THE QUICK FIX
This was to be the State of the Union address that Presidents dream about. The Jan. 28 speech to Congress and the nation would be a curtain call for George Bush's first three years in office and a rousing send-off for his reelection campaign. The President would throw the spotlight on his new world order: The Soviet menace vanquished. Saddam Hussein cut down to size. America standing tall. Bush would draw an unmistakable contrast between himself and the Democrats who opposed the Reagan-Bush defense buildup and the war against Iraq.
The economic state of the nation was to be little more than a footnote. A steady recovery would have left the brief, shallow 1991 recession a fading memory. Even the vexing budget deficit would be coming under control.
NO BASKING. Funny the tricks history plays. Moscow's emerging democracy seems a million miles away, far from the thoughts of most Americans. Saddam Hussein is still in power, hanging on to his nuclear weapons capability. And then there's the economy...
Instead of simply basking in the applause of a grateful nation, Bush now must convince impatient voters that he can turn the economy around (page 25). Says Brentwood (N.H.) florist Chris Wuethrich, a die-hard Republican: "I think the State of the Union is going to be the key, if Bush comes up with something new and dramatic. Right now, I think it's the same old rhetoric."
Bush must feel like a CEO whose grand plans for expansion have been wrecked by the recession. He needs to think about the long-term future of the business, but all his attention is consumed by keeping the company going for the next year. "There are structural problems that we could deal with," says Lehman Brothers Chief Economist Robert J. Barbera. "But is it pragmatic to make adjustments for the long term when you're at the trough of a recession and the start of an election year?"
It's not if youare George Bush, whose mantra for '92 is shaping up as fiscal discipline and caution. Says a senior Administration official: "The economy will come back. Housewrecking the budget would tell the rest of the world that we cannot manage our affairs in a sensible fashion. The markets don't put up with this stuff."
Bush is feeling great pressure to balance the political need for a highly visible quick fix with policies that focus on what really matters to the U.S. economy--increasing productivity for long-term growth. Says Senator Pete V. Domenici (R-N.M.), the senior Republican on the Senate Budget Committee: "The President has to show the American people that he's got policies that can deal with the long term as well as the short term."
The White House is well aware of the need for such a package. But fatigue and sharp divisions among his top aides have made it tough for Bush to act boldly (page 60). Privately, his senior aides agonize over the difficulty of getting action on the critical issues of education, investment, and trade in the highly charged climate of an election year. Council of Economic Advisers Chairman Michael J. Boskin concedes that without fundamental, productivity-enhancing changes, the U.S. economy will be lucky to grow by even 2.5% a year over the long run.
Boskin says the Administration is aiming at three goals at once: getting the economy growing, dealing with a "major long-run productivity problem," and addressing structural imbalances, including the huge increase in household debt over the past decade and the need to convert to a post-cold-war economy.
Bush may recognize the problem, but he's unlikely to take the bold steps needed to do something about it. His speech to Congress is likely to include plenty of rhetoric about long-term growth. He'll talk about the importance of research and development, increased national saving, business investment, education, and health care reform (table). But barring some stunning surprise, he'll offer few solutions. "My biggest fear," says one Administration insider, "is that people will think we're not doing enough, that we're being too cautious about the future."
The President will talk about using the same skills that won the Persian Gulf war to keep the U.S. economy the strongest in the world. He previewed the message in a recent political tour of New Hampshire: "I'd like to take the same kind of energy and leadership that we had in Desert Storm and use it to help the working men and women in this country."
WEAK SPOTS. For Bush's sake, whatever he tries had better work. Democrats, both those in Congress and the party's Presidential hopefuls, have shifted the political debate away from Bush's strong suit of foreign policy onto such issues as middle-class tax relief, health care, and government investment in human capital, where the President is weakest. Washington, says House Speaker Thomas Foley (D-Wash.), should take steps that "would help both in long-term economic growth and in the short-term confidence of the country."
The Democrats have sharpened the focus on short-term performance by making the economy the marker against which the entire Bush Presidency should be judged. "The single greatest problem is the recession," says Senate Majority Leader George J. Mitchell (D-Me.). "We simply have to take action to lift this economy out of recession."
Bush will respond in both the speech and his fiscal 1993 budget, due out on Jan. 29. But his message will be complex and will interweave several themes: Get the economy back on its feet, but prepare the ground for long-term growth. Real estate will lead the U.S. out of recession, so bolster eroding asset values and help first-time home buyers. Target more resources to families with children. Increase long-term savings and investment.
