Recessions and Tax Cuts
December 6, 2000

"Suddenly," thought Sylvia, "recession is in the air."

Everywhere, there were signs of a stalling economy. The output of goods and services grew a mere 2.4 percent in the latest quarter. Businesses seemed reluctant to spend more on equipment and factories. The real estate sector had lost its bounce. Even consumers appeared to have lost their appetite for the untrammeled spending they had become addicted to -- spending financed by easy credit.

The stock market was in a funk. The Dow was down for the year, so was the S&P 500. The Nasdaq was the worst of all, down by about 30 percent since the beginning of the year. And the carnage in the stock market was taking a toll. Consumers, their wealth markedly diminished, became circumspect about spending. With stocks languishing, firms found it difficult to raise capital to finance new projects. The dot-coms bore the brunt. Having soared to dizzying heights, where they perched but briefly, the shares of many of the e-firms plummeted to excruciating lows, impairing their ability, in some cases fatally, to raise additional capital to continue their profitless operations.

As the evidence of a slowdown mounts, noted Sylvia, analysts have begun to entertain the possibility of a looming recession. With the new President (Bush?) about to step into the White House, the magnificent U.S. economy, at long last, appears to have run out of steam.

One would think that the immediate likelihood of a recession would serve to fill Bush and Co. with consternation. Far from it: in fact, noted Sylvia, several conservative commentators almost appear to relish the prospect.

How come?

It didn't take her long to figure it out. The answer lay in tax cuts.

In his campaign, Bush promised to cut all marginal income tax rates. Critics pointed out that this would favor the wealthy disproportionately, and that the budget surpluses built up assiduously over the last few years would disappear. Even Greenspan weighed in with his customary obliqueness about the possibility of higher interest rates -- but Bush was adamant.

There was another charge, viz. that tax cuts were unnecessary in a robust economy, and would in fact kindle inflation. But now, noted Sylvia, if the Cassandras were right, a recession loomed (beckoned?) -- and Bush could justify using tax cuts to spur consumer spending and combat the incipient economic stagnation. Finally, thought Sylvia, intellectual respectability for the tax-cut idea!

But, wondered Sylvia, was a recession indeed lurking around the corner? If labor productivity continued to rise, even if at a slightly slower rate, the economy's output of goods and services would expand. Aiding this were developments in the oil market: The price of oil, after climbing relentlessly in the past few months, appeared to have settled down around the $30-a-barrel mark.

It was premature, decided Sylvia, to assert that a recession lay just ahead. But she doubted that such concerns would mitigate the ardor of those enamored of tax cuts.

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