Treading Water Jude Wanniski May 13, 2003

We are accustomed to worry about everything that can possibly go wrong with the political economy. For 25 years that has been our stock in trade with the financial community. At the moment, we find ourselves unable to seriously worry all that much about anything, even though the whole world seems as dicey as ever. We seem to be walking in place or treading water on a host of issues that are being sorted out by the powers that be and the powers that want to be. Here are a few thoughts worth sharing:

Tax Bill: We are going to get a tax bill through the Senate and then through a House-Senate conference, and it will be okay or a little better than okay. There are so many moving parts to the political calculations as we proceed that it is a waste of my time and yours to worry about this wheel or that gear or the other switch. What remains most important is that President Bush and his team are on the right track on the tax bill and they know it, which means they will not throw in the towel in their efforts to make the most of the opportunity they have now to reduce taxation of capital. The GOP’s determination to fight this through all the Robin Hood rhetoric coming from the Democrats has washed away any suspicion the Republicans might cave in as they have so often in the past when confronted with class warfare arguments. There are now a handful of Democrats who are clearly itching to vote for the tax cuts and the President is traveling to their states to apply pressure in that direction.  As long as the provisions in the tax bill are completely up in the air, though, it is difficult to whip up the grass roots enthusiasm that might give a Senator or two the excuse they need to change their minds. The White House is still dreaming about phasing in the end to the double-tax on dividends, but Olympia Snowe of Maine says she will not support any sunsetting gimmick that could make that possible. At least two more votes would then be needed. Let’s not worry about that.

State and Local Revenues: It is nice to see Treasury Secretary John Snow making the argument that the federal tax cuts the administration is requesting would add at least $20 billion a year to state and local treasuries. The issue came up over the weekend when Pennsylvania Governor Ed Rendell argued that the Bush administration should forget about tax cutting, as this failed when tried in 2001, and instead spend heavily on revenue sharing for infrastructure projects. The cuts in capital taxation would be far superior to the revenue sharing measures, although we would have no objection to a one-time injection of $20 billion to state and local governments – for whatever they choose to use them for. The net effect would be to hold down tax rates that would otherwise go up to cover unavoidable spending. Our Michael Darda points out that according to the Federal Reserve, state and local revenues amounted to $1.3 trillion in 2002, or 12.2% of GDP. With federal revenues around 1.87 trillion, the combined total amounts to just under 30% of GDP. The House Plan already enacted would add at least 1% to the GDP growth rate we think, generating about a trillion dollars in total cumulative state and local revenues over the next decade. A 100% elimination of the double-tax on dividends would eventually add 3% to annual GDP, says tax analyst Gary Robbins, but it would take several years to ramp up to that level as American businesses adjust to the new tax structure. In any event, this is really the only way to proceed if the budget deficit problems are going to be addressed at all levels of government – and little by little the GOP is becoming more comfortable with explaining these dynamics.

Dollar Policy: Secretary Snow caused some excitement in the forex markets Monday with his weekend comment that American exporting manufacturers benefit from a weak dollar. It is of course true that some companies get increased foreign orders for a time when the dollar loses value against the euro or the yen, but the national economy gets no net benefit from a weaker dollar (inflation) or a stronger dollar (deflation). The dollar/gold price is probably a bit higher because the Fed has been worrying about "less inflation," which causes a shift in cash balances in those multinationals that hedge in the forex markets. This can’t be much, though, because there are no immediate signs the Fed can do anything about the dollar with its current operating mechanism, which fixes the overnight interest rate, not forex or gold. Oddly enough, at the moment the three key currencies are at or very close to their optimal gold rates. The dollar/gold price is at about $350, which is where there we think there are no inflationary or deflationary impulses at work. The euro gold price is at €300, which is where it is in balance. Yen/gold is near ¥41,000, which is close to its equilibrium. If Greenspan were still interested in a fixed international monetary system, he could not find a better time to promote it, as the stars and currencies are in alignment, and may not be later this year or the next.