This Stimulus Plan Pushes the Wrong Buttons

Tax breaks aimed at business investment won't work because of existing overcapacity. What's needed is a way to buck up consumers

By Howard Gleckman

While Congress and President George W. Bush squabble over the details of an economic stimulus package, most lawmakers agree that a key element of any plan should be new tax incentives for business investment. Such breaks made up 70% of the $100 billion first-year cost of the measure the House passed on Oct. 24. And similar provisions are certain to be in the Senate version that should appear in early to mid-November.

At first blush, the idea makes a lot of sense. Business investment is in the tank. Durable-goods orders fell 8.5% in September, following a 0.5% fall in August. So, why not use tax breaks to help businesses? If profits rise, stock prices will zoom, layoffs should end, and newly confident investors and workers will head back to the shopping malls. Similarly, if tax breaks encourage companies to buy new equipment, makers of that gear will hire workers who in turn will start consuming again. Either way, the economy gets back on track.

However, before Washington tries to fix today's economy, it needs to think harder about the series of troubles that have created the current situation. A huge overcapacity problem has been compounded by a succession of shocks to consumer confidence. The slumping stock market was followed by a rise in unemployment, then by the September 11 attacks on the World Trade Center and the Pentagon, and now by the daily stories of the anthrax threat.


  In such an environment, Washington needs to throw out the stimulus textbook and recognize that the most effective ways to improve consumer confidence are decidedly noneconomic. They're steps such as boosting airport security and destroying Osama bin Laden's terror network. Unless Washington can do that, don't expect a few tax breaks to get businesses investing again.

Furthermore, most of the tax-break ideas on the table wouldn't work very well in the short run, anyway. Some make sense in the long term but won't do much to juice the economy over the next several months -- when it needs help the most.

The House bill's business provisions come in two varieties. Some are little more than special-interest tax breaks for a handful of well-connected companies -- and they should die a quiet death as the bill moves through the Senate. But the House bill also includes some important provisions that could well become law. The most interesting would work like this: A company that buys new equipment during the next three years could write off an extra 30% of its cost as soon as it's purchased.


  Does such an idea make sense today? After all, businesses are operating at only 75% of capacity, the lowest level since 1983, and high-tech companies are running their plants at barely 60%. With no profits, few customers, limited access to capital, and huge overcapacity, many businesses are in no position to buy new equipment -- even with a tax break. "There's no way," says Mark Zandi, chief economist at the consulting outfit "They already have a lot of equipment they don't know what to do with."

It's true that investment tax breaks will benefit some companies in the short run. For businesses whose investment decisions are right on the edge, a tax break might be just enough to turn a nonprofitable purchase into a profitable one. And some companies are looking to buy new equipment as a way to cut costs, rather than to expand capacity. Tax breaks will help them too.

However, would they be enough to turn around the sluggish economy? Not likely. According to Brookings Institution economist Bill Gale, the House's investment incentives would boost capital spending by little more than 0.15% of gross domestic product.


  In the long run, allowing companies to write off the full cost of capital equipment in the year they make the investment could spur business purchases and boost growth. But when deciding whether to buy new equipment, companies frequently are driven by long-term rates of return, not short-run costs. As a result, they would look for a permanent tax reduction, not the kind of temporary breaks that Congress and the White House are contemplating.

Still, this is supposed to be a stimulus package, not a long-term restructuring of the tax code. At a time when the U.S. is suffering most from weak consumer spending, aiming temporary tax subsidies at capital purchases seems like the wrong medicine. As James Paulsen, Wells Capital Management's chief investment officer, puts it: "You don't need more business investment. You need more final demand."

Gleckman is a senior correspondent in BusinessWeek's Washington bureau. Follow his views every Tuesday in Washington Watch, only on BW Online

Edited by Beth Belton

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