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The Bush administration is promoting two domestic policy initiatives to stimulate economic growth, an economic stimulus package and an energy policy. The economic stimulus package is primarily directed at helping revive the US economy immediately. The energy policy is designed to make the US economy less dependent on imported oil. Both are controversial.
The Economic Stimulus Program
With the evidence that the recession has ended there is less support for the Bush economic stimulus package. The concerns about the stimulus package are whether it is needed and, if needed, what mix of tax cuts and program spending would accomplish the objective of stimulating the economy. While a properly designed stimulus package would speed up the economic recovery, the differing opinions about the proper mix of spending and tax cuts have made such an initiative unlikely. The most controversial issue appears to be the proposed tax rate changes. The question is who should receive tax relief, and how much is appropriate to achieve the objectives without creating a future government deficit problem.
Tax rate cuts can fuel an economic recovery. As individuals’ disposable income increases, they spend more, creating jobs and income for others who spend and so on. If the tax rate cuts target individuals that are likely to spend, then a tax rate can be successful in stimulating the economy. If the tax rates manage to stimulate the economy, tax revenues may actually increase.
Which income group should receive the benefits of a tax cut? A reduction in tax rate aimed at individuals in the lower income brackets is most likely to result in increased economic activity. These individuals are much more likely to spend the additional disposable income, especially if they believe the change is permanent, thereby meeting the stimulus package’s objectives.
Individuals in the upper income bracket are less likely to spend and more likely save any increase in income from a tax rate cut. Individuals in the upper income bracket rarely deny themselves goods and services they desire. The upper income bracket is already saving a significant portion of their income and would likely save, rather than spend, any increase in income resulting from a tax rate cut.
Is tax relief necessary to stimulate the economy? Typically, during recessions consumers reduce their spending on goods and services. Unlike other recessions, consumers have not reduced their spending during the downturn. Retail sales and home sales remain high. As a result, it raises questions as to how successful a tax rate cut would be in stimulating the economy. If consumer or business spending does not increase significantly, the loss in tax revenues may have a negative impact on future economic growth.
The Energy Policy
The second policy initiative is less important in the short-term but extremely important in the long-term. As the US has become more and more dependent on imported oil, foreign agencies or governments can disrupt the US economy by withholding oil from the world markets and driving up oil prices. It happened in late 1970/early 1980 and more recently, just as the US economy was entering the current recession.
Higher oil prices contributed to the most recent problems with the US economy by reducing the consumer’s disposable income. The proposed energy policy if adopted would make the US less dependent on foreign countries and therefore reduce the swings in energy prices. With greater domestic production of oil and gas, the chance of disruptions to economic growth as a result of actions by the Organization of Oil Exporting Countries (OPEC) would be reduced.
Allowing outside agencies such as the or individual countries such as OPEC or Saudi Arabia to use oil as a policy weapon and disrupt the US economy by withholding oil should be unacceptable. OPEC (primarily Saudi Arabia) withheld oil from the world markets in the early 1980s and recently. The effect was to drive up the price of oil well above the cost of providing that oil. Because of the amount of oil imported by the US, this increase in price acts as a sudden tax increase to consumers without the offsetting benefits of increased government spending. The effect is similar to the Federal Reserve reducing the money supply. With a rapid increase in the price of oil you can expect the economy to contract or for economic growth to be reduced.
The controversy over the energy plan is about which resources should be developed. Of particular concern to environmental groups is oil drilling in the Arctic National Wildlife Refuge (ANWR). A second concern is the failure of the plan to place more emphasis on technological development and advocate conservation as a solution.
The controversy about who was on the task force to draft the energy policy is unfortunate. It is obvious that major input was received from the energy industry. The emphasis is on development of resources, with environmental policy and other issues to be studied. Still, as a working document it identifies issues and problems that need to be addressed.
I support the overall objectives of the energy plan, including development of oil and gas resources in ANWR. Vice President Cheney’s refusal to release the names of individuals that were instrumental in developing the plan can only distract from a rational discussion on the merits of the elements of the plan.
Stocks in the News
An economic recovery does not mean the stock market will rebound quickly. While the stock market tends to follow the economy, without a robust economic recovery, which appears unlikely at this time, the market appears to have entered a trading range that could last for months, if not years. The market will remain volatile as investor uncertainty remains about the speed of the economic recovery and accounting issues continue to surface.
More and more companies have begun to disclose accounting irregularities. It is almost impossible to identify these companies as so many large companies have multiple divisions and operate in many countries. The accounting scandal surrounding the Enron collapse may finally result in more reliable corporate financial reporting.
Stocks of companies that have an exposure to asbestos lawsuits will also be at risk. It appears that the president would like congress to limit liability to asbestos lawsuits. There will be considerable opposition to such a move. However, it is long overdue but should not be asbestos specific. Any legislation should address all nuisance lawsuits.
A prudent investor should avoid stocks of these companies unless they have a high tolerance for risk. While some of these stocks represent a good investment opportunity, as accounting irregularities may be overstated and the asbestos exposure may be reduced, these stocks are likely to fluctuate widely as concerns persist. Picking winners will not be easy.
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