Stock Market vs the Economy

Steve Liesman wrote an interesting article for the Wall Street Journal: “Washington Needs to Decide If It Favors Capital or Labor.” It’s about a economist’s views on the Bush tax cuts:

With strong rhetoric, Democratic presidential candidates have linked President Bush’s tax cuts to job losses. But they’ve failed to provide the intellectual connection, explaining just how the president’s changes to the tax code have eliminated a job.

Now there is help for the Democrats from an unlikely source: a supply-side economist who has consulted with the White House on economic issues and was even mentioned as a potential adviser to President Bush. In a recent report, David Malpass, chief global economist at Bear Stearns, said recent changes to the tax laws may actually have reduced hiring. His comments raise an issue that gets at the heart of the debate over the correct economic policies to forge economic growth and create jobs. Specifically, what are the appropriate incentives government should provide business? Should it favor capital or labor?

Liesman contacted a “half a dozen economists across the political spectrum, including professors and business economists, who nearly all agreed that the depreciation change could indeed have led to reduced hiring.” The consensus of the group was that “nearly all agreed that the depreciation change could indeed have led to reduced hiring. (There were arguments over whether it caused a lot or a little, but the dynamic wasn’t disputed.) “

This is a rhetorician’s false dichotomy. The choice shouldn’t be between capital and labor; rather, it should be in between an effective policy and a more effective policy. That’s the advantage of being “unburdened by an education in classical economics;” I am free to draw conclusions rooted in reality rather than obtuse and irrelevant academic distinctions (The real world tends to do that).

IMHO, allowing acceleration of depreciation ultimately makes capital goods cheaper. That should lead to an increase in demand. Someone’s gotta build those printers, drilling rigs, SUVs and other machinary. So eventually, labor benefits.

I think that (Bear Stern’s economist) Malpass makes the wrong comparison in pitting Capital versus Labor. Capital spending eventually leads to more labor — somewhere. When companies buy manufactured goods, they are helping to employ the workers who make those goods. In that sense, Capital should eventually lead to increased hiring, whether it’s in the US or South Korea or where ever. In Thursday’s
Market Commentary, I noted that the accelerated capital depreciation was ina ctuality a nice piece of corporate welfare for the likes of Ford and GM:

“I am least impressed of all by what may be the biggest issue impacting the markets and the economy: the nature of the recent tax cut package. I’ve discussed this in the past. The biggest positive is clearly the accelerated depreciation of capital goods (although including SUVs in that is a little disguised bit of corporate welfare for Ford and GM).

As we watch the impact of the cuts play out in the broader economy, my worst initial concerns are slowly becoming confirmed: Much of the tax cut program was focused on the stock market itself, instead of on the broader economy. That’s like treating a patient’s symptons, but ignoring the underlying disease. That may be manifesting itself in the stubborn jobless numbers 21 months post-recession.

The focus has been to move the market up, get consumer confidence higher to increase spending. The hope was to increase the confidence levels of the CEOs, a group that still suffers from bear market fatigue. Once the executives refind their lost nerve, then perhaps rehiring starts again. At least, that’s the theory; We’re still awaiting the outcome.”
–What’s your timeline?, 9/11/03

Perhaps the better comparison for Malpass to look at might have been the Stock Market vs the Economy. I simply cannot recall any previous time where the focus was on stimulating the Markets, rather than stimulating the economy.

The President’s tax package was very much focused on the Stock Market. It replaced an odd accounting permutation – the preference for debt over equity by public companies (via double taxation of dividends) – by creating a new odd permutation, a new “dividend class” taxpayer bracket; For some reason, we also lowered the capital gains tax – on the heels of the biggest investment bubble in history.

It’s hard to imagine that capital investment really required additional stimulation.

The bulk of the tax cuts were for the investor class (ie, the top 10%); As you can see, it had the expected response – it stimulated investment in the market. To stimulate the economy, you cut taxes for the spending classes – the middle class. They typically spend most of their discretionary income. That in turn stimulates manufactured goods and service consumption, which should lead to additional hiring. The trade off is less of a fund flow driven rally, and more of a better set of employment numbers.

All told, I don’t believe that’s the most effective way to spend a trillion dollars. As the Presdient often says, “if you want more of something, tax it less.” So, on top of middle class tax cuts, if you want to increase hiring, give companies a tax credit for new hires or health care costs or just cut the payroll tax. It’s really not that complicated – when you increase your domestic headcount over a previous percentage – i.e., 2001’s high number, the firm gets a tax credit. Note that overseas outsourcing or reducing US headcount will not qualify you for the cuts.

The focus on the market was, in my opinion, poorly executed. It ignored the small individual investor. The tax cuts cost a lot, and generated very little in return. There was a real opportunity to use taxes to put some spending cash back into the hands of the people who will likely spend it. That oppportunity was squandered. My inclination would have been to see the deductible amount of loss carry forward – now limited to a mere $3,000 per year – raised dramatically to $10,000 a year immediately, and then scale up to $25,000 by 2013. A significant raise in the amount people can contribute (pre tax) to thir IRAs and 401ks would also have also been advised. Many folks need to accelerate their contribution rates in order to make up for their recent bear market losses . . .