Economic Stimulus - Whose Plan is Best?

IN THIS ISSUE:

1. The Bush Stimulus Plan – Pluses & Minuses.

2. The Democrats’ Plan – Pluses & Minuses.

3. At The End Of The Day, It’s All Politics As Usual.

4. It Could be Mid-year Before Any Plan Passes.

5. Why We May Need No Stimulus Package At All.

President Bush’s Economic Stimulus Plan

In an effort to pre-empt the Democrats’ plan, the White House said on Monday that Bush’s stimulus plan would include $600 billion in expenditures over 10 years to boost the economy, including providing over 90 million taxpayers with a tax cut this year and benefit some 35 million people who get income from dividends. "The president's plan will encourage consumer spending, it will promote investment throughout our country and in the business community and in small business, and it will also help the unemployed.", said White House spokesman Ari Fleischer on Monday.

The Democrats, as expected, have been railing that the Bush plan is merely more “tax breaks for the rich,” it doesn’t help the working class and it won’t help the economy in the near-term. What else is new? But before we go there, let’s look at the highlights of Bush’s latest plan:

1. $600 billion in new spending and tax reduction over 10 years;

2. Accelerate the 2004 tax cut into this year (more on this later);

3. Eliminate entirely the tax on stock dividends paid to investors;

4. Corporations – accelerated tax write-offs for capital spending;

5. Increase tax credits for families with children to $1,000;

6. Extend federal unemployment benefits; and

7. $10 billion in new financial aid to the states.

According to White House estimates, Bush’s new plan would provide 92 million taxpayers with an average tax cut of $1,083 in 2003. Fleischer said 46 million married couples would receive average tax cuts of $1,716; 34 million families with children will benefit from average tax cuts of $1,473; and 13 million elderly taxpayers would receive a $1,384 tax cut. The White House didn’t reveal how these tax cut estimates were calculated. "So the president's plan is a plan that helps all Americans," said Fleischer, including those in all tax brackets.

A big part of Bush’s stimulus plan is the complete elimination of taxes paid on dividends by corporate shareholders. Currently, corporations are taxed on their profits, and shareholders are also taxed on these profits when they are distributed as dividends. The White House estimates that this change will cost apprx. $300 billion over 10 years, and believes it could boost stock prices significantly over the coming years.

Another big deal is the extension of unemployment benefits. Until recently, President Bush was said to have been firmly opposed to such an extension, but he has obviously changed his mind due to political pressures (more on this later).

The Democrats’ Stimulus Plan

The Dems, who are notorious for disliking tax cuts, offered a substantially smaller stimulus package but claimed it would have much more immediate economic benefits than the Bush plan and without ballooning the budget deficits. Here are the highlights of the Democrats’ stimulus plan:

1. $100 billion in tax cuts targeted at low income groups;

2. Tax rebate of $600 for couples and $300 for individuals;

3. Increased tax write-offs, but only for small businesses;

4. Extend unemployment benefits another 26 weeks; and

5. $30 billion in federal aid to the states.

Newly elected House Minority Leader Nancy Pelosi had the following to say on Monday about the Democrats’ stimulus plan: "[It’s] a real stimulus that is fair, that is fast-acting and that is fiscally possible …in the Bush administration, joblessness is rampant … [READ CAREFULLY] it's the first presidency in modern history where jobs are going below the line instead of increasing."

First time in modern history? Say what, Ms. Pelosi?? I guess she conveniently forgot about the recessions of 1970, 1974, 1980-82 and 1990-91 when unemployment went up. [Hint: she knows most Americans won’t realize she’s dead wrong on this. It just scalds me when politicians (of either party) make statements which are totally and purposely wrong to support their positions! But that’s another discussion for another time, I guess.]

The point is, the Democrats, generally speaking, dislike tax cuts and always push for lower (if any) tax relief and say whatever is politically supportive of their position at the time.

Which Plan Is Best?

Despite all the rhetoric by both parties, here is the essence of the difference between the two stimulus plans. Bush’s plan is dominated by tax cuts, while the Democrats’ plan is dominated by increased government spending. Bush’s plan is designed to provide stimulus over the long-term, while the Dems’ plan is heavily front-loaded for the near-term. Bush’s plan would increase the budget deficit more than the Dems’ plan, at least in the first year or two.

Which plan is best depends on your political and economic persuasion. If you believe 1) that tax cuts are good for the economy, and 2) we will once again grow our way out of budget deficits (as we did in the Clinton years), then you will conclude that the Bush plan is the best.

If, on the other hand, you 1) do not believe that tax cuts boost the economy (and only benefit the wealthy), and 2) that more federal spending out of the Treasury is the best way to help the economy, then you will conclude that the Democrats’ plan is best.

A Few Questions, Please, Politics Aside

First, the Democrats say their plan is better in the short-run. Question: How is the Dems’ maximum tax cut of $600 for a family in 2003 better than Bush’s average of $1,473 for a family with children (assuming their estimates are reasonable)? I don’t get it.

Second, will the Bush administration admit that there is no guarantee that their plan will result in an economic boom that allows us to balance the budget again in a few years? It is true that tax cuts in the 1980s under Reagan, and subsequent tax reductions, resulted in an increase in total tax receipts and contributed greatly to the economic boom of the ‘90s. But there is no guarantee the same result will occur this time around.

