Will Pennies From Heaven Reinvigorate the Economy?

0 Comments | Insight on the News, June 25, 2001 | by Jamie Dettmer

Having finally passed the biggest tax cut since the Reagan era, politicians and economists now are debating belatedly when Americans can expect to see an improvement in the sluggish U.S. economy.

The more optimistic -- including Bush administration officials who sold the phased-in tax cut as a recession-beating measure -- maintain that an improvement will be noticeable sometime this summer. Treasury Secretary Paul O'Neill, who apparently has overcome his initial skepticism of the reviving effects of tax cuts, hopes that September will be the golden month.

The treasury secretary now says a reduced tax burden should boost economic growth. "The effect of this change could be a half a percentage point incremental ... rate of growth going forward in time because of the re-flow effects, the dynamic effect of what this will mean for savings and investment and consumption."

And the more bullish among investment bankers claim that the boost could be even more significant. Deutsche Banc Alex. Brown argues that the cut in income-tax rates that becomes effective July 1 is likely to add about 1.2 percentage points to the third-quarter growth rate and 0.7 percent to the rate for the final three months of the year.

But most economists are more cautious, maintaining that the series of cuts in interest rates by the Federal Reserve will be more important in reviving the economy. Before the tax cuts were enacted, most forecasters had predicted that growth would increase modestly in the second half of the year and accelerate into 2002 as a result of the Fed interventions.

That also is the view of Federal Reserve Chairman Alan Greenspan, who said recently, "Our front-loaded policy actions this year should be providing substantial support for a strengthening of economic activity later this year."

The more bullish tax-cut-related economic-growth claims are based on the assumption that consumers will spend about one-fourth of their refund checks of $300 for single taxpayers and $600 for married couples filing jointly. O'Neill has said he wants to accelerate the delivery of the 95 million refund checks, and he hopes to get them mailed before September. "I am looking for ways that we might be able to do better than the September period that people have been talking about," he said.

But the bullish growth predictions fly in the face of research undertaken by the Congressional Research Service back in 1992 analyzing the efficacy of using counter-cyclical fiscal policies.

The 10-page report -- whose details were unearthed by Insight before the tax cuts were enacted -- argued that the immediate effects of countercyclical manipulation tend to be small and that implementation of tax cuts or hikes are too laggardly to offset economic fluctuations. The report voiced grave skepticism of tax rebates as fiscal stimulants, noting that the great rebate President Gerald Ford implemented came after the economy already had turned.