Jewish World Review April 28, 2003 / 27 Nissan, 5763

Caroline Baum

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Consumer Reports


What Stephanopoulos Didn't Ask Graham --- and why


http://www.jewishworldreview.com | (Bloomberg) Sunday on ABC's "This Week'' with George Stephanopoulos, the host interviewed U.S. Senator Bob Graham of Florida, who has thrown his hat into the 2004 presidential race with a gaggle of other Democratic hopefuls.

Graham weighed in against President George W. Bush's tax cut. Instead of eliminating the double taxation of dividends, the keystone of the Bush proposal recently neutered by the Senate, Graham said we needed to "create demand'' by "putting money in the pockets of people who will spend it.''

Boy, I wish I had been sitting in Stephanopoulos's seat. Then again, it's much more fun to fantasize about what I would have asked Graham -- and what he would have said in response.

CB:: Would you explain to me, senator, how you create demand by transferring purchasing power from one entity, in this case the government, whose sources of income are limited to taxing or borrowing from the public, to another?

BG: Higher income people save more. Lower income people spend more of what they earn. Giving tax cuts to the wealthiest Americans is unfair. If we are going to help our economy, we must quickly put money into the pockets of as Americans who will spend the money as soon as possible.

CB:: Alan Greenspan told us the rich benefited most from the stock market bubble and were similarly hurt the most -- their spending declined more -- by the bubble bursting.

BG: I don't know anything about that.

CB:: That's all right. Neither does he. Go ahead.

BG: What we need is a tax cut that gives Americans the confidence they need right now to begin pumping their hard-earned dollars back into the economy.

In the Beginning

CB:: Where exactly does the government get the money to provide the tax cuts that will give Americans the confidence to begin pumping their hard-earned dollars back into the economy? It has three options: It can tax, it can borrow, it can inflate. We'll leave bachelor No. 3 for another time.

If you raise taxes on one group and redistribute the income to another group, there's no net stimulus. A spends instead of B. Yes, the poor do have a higher marginal propensity to consume. But that's not stimulus. It's a transfer of the ability to spend from one party to the next.

Helping the needy is a noble goal, but let's not confuse charity with stimulus. Stimulus means growing the pie. Redistributing income is what it says: robbing Peter to pay Paul. While those in receipt of the government's largesse may be better off, we aren't better off as a nation.

Redefining Help

Besides, handouts don't necessarily help at all. The welfare system was a classic case of well-intentioned help becoming a huge hindrance by creating incentives to have more children and stay on the dole.

As far as deficit financing is concerned, if the Federal Reserve accommodates increased government borrowing by printing money (to prevent the overnight rate from rising), it can increase demand in the short run. Eventually, the money illusion fades and we are left with higher inflation, not faster real growth.

BG: Well, faster real growth is what I'm talking about. We need to get this economy moving again. There are probably many arguments to be made about the elimination of the dividend tax or some of the other tax cuts proposed in the president's budget, but there is not one to be made that these cuts provide an economic stimulus, certainly in the short term.

Short-Run Illusion

CB:: Did you ever consider that short-term economic stimulus is another misnomer? If it's only good in the short-term, it isn't good at all. We waste too much time -- and you folks in Congress waste too much of your political capital -- crafting schemes to pump up spending for the election cycle and not enough focusing on long-run policies that create incentives to work, save and invest for the future.

I don't know whether the elimination of the double taxation of dividends and retained earnings will lift the stock market by 5 percent, 10 percent or not at all. And a forecast shouldn't be a prerequisite for tax reform. Corporations' preference for financing with debt, which is deductible, rather than equity, which is not, encourages borrowing. It would have been cleaner to eliminate the double taxation at the corporate level, but I suspect the Bush administration didn't want to fight the PR battle that it would create by giving those evil corporations a tax break.

It's About Incentives

BG: The federal government is facing several tough challenges, including the need to strengthen and reform Social Security, modernize Medicare and provide a prescription drug benefit to its participants, and fund the ongoing war against terrorism. Additional tax cuts will rob us of the resources necessary to meet these challenges.

CB:: All I can say is those challenges are less onerous with an economy growing at 4 percent than 2 percent. And if you want to raise the growth rate, you have to encourage entrepreneurship, give someone the incentive to create the next big idea. To do that, you have to increase the potential reward, or profit, for taking the risk.

It's not about how much money someone is willing to give up to buy a good or a service. It's about how much work some individual is willing to do: the profitability of going to work.

BG: It was a lot easier with Stephanopoulos sitting in that chair.

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Caroline Baum is a columnist for Bloomberg News. Comment by clicking here.

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