-based economy for investments tax credits but clearly we are not ready for it.  To some extent there are underlying technical problems but, more than that, there is not broad-based knowledge or support for this.  Too few people even know than you can produce energy from hydrogen. Arguing for hydrogen-base economy becomes akin to arguing for Esperanto. May be a good idea but ain't gonna happen.

It is easy to blame politicians for promoting whatever gets them elected but, to a significant extent, if that's what the voters want that is what they will get.  So we will have Joe Millionaire on TV, McDonalds hamburgers, and the kind of politicians that we have.

So, sadly, we are left with a couple of tired old tax cut packages.  The presumption, I think, is that the Bush plan will result in more investment because the elimination of the tax on dividends will return would-be tax receipts to a wealthier set of folks who are more likely to invest it than spend it. There is an underlying flaw with this seemingly intuitive notion.  The IRS reports that dividend
income is (roughly) divisible into 5 quintiles.

The following is a table of range of adjusted gross income and total dividend income:

The thesis that elimination of tax on dividends is going to result in big investment dollars seems, to me, shaky. An underlying reality is that stocks are no longer owned by the rich but by the 401K's of the middle class.  The notion that the elimination of a tax on dividends will benefit solely or mainly the rich is not based in reality.

One might conclude that the two tax-cut packages are about nothing more than posturing for the 2004 election.  We deserve better.

My underlying assumption is that consumer spending is still doing fine and an "across the board" tax cut is geared to stimulating consumer spending.

The real question, I think, is this:  assuming that the federal government is going into the hole, is it better off (economically) for the government to keep taxes where they are and to increase spending and hope that government spending will stimulate the economy?  More succinctly:
can the federal government spend dollars more wisely than consumers?

A sad fact is that we really do not know the result of changes in the economic forces of taxation, spending and interest rates.  I really do believe that we are gaining a better understanding of economics, fiscal policy and interest rates.  We are not yet to the point where we know exactly what dose of what drug the economy needs.

For myself, my background in science predisposes me to the belief that what is needed is a large investment in basic physics research.  A real understanding of the nature of energy and matter (the provenance of physics) might lead to a permanent solution to the energy issue and a whole lot more. Economic activity consists of work. Work is force times distance. Energy is the ability to do work.  We need new sources of energy and the manner in which they will be discovered is through basic physics research.

There are (at least) three problems with this:
1) it is not necessarily a set objective like going to the moon. It is a lot more amorphous than that.  The public can understand what going to the moon is but they do not know what the difference between fission and fusion is, and they have never heard of superstring theory
2) the people who understand science and what are its possibilities are, by their nature, not the sort of folks who understand how to muster political force for their own interests
3) the last time something like this was done was the superconducting supercollider which turned into a political disaster. Read this article about the history of the superconducting supercollider:
http://www.psncentral.com/research/SSC.htm

My advice: next time we have a large-scale project, locate it in Wyoming.

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