The trouble is that the President, for whom caution and compromise are watchwords, has put together an economic agenda that tries to be all things to all people. But it will satisfy no one. "Conceptually, it looks pretty good," says Representative Vin Weber (R-Minn.), a leader of House conservatives. "But it's not aggressive enough. It says they really don't believe their package will do anything to spur the economy."
MANY GOODIES. Bush's bow toward the quick fix will include a promise of middle-income tax cuts and some new real estate tax breaks. Both are tremendously popular on the Hill. Neither, Bush aides privately admit, will do much to spur growth. Nonetheless, Bush's recovery plan will include an increase in the personal exemption, a new $5,000 tax credit for first-time home buyers, and a proposal to restore the ability of developers and some others to write off real estate losses against real estate income.
Savers would enjoy liberal new rules for individual retirement accounts, investors would get a capital-gains rate cut, and business would enjoy faster write-offs of equipment and a permanent credit for research and development costs. Beyond taxes, Bush will temporarily freeze government regulations that add costs to business. He'll urge establishment of joint government and business research ventures for biotechnology and development of high-tech materials. And he will again propose major changes in the banking laws. Finally, Bush will suggest reforms in job training programs as well as some new money for Head Start, the popular preschool program.
Bush will promise to do it all within the restraints of the 1990 budget agreement. His budget package will include more than a bit of accounting gimmickry--what budget in the past decade hasn't?--but it will mostly keep within the framework of the budget deal. That means very little net fiscal stimulus, perhaps $10 billion this year.
Will Bush's package do the job, either in the long run or the short term? Can it, as he promises, get the economy moving? And most important, will it set the table for the productivity growth the U.S. needs to remain competitive?
The answer, sadly, is probably not. Bush must steer through a mine field of conflicting choices. He has to increase consumption to jump-start the economy today, yet boost savings for the future. He must use subsidies to stimulate private investment, while keeping government borrowing under control. And he must find a way to slash Pentagon spending while minimizing economic dislocation.
This struggle will be reflected throughout his economic plan. While Bush is still fleshing out the details, the package will be anchored by a modest reshuffling of the tax burden. Because he wants to maintain some budget discipline, he must pay for tax relief either by raising other taxes or by cutting spending. The most likely target: cuts in medicare benefits for wealthy retirees, a political nonstarter. House Ways & Means Committee Chairman Dan Rostenkowski (D-Ill.) has already warned Bush that he'll insist on a surtax on millionaires as a way to pay for at least part of Bush's proposed tax relief.
TEMPTING MORSEL. The most visible tax cut will be an increase in the personal exemption, which is now about $2,300 a person. The plan is intended to put about $10 billion a year into taxpayers' pockets, mostly to the benefit of families making $50,000 to $100,000. Some of the money will be used to pay down debt. No one knows how much will be used to buy Japanese-made VCRs or German automobiles. Certainly, a few dollars will be spent on U.S. goods. "It's just pro-consumption, antisaving," says William C. Melton, chief economist at IDS Financial Services Inc. "It might be useful in the short term, but in the long run, it's just more Reaganomics."
And while offering a home buyers' tax credit to boost real estate asset values is a tempting political morsel, it is not without risks. The favored tax treatment of home ownership already makes it among the most heavily subsidized activities in the nation, costing the Treasury more than $75 billion in revenue last year. In addition, inflated real estate values were the biggest single contributor to the collapse of the savings and loan industry and the banking crunch, a turn of events that was largely responsible for throwing the economy into recession.
A long debate over the plan could dissipate any quick boost that increased home sales might give the economy. Says Neal M. Soss, chief economist at First Boston Corp.: "It will freeze housing sales, because a seller will demand the extra value that the credit adds to his house, while a buyer won't pay until the credit is a sure thing."
Other proposals run into similar problems. Bush will recommend broad new incentives to save through IRAs. While the plan should produce a bit of revenue for the Treasury in the first year, it will cost tens of billions in the future.
WILD SHIFTS. Budget constraints have also sunk hopes that Bush will tackle fundamental questions of how the tax code affects business decisions. There have been two critical issues hanging over investment choices in recent years--tax-favored borrowing and wild shifts in the ability of companies to write off capital investment. The Treasury Dept. staff released a report in early January urging reform of a system that requires both corporations and shareholders to pay tax on company profits paid out as dividends.
