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of 1/15/03
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Confusing
government aid and economic stimulus By Lee Shelton There is apparent confusion concerning the proposed “economic stimulus package,” even among the economists addressing the issue. There is an understandable “what’s in it for me” mentality when one considers such proposals — “how do I directly benefit,” coupled with “what are others getting that I am not.” However, this is not designed to be an aid or financial relief package, but one that is designed to stimulate certain behaviors in order to create jobs. How are jobs created and by whom should be the first focal point. Are businesses going to add employees and build inventories on the basis of one-time or short-lived monies passed back to consumers who are already over extended with consumer debt? As the tax on dividends has been the subject of most of the discourse — in terms of fairness — let’s look at this from the perspective that this is intended to stimulate certain behaviors and, thus, stimulate the sustained growth in the economy. Businesses are overloaded with debt. As a result risk spreads (corporate debt costs over treasuries) have widened dramatically. Record bankruptcies and investor fears, among other things, have raised the real cost of debt beyond the reach of many growth companies. This has in turn dramatically increased loan losses at financial institutions, which further increases the pressure on the “risk premium” on corporate debt. The dividend exclusion tips the playing field in terms of equity (there are two ways to finance business — debt and equity). As equity builds, demand for debt falls along with fears of more bankruptcies. Corporate spreads (to treasuries) should narrow as financial institutions see corporate leverage and demand for more debt begin to fall. That is the cycle that we need to create to build a recovery of profits and increase capital spending by business, thereby increasing the need for more employees. Tax policies must be fair, but with proper balance a dividend exclusion could foster far-reaching benefits. Corporations with good prospects but low current earnings and rising debt costs will gain an alternative to repay debt by selling equity. Growth firms and start-ups, with taxable income that is offset by depreciation and little need for interest deductions, will also find equity a more attractive source than before. For investors, reduced corporate interest costs will lead to increased equity values and recovery of their retirement nest eggs. This benefits a wide swatch of the households. As retirement accounts recover, retirees will have opportunities to stabilize their tax-exempt retirement accounts and to hold more equities individually, with an opportunity to enjoy both appreciation and cash flow income. Sure, there will be some that don’t directly benefit, but this is a macro plan to stimulate the economy, and in that sense it is a logical path to take. Over time the “deficit” impact should be small — provided the process works. The interest rate gap between corporate and treasuries is historically wide now, too wide for a sustained economic recovery. If rates on treasuries rise while spreads to corporate debt narrows, the impact on growth will be low. As corporate profits rise, corporate tax revenues will recover and offset the interest deductions to individuals; thus, the next effect on treasury rates may also be low. In summary, the Bush administration’s proposal appears on target for today’s main problem impeding economic growth. But, once again, this is a macro economic stimulus plan — not a “what’s in it for me” economic assistance package, which is creating some misunderstandings, even among economists. Lee Shelton Maggie Valley Lee@Ensync.com |