February 26 , 2003

Something did not ring true concerning Federal Reserve chairman Alan Greenspan's testimony before Congress last week. 

He argued, with some justification, that war concerns had delayed economic decisions.  As a result, he could not be sure how strong the underlying economy would be once those concerns were diminished.

He then stated that this uncertainty was an argument for delaying any further economic stimulus until those trends became more apparent. 

There was no question that the Chairman was becoming increasingly concerned about budget deficits into the future.  According to the Office of Management and Budget, not only would deficits exceed $300 billion in the current fiscal year, but they were projected to be higher next year.  And war with and occupation of Iraq was not included in those estimates. 

Moreover, in place of the $5.6 trillion of budget surpluses in the next decade, estimated just prior to the $1.3 trillion tax cut enacted in 2001, deficits would remain above $100 billion through 2008.  In place of worries about how monetary policy could continue with no available government bonds was concerns about how to place $9 trillion in government debt by the end of this decade. 

I share the Chairman's concerns about rising government debt well into the future.  After all, the baby boomers will become senior citizens by the end of the next decade and begin to draw more resources than will be paid through payroll taxes.  Currently, the government deficit is offset by almost $170 billion of payroll tax surpluses.  Excluding those social security surpluses, deficits would be approaching $500 billion in fiscal year 2004. 

However, his conclusion that uncertainty from war induced economic indecision should be met by government policy indecision simply is not justified.  Indeed, we should take out insurance to make sure that economic expansion occurs regardless of what happens to war in the Middle East. 

Of course, he is correct to worry about programs that produce long term revenue loss.  Those include the permanent elimination of estate taxes and the removal of the double taxation of dividends.  These are programs that could easily await the outcome of war uncertainties and the blossoming of economic growth.  If the revenues can justify further erosion of the tax base, then double taxation should be eliminated.  If the revenues are not there, this is a program that must await better deficit control by the federal government. 

(The elimination of estate taxes is an entire other issue that requires careful study.  Are the productive motivated by leaving a legacy to their progeny that more than offsets the potential damage generated by putting resources in the hands of those who had not earned them?)

On the other hand, moving already enacted tax cuts from 2004 and 2006 to 2003 provides the type of insurance that overcomes adverse effects from delayed decisions because of war concerns.  Indeed, I am surprised that Greenspan did not acknowledge that decision delays in a dynamic economic environment are themselves drags upon economic recovery. 

Moreover, I believe there are ample clues to suggest that the underlying economic strength is not as robust as the Chairman believes.  That $130 billion reduction in tax liabilities enacted last year to stimulate the economy has been exhausted. 

About $65 billion is being used to pay higher prices for energy materials.  Eventually, a portion of this will lead to higher energy development.  However, short term price spikes do not lead to that many newly drilled wells.  And 55 percent of the higher price tag goes to international producers. 

Another $50 billion is being absorbed by higher taxes and lower spending at the state and local government levels.  Thus, virtually none of the tax stimulus remains to drive the economy forward. 

Also, the continued erosion of household wealth from falling stock values continues to lead to higher household savings.  Combined with an exhaustion of SUV spending, consumption is more likely to grow more slowly than more rapidly in the next year. 

While housing has held up well, single family unit expansion now is occurring at the expense of apartment occupancy.  Actual housing growth probably is near a peak for the current expansion of households. 

Furthermore, two independent surveys suggest that corporations remain reluctant to increase capital spending.  Those surveys may be wrong, but they reflect the uncertainty that capital appropriations committees currently feel about economic prospects. 

In short, these factors suggest that underlying growth after wartime uncertainty is resolved may not be as robust as Greenspan believes.  Certainly, his forecast of 3 to 3.25 percent growth in the next twelve months is on the high side of most forecasts. 

His outlook may prove to be correct.  But I sure would like a little stimulus in the form of short term tax cuts to raise the odds in his favor. 


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