A Tax Cut That Would Sink The Economy
by Maria Tomchick
Dissident Voice
January 13, 2003
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 reflects 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 a 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 may
be contacted at: tomchick@drizzle.com