To Preserve The Boom, You've Got To Invest Money

The Republicans cite the softening economy to advance their proposed $1.3 trillion tax cut. Supposedly, a weak economy would benefit from the economic stimulus. But the plan is likely to be dead on arrival politically--and it isn't smart economics, either.

George W. Bush made a massive tax cut the centerpiece of his campaign, but it aroused little enthusiasm among voters. Unlike the Democrats' stampede to the supply side early in the Reagan Presidency, few Democratic legislators will be intimidated this time, and few will defect. Indeed, in the bitter aftermath of the election, Democrats will fight hard for more modest, targeted tax relief, and will starkly dramatize policy choices.

For instance, by keeping estate-tax revenues rather than returning them, Washington could afford prescription drug coverage. Who is the more plausible constituency for the Democrats: the 30,000 multimillionaires who would benefit from estate-tax relief, or the 30 million older Americans who have trouble affording the medicine that they need? In the same vein, the GOP claimed in the election that the country could afford both a huge tax cut and a Social Security rescue. But when legislators crunch the numbers, the fuzzy math will be all too clear. We can't spend the same money twice.

WHO'S TO BLAME? Also, the GOP's timing is off. For reasons of budgetary sleight of hand, most of the Bush tax cut would take effect several years hence, in the wrong part of the business cycle. If the economy is softening, the culprit is not some fundamental weakness but a risk-averse Federal Reserve. Pursuing the fabled "soft landing," Alan Greenspan has ordered six interest-rate hikes. But what the chairman can take away, the chairman can give back. Lately, Greenspan has been signaling a January rate cut, which would be all the short-term tonic the economy needs.

But what about the long term? The Fed will let the economy grow only so fast, for fear of inflation. Even if a huge tax cut gunned demand, the Fed would limit the stimulative effect. Today the main constraint on growth is neither weak demand nor production bottlenecks, but the Fed's view of tight labor markets.

The Fed now believes that if unemployment goes much below 4%, labor costs begin to outpace productivity growth and inflation looms. At that point, the Fed hits the brakes. Under Greenspan, the Fed has allowed somewhat faster growth because rising productivity thus far has accommodated rising wages without inflation. But growth is still limited.

In a full-employment economy, what holds back higher growth is qualified labor supply. That argues not for spending the surplus on a tax cut, but for education and training outlays to expand the labor pool and improve the quality and productivity of U.S. workers. Today, nearly all the qualified people are working. But millions of others are unqualified for available jobs. Both Gore and Bush claimed to be for better education, but education costs money. Unless you want deficits, you can't spend the same dollar on a tax cut that you spend on smaller classes and improved schools.

This is really a three-way debate. One school, mostly Republican, holds we should "give the money back" to the citizenry via a massive tax cut. Although the tax cutters have lately invoked the specter of recession, they should be honest enough to admit they favor tax cuts in principle, whatever the economic weather. The second school wants to pay off the entire national debt, contending that no public debt means cheaper capital for private investment and hence higher rates of growth. Centrist Democrats of this persuasion also use their position tactically to head off a GOP tax cut. They do this by defining debt paydown as a necessary means ("lockbox") to set aside funds to replenish Social Security.

This approach is nimble tactics, but also questionable economics. The implicit premise is that public spending by definition crowds out private investment, and that a marginal dollar of private capital is always more productive than a marginal dollar of public outlay.

But with dot-com lunacy having no scarcity of willing investors and foreign sources of funds beating down our doors, do we really have a capital shortage--or just a tightfisted Fed? How many more Internet failures do we need? Wouldn't it improve productivity more to invest some of the surplus in relieving airport congestion or improving schools? That certainly beats both the proposed Republican destination--the pockets of gazillionaires--and the Gore plan to retire a debt we've usefully carried to finance public outlay since the days of Alexander Hamilton.

Granted, this third view has been all but drowned out by the debate between tax cutters and debt retirers. But if we want to maintain the current boom in the face of a nervous Fed, social investment to enhance productivity is the most sensible policy.

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