Similarly, most economists recognize the need to match depreciation more closely to the cost of capital equipment. Many have endorsed a scheme that would allow companies to take full tax write-offs in the year an investment is made. Such a plan would cost the Treasury tens of billions in the first year, although the cost would be largely washed out over five years. But Bush has ducked that one, too. Instead, he'll propose a modest accounting change that will permit companies to accelerate write-offs under existing depreciation schedules. Administration aides recognize the problems, but the White House is going to take it slow. "In an election year," says one senior Administration official, "you're not going to get sea changes in the tax system."
The defense budget represents another missed chance. Enormous changes in the world have given Bush an extraordinary opportunity to restructure government. The first issue facing Washington policymakers over the next decade is what to do with hundreds of billions of dollars in planned military spending that can be saved in the post-cold-war world. Bush could free money for tax cuts, deficit reduction, or public investment (page 24). But it would take a restructuring of both the military and health care, which threatens to swallow the entire peace dividend. And Bush isn't likely to tackle either issue head-on.
His health care plan (page 26), which probably won't be proposed in detail until February, offers only modest hope for containment of soaring costs. And he will suggest only about $4 billion in defense cuts for fiscal 1993.
DEFENSE NETTLE. Even hawks such as Domenici and Senator Phil Gramm (R-Tex.) believe that major Pentagon cuts must be made over the next 5 to 10 years. Gramm favors cutting planned military spending by $74 billion over the next five years. But for now, the Administration is insisting that it will spend billions more than even its own force estimates require. Says defense analyst Gordon Adams: "Something's got to give." Until Bush grasps the defense nettle, he won't have the wherewithal to invest in the future. "The government doesn't have money to give away," says DRI/McGraw-Hill economist David A. Wyss. "Anything you spend on tax cuts has to come from somewhere--and that somewhere is the bond market."
Fear of an adverse reaction in financial markets may keep Bush from acting boldly. His willingness to resist the temptation to score easy political points may serve him well, especially if recovery already waits in the wings.
But Bush's reluctance to use his power to address the nation's long-term problems may come back to haunt him and the economy. It's easy to say that the political demands of an election year make such policies unrealistic. But Bush should remember 1988, when he had to struggle to overcome concerns about his ability to see and describe America's future. This year, when nearly 80% of the public worries that the nation is headed the wrong way, Bush's lack of the "vision thing" could cost him his job.THE BUSH GROWTH PLAN
TAXES Relief for the middle class, especially families with children. Tax
breaks for capital gains, capital investment, first-time home buyers. Expansion
of individual retirement accounts
DEFENSE Further cuts in spending for both operations and weapons procurement.
Deep cuts in strategic weapons, modest troop reductions. Biggest budget impact
remains several years off
HEALTH CARE A "market-oriented" approach. Tax credits for low-income people,
deductions to help the middle class. The wealthy may be taxed on
REGULATION A 90-day freeze on new federal rules that increase cost of doing
business, such as pollution and worker-safety regulations. Possible new push to
expand banking powers
THE BUDGET Maintain at least the outlines of 1990 budget agreement. To avoid
swelling the deficit, use accounting changes and entitlement cuts to finance
BUSH'S PLAN SKIMS OVER THE WORST ECONOMIC TROUBLE SPOTS
CAPITAL FORMATION Bush will stress savings and investment, but his proposals
will be modest. He should recommend broad reforms in the tax treatment of
capital investment, including allowing business to deduct the full cost of new
equipment in the first year. His plan to expand individual retirement accounts
may increase private savings, but at the cost of big new federal deficits
FINANCIAL SYSTEM Business ran up massive debt in the 1980s in part because tax
law favors borrowing over equity financing. The White House should urge an end
to the double taxation of dividends
DEFENSE Bush will focus on short-term shifts in military spending, while what's
needed is a long-term plan. Those shifts need to be coupled with broad changes
in domestic policy that the peace dividend will make possible
HEALTH The White House will offer piecemeal reforms. But sweeping changes are
needed to provide affordable health care and reduce costs for business. Without
those changes, health care costs will swallow the peace dividend
EDUCATION Bush is proposing more money for Head Start, the preschool program
for poor kids, and some streamlining of federal vocational education programs.
But these efforts fall far short of the major overhaul needed to educate a work
force that will keep the U.S. competitive
Howard Gleckman, with Amy Borrus, Paula Dwyer, Douglas A. Harbrecht, and Mike McNamee, in Washington