Rove May Find `It's the Economy, Stupid' Won't Work (Update3)

By Brendan Murray

May 30 (Bloomberg) -- Karl Rove, President George W. Bush's top political adviser, laid out a plan to win the 2002 congressional elections by stressing national security. For 2006, Rove is framing a strategy for Republicans to sell the U.S. economy.

In a recent speech, Rove argued that Bush's policies of tax cuts and trade agreements had pulled the nation out of recession, created millions of jobs, boosted productivity and increased disposable income. That record can help lead Republicans to victory in November, Rove said in the May 15 speech at the American Enterprise Institute in Washington.

Political experts say it may be a tough sell: Voters don't feel optimistic, polls show, and growth rates are expected to slow as the housing market cools and gasoline prices remain near all-time highs.

``The administration needs to change the electorate's overall psychology,'' says Stuart Rothenberg, who publishes a nonpartisan Washington political report. ``It would be a huge asset for the Republican Party if people could start to focus on the economy, appreciate it and see it as something that has worked, but I see no evidence that that's going to happen.''

Seventy percent of 1,002 respondents in a May 8-11 Gallup poll said the economy was in fair to poor condition, up from 63 percent in an April poll.

`Abstract Numbers'

``People either feel it in their day-to-day lives or they don't, and no amount of repetition of abstract numbers to the contrary is going to change their perceptions,'' says Bruce Bartlett, a policy analyst in the Reagan administration and author of a 2006 book critical of Bush.

By most major indicators -- from a historically low 4.7 percent unemployment rate to strong corporate profits to the stock market -- the economy is moving forward. ``We are like marathon runners winning the race,'' Edward Lazear, chairman of the White House Council of Economic Advisers, said in a May 23 interview.

The next day, Al Hubbard, director of the policy- coordinating White House National Economic Council, said Bush may spend more time in coming weeks to ``highlight all the economic success.''

Bush today also nominated Henry Paulson, chief executive officer of Goldman Sachs Group Inc., to be Treasury secretary succeeding John Snow. Part of the secretary's job is to promote the president's policies and convince the public that the economy is in good hands.

Low Inflation

In his AEI speech, Rove, 55, emphasized the creation of 5 million jobs in recent years. He also said Bush's tax cuts have stimulated growth, making up for revenue lost with lower rates. A tax reduction on stock dividends to 15 percent from 40 percent prompted the biggest companies in the Standard & Poor's 500 Index to raise dividend payments on 725 occasions, he said. That money is ``going into retirement funds and individual retirement accounts and people's pocketbooks,'' he said.

And he described ``core inflation,'' which strips out food and energy, as low, citing a U.S. Labor Department report showing a 2.1 percent gain in the 12-month period ended in March.

``The president's tax cuts, trade liberalization and spending restraint helped strengthen the economy's foundation and added fuel to our economic recovery,'' Rove said. ``Not a bad record.''

Other factors, though, may explain why Bush has consistently failed to get credit from the public for growth, and illustrate the difficulty Republicans will have turning Rove's message of economic optimism into votes.

Companies Gain

Since the last recession ended in November 2001, the U.S. has added a net 4.35 million jobs, or an average of 82,000 a month, according to the Labor Department. That's less than half the 9.57 million jobs, or 181,000 a month on average, created in the same period of time after the previous recession ended in April 1991.

``Almost all the benefits of productivity growth have gone to firms, and very little to workers,'' says Harvard University economist Jeffrey Frankel, a member of the Council of Economic Advisers under President Bill Clinton, whose adviser James Carville used the slogan, ``It's the economy, stupid,'' to stress the importance of the issue in the 1992 election.

One explanation for the public malaise may be the distribution of prosperity. Total compensation for Americans fell to 65.4 percent of national income in 2005, down from 66.2 percent in 2001, Federal Reserve figures show. At the same time, corporate profits rose to 12.3 percent of national income, up from 8.5 percent in the year Bush took office.

Tax Revenue

``From middle incomes down, there has been very little gain,'' says Robert Solow, an economist at the Massachusetts Institute of Technology who won the 1987 Nobel Prize in economics. ``No wonder they feel they're not sharing in this prosperity.''

Corporate profits, however, rose as a share of gross domestic product to 12.6 percent in the first quarter, the highest since the final quarter of 1951 and up from 7.5 percent in the first three months of Bush's presidency, according to Commerce Department figures released last week.

As for the impact of Bush's tax cuts on government income, Treasury Department figures show that as the economy recovered from the 2001 recession, federal revenue fell 6.9 percent in fiscal 2002 to $1.85 trillion and dropped again in fiscal 2003. In the third quarter of 2003 --the strongest three months of economic growth in the Bush presidency -- revenue fell 4.9 percent to $430 billion from the same quarter a year earlier.

Rove's argument about the impact of dividend tax cuts on retirement savings doesn't take into account a Fed study on the effect on the broader investing world. The December report found ``little if any imprint of the dividend-tax-cut news on the value of the aggregate stock market.''

Toning Down

Two days after Rove spoke, the government revised upward the inflation figure he had cited to 2.3 percent, the biggest year-over-year gain since March 2005. Economists say that may be a sign the robust economy is allowing companies to pass along higher costs of labor and commodities.

The Federal Reserve is likely to fight any continuation of that trend with higher short-term rates, says Alfred Broaddus, former president of the Federal Reserve Bank of Richmond. ``The Fed will almost certainly need to react with further tightening to protect its credibility as an inflation fighter,'' he says. ``So the president may want to tone his comments down a notch.''

The housing market -- which has contributed to about half the economy's growth since 2001, according to a Merrill Lynch & Co. report -- offers more cause for concern. Housing starts fell 7.4 percent to an annual rate of 1.849 million in April, the fewest in 17 months, the Commerce Department said May 16.

The Fed is watching the real estate market, recent comments by central bank officials indicate. Fed Chairman Ben S. Bernanke, in testimony last month to the Joint Economic Committee of Congress, said a slowdown in housing ``could prove a drag on growth this year and next.''

`Are You Better Off?'

While the Commerce Department said the economy grew at an annual rate of 5.3 percent in the first quarter, economists say gross domestic product growth will slow to a 3.5 percent pace in the second quarter and 3 percent in the third.

``The risk is that Democrats can play on the old `Are you better off than you were?' and a lot of Americans are feeling that they're not,'' says Tim Penny, a former Democratic congressman from Minnesota who backed Bush's plan to overhaul Social Security last year. ``This really is a referendum on Bush's tax cuts in an environment in which voters are feeling pinched economically.''

Bush aide Hubbard says the administration is confident of the outcome of such a referendum. ``We would love to debate whether people are better off today than they were 5 1/2 years ago,'' he says.

To contact the reporter on this story: Brendan Murray in Washington at brmurray@bloomberg.net

Last Updated: May 30, 2006 12:22 EDT

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