Washington Tries to Spell Relief

But the one danger may be too much stimulus

With the economy still reeling from the aftershocks of the Sept. 11 terror attacks on the Pentagon and World Trade Center, once-feuding lawmakers have stood shoulder-to-shoulder behind a new mission: putting the full might of the federal government behind efforts to fight a potentially nasty recession.

The pressure for action is coming from all sides--unions fearing a wave of layoffs, small-business owners, and especially America's corporate chieftains. "So many people have the lid on," says FedEx Chief Executive Fred Smith. "We have to stimulate people to buy." To others, the situation is even more dire. "The objective is to keep Americans working," explains John Dillon, CEO of International Paper.

But getting from those laudable sentiments to concrete action sure isn't proving easy. Already, some in Congress and the Bush Administration have put the brakes on hurry-up attempts to craft a second stimulus package. What they're finding is that, despite the clamor for new tax cuts, many of the ideas don't provide much short-term bang for the buck. "My great fear is that we will do long-term damage to the deficit in a futile effort to stimulate the economy," says Brookings Institute economist William Gale.

Nevertheless, given the "do something" attitude, lawmakers may feel obligated to enact some sort of rescue program--if only as more of a psychological pick-me-up than as actual medicine for a sick economy. But even that prospect has its critics. "If we are going to war, that's the wrong time to cut taxes," warns David A. Wyss, chief economist at Standard & Poor's, "The best thing to do is fix what needs to be fixed--defense and airport security. That will bring the economy along with it."

But that is a minority view. Odds are strong that Congress will soon provide new tax relief. If a bipartisan deal is to be struck, it will likely include investment incentives backed by Republicans and individual tax cuts favored by Democrats.

MASSIVE STIMULUS. Details won't emerge until after Oct. 1. But at a private session with members of the Senate Finance Committee on Sept. 25, Fed Chairman Alan Greenspan said an additional tax cut of roughly $50 billion, or 0.5% of gross domestic product, would be about right.

Anything policymakers do now will come on top of the massive stimulus Washington has already pumped into the economy. In May, Congress cut taxes by $40 billion for this year alone. The Fed has whacked interest rates eight times in nine months, lowering the cost of short-term borrowing by 3.5 percentage points.

And since Sept. 11, Congress and President Bush have only loosened the purse strings further. They've agreed to an additional $40 billion in emergency spending, as well as $15 billion to bail out the airlines. The Senate Finance Committee figures up to $400 billion has been injected into the economy since January, nearly 4% of GDP.

While the Fed is surely going to drop rates further, what will Congress do? The first question lawmakers have to answer is whether to make any new tax cuts permanent or temporary. Some, including Senate Finance Chairman Max Baucus (D-Mont.) and the panel's top Republican, Charles E. Grassley of Iowa, say any cut should phase out after one or two years. In theory, temporary investment incentives provide an even faster kick by pushing companies to buy equipment before the windfall expires. They also keep long-term budgetary costs under control.

But there's a downside. A temporary tax break might only accelerate investment set to happen anyway. Such borrowing from the future does little to boost long-term growth. "It is just setting the stage for next year's recession," says University of California at Berkeley economist Alan J. Auerbach.

TWO APPROACHES. What options are actually winning support in Washington? Certain industries are already clamoring to put their imprint on any handout. Tech execs want new incentives aimed at boosting capital spending, noting that investment in computers and telecom gear fell more than 20% in the first half of the year. They suggest two approaches: either provide an investment tax credit or allow faster write-offs of equipment purchases--say, over three years instead of five. Either idea could generate new demand for equipment. And because the tax breaks would benefit only new investment, they would be relatively cost-effective.

But either choice would probably be hugely expensive. One plan for accelerating business write-offs would cost in excess of $350 billion over 10 years. Another problem: a lack of customers. "If you think no one is going to buy your stuff, you may not want to invest even if it looks cheaper," says Joel B. Slemrod, who heads the Office of Tax Policy Research at the University of Michigan. Furthermore, because these incentives benefit some manufacturers more than others, some pols are leery of squabbles between industries that come out winners and those that don't.

Meanwhile, top White House economist Lawrence B. Lindsey and others, particularly in the GOP, are considering a different solution: They would like to reduce the corporate tax rate from 35% to 25%. This should boost both profits, and, as aftertax earnings rise, stock prices. Says Kevin A. Hassett, an economist at the American Enterprise Institute: "If you're worried about financial issues, bankruptcy, and layoffs, cutting the corporate tax rate is the best way to put money in business' pocket right away."

However, that plan also has drawbacks. Early cost estimates are in excess of $700 billion over 10 years, according to Brookings' Gale. And because a cut in the tax rate would reward companies for investments they have already made, it might do little to boost the current economy.

Another initial suggestion--reducing capital-gains taxes--also has troubles. Although it has the support of supply-siders, such as Senate Minority Leader Tent Lott (R-Miss.), it has generated limited enthusiasm elsewhere in Washington. Economists fear a temporary cut in the tax would drive investors to sell stock in what is already a slumping market. "Increasing volatility in the capital markets now is the last thing I want," says Barry Rogstad, president of the American Business Conference, which represents midsize companies.

Many Democrats, including ex-Treasury Secretary Robert E. Rubin, say investment incentives miss the point. They insist the real problem is a collapse in consumer confidence and spending. The prescription: cutting individual taxes in one of several ways on the table. One would give a rebate to low-income workers who didn't get checks from the May tax bill. Another would cut payroll taxes by one or two percentage points, or provide an income tax credit for those taxes.

Each idea would put $10 billion to $20 billion into consumers' pockets. But some economists doubt whether much of that cash would be spent due to fears of layoffs, sagging stocks, and worries about personal safety. Still, a consumer-oriented tax cut will be part of a bipartisan bill, since it is the price of getting Democrats on board.

While the pressure to act is great, such steps aren't immediately guaranteed. Treasury Secretary Paul H. O'Neill and others are urging Congress to go slow. And some economists say Washington's best course is to do nothing. With so much stimulus already chugging through the economy, they're already seeing interest rates rise as the bond market begins to worry about massive new Treasury borrowing. If that continues, it could offset any stimulus. According to Gale, a 0.75 percentage-point boost in rates would eliminate the benefits of a big tax cut. That's one reason why Greenspan wants a relatively small fiscal stimulus package.

Many economists have an even bigger fear: that the events of Sept. 11 administered such a shock to the national psyche that no standard stimulus will quickly get growth back on track. "How do we restore Americans' sense of confidence?" asks Rogstad of the American Business Conference. The answer may be a good deal more complicated than lowering taxes or slashing rates further.

By Howard Gleckman, with Lorraine Woellert and Rich Miller, in Washington

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