Third, whichever plan is adopted, what assurance is there that Americans are going to spend the tax cuts and spur the economy? There is none! It appears we are about to start a new war with Iraq in the next 60 days, and people are very nervous about that, not to mention the economy and the stock markets. What if most Americans simply decide to save the tax cut money, whatever it turns out to be, and wait to see what happens? It could happen, in which case the net result for the economy is more or less neutral.

Let Me Be Clear About One Thing

I have never met a tax cut that I didn’t like! I believe that sending more of our hard-earned money to Washington is a bad thing. I believed this when I was in the lowest tax bracket, and I have believed it for all the years I have been in the highest tax bracket. So, I like tax cuts whenever they are suggested. But there’s a caveat. I believe (and have for over 20 years) that: tax cuts should be accompanied by reductions in the size of the federal government.

This never happens, of course, as the size of government just gets larger over time. The annual federal budget has never decreased, at least in the last 25 years I have followed it.

The Two Strategies – It’s All About 2004

While the two stimulus packages are vastly different, both are a part of the respective political strategies for the 2004 presidential elections. President Bush’s plan is longer-term oriented with the goal of having the economy humming along strongly in 2004. He does not want to make the same mistake his father did in 1990/91.

The Democrats, first and foremost, could not afford to be seen as doing nothing about the economy, so they came up with a much smaller stimulus plan that is front-loaded. As noted above, their plan has a much smaller tax cut and is mostly new federal spending. This lowers the odds that the economy will be booming in 2004 during election season.

The Democrats are also positioning themselves as the “deficit hawks.” You can expect all the rhetoric about the Bush plan being a “budget buster” to accelerate in the days and weeks ahead.

The Likely Outcome

President Bush is very likely to get some form of his stimulus package passed, now that Republicans control both houses of Congress. However, if I had to bet today, I doubt he will get everything he wants. My guess is that he will agree to some modification on the dividends tax, either by agreeing only to lower the tax but not eliminate it, or abandoning this change altogether.

Whatever happens, it could well be mid-year, or even longer, before any stimulus package is signed into law. With the two plans so polarized, debate in Congress will almost certainly drag out for a long time.

It could very well be that the stimulus finally comes into effect just at the time when the economy is recovering very nicely on its own, which raises the question...

Do We Even Need A Stimulus Package?

The US economy grew faster in 2002 than most economists and market analysts predicted. Gross domestic product grew at an annual rate of 5%, 1.3% and 4% respectively in the first three quarters of 2002 and is expected to have been around 2% in the 4Q. That’s an average of 3% for the year. As for 2003, my best sources believe we will see continued economic growth with another 3% year, or better, assuming there are no more serious terrorist attacks in the US.

All of this raises the question of whether we even need a stimulus package now. To hear the mainstream media and the Democrats talk, the economy is absolutely horrible and 6% unemployment is horrendous. Yet 3% economic growth is very positive, especially in the wake of 911, and 6% unemployment was what used to be considered “full employment” only a few years ago.

On this issue of whether we need a stimulus package, I suggest that you read the very good article by The Economist in SPECIAL ARTICLES below. This article contains some very educational points about how tax cuts, fiscal stimulus and monetary policy may, or may not, affect the economy.

Conclusions

Following their defeat in the mid-term elections, the Democrats have circled the wagons. They seem to want to position themselves to be as different as possible from President Bush, while at the same time hoping the president makes a critical mistake or two between now and election time in 2004. As discussed above, their stimulus plan is an example of being different from, and opposed to, the president’s plan.

The Dems’ plan targets its relief to those in the lower income brackets, while Bush’s plan provides tax cuts to all Americans. I can’t help but point out a statistic I have written about in past E-Letters. That is, the bottom 50% of US taxpayers pay less than 4% of all income taxes collected. The Dems’ game of “class warfare” and “tax cuts for the rich” plays very well to this audience.

Bush is making a big gamble that the economy will be stronger in 2004, in part due to his tax cuts and stimulus. He may be correct, especially if there are no more serious terrorist attacks, or other major negative surprises, in the US between now and election time. If he is wrong, however, the Democrats will scream, “We told you so!” and could be in a substantially better position in 2004 than they are today.

If we are going to have a stimulus package, I favor the Bush plan over the Democrats’ plan. But as noted above, I believe tax cuts should be coupled with reductions in the size of government (not likely to happen).

Whatever happens, it will be interesting to watch the political wrangling over tax cuts and stimulus in the weeks ahead. The equity markets are likely to continue to be quite volatile, especially as we draw closer to war with Iraq. We could see another excellent buying opportunity in stocks and mutual funds just ahead when (and if) the war unfolds.

All of this uncertainty continues to suggest using “market timing” strategies for most of your equity investments this year. You can get my new 12-page SPECIAL REPORT on Market-Timing, free of charge, at www.profutures.com or call us toll free at 800-348-3601.

HAPPY NEW YEAR,

Gary D. Halbert

SPECIAL ARTICLES

The Economist – Do we need a stimulus package?

The Bush stimulus plan.

The Democrats’ stimulus plan.