sent 31 January 2001
Re: "GOP tax-cut push buoyed by growing surplus estimates," by Alan Fram, Kansas City Star, 31 January 2001.

Why the Fed Can't Do it this Time: Larger Tax Cuts are Needed to Prevent a Hard Landing

There is growing recognition that our economy is in a tailspin, with even Chairman Greenspan admitting that growth has fallen to zero. Some, like President Bush, have recognized that substantial fiscal stimulus is required to prevent a hard landing, while others-especially Democrats-have argued that the Fed, alone, can prevent a recession by lowering interest rates. Your article, "GOP tax-cut push buoyed by growing surplus estimates" (by Alan Fram, 31 January 2001), reported that on current projections, the federal budget surplus will total $5.6 trillion over the next decade, providing support for President Bush's proposed $1.6 Trillion tax cut. While we support his tax cut, we fear that it will be far too small, and come far too late, to cushion this downturn. We advocate an immediate, annual, $450 billion tax cut, designed to provide tax relief to all Americans while stimulating demand.

The Clinton-era expansion was fueled by unprecedented private sector borrowing, which is spending in excess of its income by an amount equal to about 6.5% of GDP. All the recent economic data, however, indicate that borrowing by households and firms is declining, as they try to bring spending more into line with incomes. If the private sector were to balance its budget in the first quarter of this year, the economy would collapse. Indeed, holding GDP constant in the presence of such belt-tightening by the private sector would require that the federal budget adjust by perhaps 6% of GDP-moving from a surplus of more than 2% of GDP to a deficit of 4% of GDP. Now, it is possible that the adjustment in the private sector will be somewhat smaller than this, or that the US trade account could improve a bit-either of which would reduce recessionary pressures. Still, we believe that a substantial adjustment of the federal budget surplus will be required to prevent the slowdown from degenerating to a hard landing. In other words, fiscal policy must be adjusted so that the budget can move toward a deficit that would reach perhaps 2.5% of GDP this year.

Why can't we simply rely on the Fed to lower interest rates and thus boost borrowing and spending? Because the private sector is already burdened with debt accumulated as a result of unprecedented deficit spending. Monetary easing could work only if households would actually increase their borrowing and cause the nation’s saving rate (already negative) to continue to decline. Further, the federal budget is now designed in a way to produce "fiscal drag," as evidenced by projections that show the budget surplus increasing even as the economic growth rate falls. In other words, the federal budget is grossly imbalanced with its huge "structural" surpluses, because even meager growth requires unsustainable levels of private sector deficits. Thus, it is time to rush tax cuts through Congress, regardless of the Fed’s decision to lower interest rates again today. The only complaint we have is that President-elect Bush's tax cut proposal is far too modest -- a tax cut of at least $450 billion for this year is in order.

L. Randall Wray
Professor and Senior Research Associate
Center for Full Employment and Price Stability
University of Missouri-Kansas City

Mathew Forstater
Assistant Professor and Director
Center for Full Employment and Price Stability
University of Missouri-Kansas City