We are the masters now, is the message coming loud and clear from the Republicans — not just in foreign policy but also when it comes to domestic politics.
On the campaign trail two years ago, George Bush promised a new world of compassionate conservatism. But, judging by last week’s much-hyped tax cut plan, it is the rich Bush feels compassion towards.
According to independent analysis, the top 1% of taxpayers will be $89 000 a year better off as a result, while the average middle class American will see just $265 cut off his/her tax bill. President Bush brands critics of his tax cut plan as exponents of class warfare. Class warfare it certainly is — conducted by the White House on behalf of the richest group of Americans.
The Republicans argue that the centrepiece of the plan — the abolition of taxes on dividends — will help the whole economy by reviving the battered stock prices and providing money for firms to invest.
In the United States the shares market plays the same role as the housing market does in Britain in supporting consumer spending. But most of the benefits of the president’s package will go to the tiny group of rich citizens who hold shares directly.
As in Britain, most American households own shares through pension funds, which are already exempt from tax. The independent Tax Policy Centre estimates that 40% of the $360bn cost to the American treasury over the next 10 years will be captured by the wealthiest 1% of taxpayers.
Because most institutions buying and selling shares will not benefit from the plan, the boost to prices will be less than the administration hoped for. That could be a blessing in disguise — the economy is still working through the consequences of the last share market bubble and the enormous overhang of investment capital it created.
The last thing Wall Street needs now is a White House-sponsored bubble to follow the dotcom boom.
As Stephen Lewis of Monument Securities has pointed out, investment spending is depressed because companies are still trying to deal with the hangover from the last party. Encouraging a further bout of overinvestment is not likely to make capital spending profitable again.
The market appears to have already worked this out. Share prices soared ahead of the president’s heavily trailed plan, but by the time Bush began speaking the euphoria had already worn off.
Over the week the widest index of American share prices, the S&P 500, rose a measly 2,5% — well below the 10% increase the administration had hoped for.
If share prices are unlikely to provide the panacea for faltering confidence the administration is looking for, their other justification for the plan — that it will provide a direct fiscal boost — also seems flawed.
Standard Keynesian economics recommends letting borrowing rise when the economy is weak. The US economy needs help now, but most of the benefits of this package will start to take effect in a few years’ time and will simply add to the already ballooning deficit.In addition, most of the money is being handed back to the rich who are much more likely to sit on the extra dosh than they are to spend it.
Karl Rove, Bush’s political mastermind, apparently persuaded him at the last minute that, rather than going for a refund on half of the dividend tax, he should go for the whole hog, doubling the cost of the package at a stroke. The reasoning appears to have been nakedly political: it puts Democrats in Congress in a difficult position by forcing them to vote against the package and thereby gain a reputation for being against giving people’s money back to them. This is still a country which — even after the September 11 attacks — still distrusts what it calls “big” government.
This is a return to the Reaganite supply-side theories which the current president’s father once derided as “voodoo economics”. The fundamentalist core of the Republican party has never stopped believing that cutting taxes is the route to growth, never mind if the budget deficit balloons as a result. The consequences are more likely to be negative for growth — a larger structural deficit that will crowd out private investment and push up long-term interest rates.
Rove may have misjudged the appetite of Americans for this brand of happy-clappy economics. Even some right-wing Republicans in Congress are worried that the plan will cause long-term deterioration in the budget position, while moderate Republicans are alarmed by its egregious redistribution to the rich.
Moreover, it is a risky political and economic move at a time when Bush is considering a war in the Middle East which could have devastating consequences for the US and the other major economies of the west.
The Centre for Strategic and International Studies in Washington estimates there is a one in 10 chance of a disastrous outcome in the Middle East: Saddam Hussein deliberately destroys Iraq’s oil reserves and damages neighbouring countries’ fields; the attack sparks years of Arab hostility to America; or the war takes much longer than military planners anticipate.
Using the CSIS’s scenarios of possible outcomes of an attack, Oxford Economic Forecasting and Macroeconomic Advisers have produced some alarming estimates of the consequences for the US and the world economy*. In the worst-case scenario, which CSIS estimates at 5-10% likelihood, OEF and MA believe oil prices could hit $80 a barrel, sending the US economy back into recession this year and pushing up unemployment to 7,5%.
Even in the intermediate scenario — for which the CSIS estimates the probability at 30-40% – in which the attack on Iraq proves more prolonged or difficult than expected, shattered confidence is likely to drag down the economy for most of this year.
If either scenario comes to pass, Bush will need all the fiscal firepower he can lay his hands on. He may regret already having pushed the budget into deficit for an uncertain reward.
What last week’s gamble does reveal is a wide divergence in economic approaches. In Britain and Europe, fiscal conservatism is the new orthodoxy for left and right.
Even as Bush was announcing his plans for a ballooning budget deficit, the European commission was warning large member states of the EU to get their deficits under control.
In Britain, Gordon Brown may be derided by the left for his long love affair with prudence but he relishes his reputation as the iron chancellor. Although his more flexible fiscal rules allow him to borrow in bad times, the underlying message is that, in the long term, governments should not push current spending costs on to future generations.
The return to supply-side economics in America will be watched with particular interest in Britain, where Labour is about to find out if voters will pay more tax for better public services. Some commentators believe that even America’s tax-shy electorate would have been prepared to pay more for national security after the September 11 attacks. Instead, the president is taking an enormous gamble with the economy — and with his political future.
*After an Attack on Iraq: The Economic Consequences.
Centre for Strategic and International Studies