Now's The Time For A Stimulus...

The case for an "economic stimulus" is that our present predicament is unprecedented. We are reacting to both the largest terrorist attack in U.S. history and the aftermath of the biggest economic boom in U.S. history. American spirits and spending may (or may not) revive quickly. We don't know. Before the attacks, business investment and exports were declining while growth in consumer spending and housing was weakening. The economy was at a standstill--or in recession. Prospects are now worse. In late September initial weekly unemployment claims hit 450,000, the highest since 1992. If the government doesn't give the economy a shove, it's not clear what will.

But what's justified in principle could be botched in practice. As Alan Greenspan warns, it is better "to be right than quick." The danger is that a stimulus package might become (along with anything labeled "antiterrorism") a vehicle for all sorts of dubious tax giveaways or pork-barrel-spending increases. Three guidelines suggest themselves: (a) any stimulus program should be simple and noncontroversial, something the White House and Congress could enact quickly; (b) because the need for "stimulus" is temporary, it should not result in new permanent cuts in taxes or increases in spending, and (c) it should be effective in supporting the economy.

Proposals for cuts in corporate tax rates fail on all counts. They would be immensely controversial, would permanently erode the tax base and wouldn't revive the economy. The central need now is to restore consumer confidence and spending. Businesses won't invest if consumers aren't buying. By contrast, there is an obvious way to spur the economy: advance the effective dates of this year's tax cuts. These go mainly to consumers, and advancing the effective dates wouldn't involve new permanent tax cuts. If President Bush and congressional leaders (Republicans and Democrats) want to compromise, they could easily craft a deal to minimize controversy.

Democrats had two objections to the original bill: it cost too much and favored the wealthy. A conciliatory White House would accelerate the parts of the tax cut that most benefit the middle class. For example, the child tax credit increased from $500 to $600 this year and would rise to $700 in 2005, $800 in 2009 and $1,000 in 2010. The entire increase could be done in the next year or two. Similarly, expanding the amount of income subject to the new 10 percent rate (now scheduled for 2008) could be done next year. Republicans might also trim cuts for the two top tax brackets by 1 percentage point (so top rates would become 36 and 34 percent). In return Democrats would support making rate cuts in the next three years--instead of between 2004 and 2006.

Finally, faster tax cuts--if quickly reflected in withholding tables--stand the best chance of aiding the economy. Economist Nicholas Souleles of the University of Pennsylvania has compared how Americans react to annual tax refunds (similar to one-time tax rebates) and permanent cuts in tax withholding rates. When withholding rates drop, consumers spend from 60 to 90 percent of the income gain within three months; by contrast, they spend only 35 to 60 percent of tax refunds. The experience with this year's tax rebate seems even worse. A University of Michigan survey found that only 18 percent of respondents said they would spend their rebate.

If any government spending is included in a stimulus proposal, it should also be simple, temporary--and noncontroversial. One idea would be to give some extra funds to states for a year or two to help them avoid cutting their own budgets or raising taxes. Most states have balanced-budget requirements, so a slowing economy means they have to do one or the other. Don Boyd of the Rockefeller Institute of Government at the State University of New York projects that state budgets will rise only 1.3 percent in 2002 after adjusting for inflation.

There is already some "stimulus" in the pipeline: more spending for defense, reconstruction, the airline "bailout" and higher unemployment benefits. The Congressional Budget Office has reportedly told congressional committees that spending in fiscal 2002 could be $50 billion to $60 billion higher than previously projected. Any new stimulus program would be added to this spending. The right amount for an extra program looks to be in the range of $50 billion to $90 billion. Altogether, the government's shove to the economy would total between $100 billion and $150 billion.

Let's be clear: a stimulus package can't work miracles. We have a $10 trillion economy (that's gross domestic product--the total of all spending). It can't be flipped like a pancake. A boost of $100 billion to $150 billion from government would amount to at most 1.5 percent of GDP. The recovery process would still require time: time for excess inventories to be sold; time for consumers and businesses to pay down debt to comfortable levels; time for the weakest companies to go bankrupt, aiding the sales and profits of survivors; time for the Federal Reserve's lower interest rates to relieve debt burdens.

What a stimulus package might do is hasten the process. If we ultimately need higher spending for foreign and "homeland" defense, we will have to bear the costs with higher taxes. But for now we need to concentrate on preventing a bad situation from becoming worse. The present economic outlook depends as much on psychology as on finance. A prudently designed stimulus program is an investment in confidence. It's worth the price.