Economy Faltering

The economy was supported in 2002 by government spending and the housing market as the consumer began to curtail spending late in the year. With state and local governments expected to make major reductions in spending and employment, only the housing market is supporting continued growth.

With debt at record levels and no improvement in the employment picture, there is concern that housing may be the next bubble to burst. While the debt levels are a concern, some of the higher level is a result of greater home ownership and lending to consumers that would not have qualified in the past. The fear is that these marginally qualified consumers are those most at risk of being unable to repay. In addition, if home values begin to drop the consumer may curtail spending further.

The hope for the economy is that the proposed tax cuts will stimulate the economy. The problem is that any benefit from a tax cut may be more than offset by the increasing price of oil. Problems in Venezuela and the threat of another Gulf war have sent the price of oil to over $30 a barrel. The past two downturns have been brought on by the rising price of oil during a shaky economy.

Assuming a normal price for oil of $25 a barrel, every $1 increase in price represents a tax of $6.8 billion a year, split evenly between foreign oil companies and governments and domestic producers. At $35 a barrel, near today’s level, the tax cut is offset by the increase in the price of oil. The negative effect on the economy from the increase in oil prices would be greater than a tax cut because more people would be directly affected.

Could other OPEC member countries increase production to offset the impact of a war in Iraq? Most OPEC countries are already producing near revenue-maximizing production levels. Saudi Arabia could increase output for a short period but is unlikely to sustain that level because of long term damage to their oil fields. Assuming the war is over quickly and little damage to the oil field occurs, world production could be back at levels to move the price of oil to its long-term trend, below $25 a barrel.

The economy may continue to muddle along, neither returning to recession nor to robust growth, unless we have a war. There is little in the data to suggest this is going to change for this year.

The Bush Economic Stimulus Plan

There is little in the Bush stimulus package that would suggest the proposed tax cut or spending package will help the economy. The proposals as presented offer little in the way of putting money in the hands of those who would spend. I would grade the proposals as follows:

Elimination of taxes on dividends--D-.

As proposed the elimination of taxes on dividends would be to the investor not the company. Most of the benefits would accrue to the wealthy and would not impact their spending. It would have little impact on the stock market except to shift investor’s preference to dividend-paying stocks at the expense of growth stocks. It would also increase the deficit significantly. Corporations would have no additional money to invest. However, if corporations were permitted to deduct dividends as cost of obtaining capital, just as interest on loans is deducted, that would be a different story. These companies would have money to invest in new technology and other business opportunities.

Extend unemployment benefits --A-

Additional money to the unemployed would be spent on goods and services. It isn’t extended to those whose benefits have run out. As a result it doesn’t help all the unemployed.

Repeal Corporation minimum tax—D.

Since corporations shift production facilities and headquarters overseas to avoid taxes this would encourage additional transfer of jobs and investments abroad as additional tax savings would now be available.

Small business deductions—B

This proposal expands write offs for capital purchases for small business. The idea is that small businesses would increase investments in capital goods. While a few would, it is unlikely to have much impact until the economic recovery is further underway.

Lower marginal tax rates—C

While this would put more money into the hands of the consumer it is heavily weighed in favor of the wealthy who already pay much less of their income as taxes than the middle classes and the poor when we include the social security tax. Yes social security is a tax with little relationship between what is paid and benefits received. It shifts much of what are nothing more than welfare costs to the middle class and poor.

Eliminate death tax--F

The myth is that taxes have been paid on the gains in people’s estates. Not true. Gains in property and stock values and the increase in the value of a business are rarely taxed. Besides, a legitimate use of taxes is to redistribute income. Most people with great wealth, say in the hundreds of millions, gained their wealth through luck or through questionable business practices. Set the exemption for inheritance taxes at a reasonable level, say above five million. That would recognize that an incentive for people to work hard, save and invest.

I would give the Administration's proposed economic stimulus package impact on economic recovery an overall rating of D. It may help the economy some but the impact of an increased deficit will offset much if not all the gains.

The Stock Market

The stock market will continue to move down as less than stellar profits by business are reported. Current stock prices are high relative to historic price-earnings ratios. Overall corporate profits are unlikely to improve significantly enough to make most stocks attractive over the short-run. High oil prices and the threat of war and its impacts continue to put pressure on a recovery. Until we see a continual recovery in employment I would not expect stocks to make a sustained advance.

Stocks in the News

Eisner has tried to improve Disney’s performance with the same formula he used when he first became CEO. Raise theme park ticket prices and re-release films from their inventory of old movies. While raising prices at Disney’s theme parks worked before because people were turned away, the problem now is not enough visitors. Raising prices may have the opposite impact on revenues than expected and could impact long-term relationships with consumers. While increasing the release of old movies will help some, most have not been off the market long enough to have much of a positive impact on earnings. I would avoid Disney until there is evidence of an economic recovery.