The Virginian Pilot, October 9, 2001 (B11)

Congress and the President are now committed to a fiscal stimulus worth 65 to 75 billion dollars. This is in addition to the 40 billion already pledged for reconstruction. What remains to be negotiated are the details of how tax policy and federal spending will change. If I might borrow from the physician's Hippocratic oath, Congress should ensure that its choices do no harm. This year's budget will likely move into the red, and that is no cause for alarm. A weakening economy naturally raises the government's spending obligations as it reduces revenues. What Congress must avoid are policy changes that further cloud an already darkening long-run budget picture.

The reasons for federal action seem plain enough. The shock to the nation’s air transport system has led directly to one hundred thousand layoffs, and another hundred thousand jobs in related firms (like Boeing) may go as well. New York may lose a substantial number of jobs, at least temporarily, because of the devastation in Manhattan. New security measures and public reluctance to fly may raise business costs somewhat, especially in the near term. Sizeable declines in broad stock market indices raise the risk that consumers will postpone spending on a wide range of durable goods. And although picking a market bottom is a fool’s errand, a slew of bad profit reports likely will keep equity markets volatile for a while.

As bad as these events are, we need to measure them against the size and wealth of the U.S. economy. An extra two hundred thousand unemployed workers adds a little over a tenth of a percent to the unemployment rate. And the stock market has savaged equity prices back to where they stood as recently as late 1998, when Alan Greenspan so eloquently warned us of the perils of irrational exuberance. In addition, the Fed has been ratcheting down short-term interest rates for over a year, and much of the stimulus to short-term borrowing by consumers and businesses remains in the pipeline. The latest cut last Tuesday pushed short term rates to levels not seen since Kennedy was debating Khruschev about missiles in Cuba.

Consumer confidence clearly is shakier than it has been in years. Indeed, the economy likely is in a recession, but consumer confidence surveys offer little information about its depth or duration. This is one reason Alan Greenspan warned last week against any ill-conceived rush to action.

Another is the widening chasm between long-term interest rates, over which he has little control, and the short-term rates that he has aggressively reduced. The long-term rate is the market's best guess of where the short-term rate will be in the future. Six months ago long-term interest rates were only slightly higher than short-term rates. Because the federal budget showed healthy surpluses to pay down existing federal debt, the market could safely forecast that government borrowing needs for baby-boomer retirement could be financed at roughly today's interest rates.

As the administration’s ten-year tax cut plan became a certainty, long-term rates on government securities moved up even as the Fed continued to push down short-term rates. The market clearly doesn't think those short-term rates can stay down for long. The only force keeping long-term rates from rising more is the temporarily depressed state of business investment.

The cloudier long-term federal budget picture bodes ill for future business investment in plant and equipment since increased government borrowing reduces the pool of savings available for other uses. This is why Greenspan has cautioned those

in the Republican leadership who favor permanent cuts in capital gains taxes and corporate taxes. These changes would further complicate the government's long run budget.

If Congress must act, any tax cuts or spending increases should be temporary and targeted to raise consumption immediately. A one-year reduction in the payroll tax rate for social security would reach all working Americans in ways the current Bush tax cut does not. And since firms directly pay half of their employees' social security contribution, the payroll tax cut would encourage firms to hold onto their employees through the downturn. This proposal is no panacea, since much of the tax cut might be saved instead of spent. But if Congress must act soon, this may be the best bet.

Better yet, couple the payroll tax cut with an agreement to revoke parts of the Bush plan that are concentrated in the "out-years," and whose benefits accrue primarily to the wealthiest one percent. Good candidates include the repeal of the estate tax and the reduction in gift taxes. After his recent address to Congress, President Bush warmly hugged Senator Tom Daschle. I suspect the political embrace doesn't extend quite this far.