sent 7 February 2001
Re: "Can Rate Cuts Do the Job?" by Rich Miller and Ann Therese Palmer, and "Why Not a Payroll Tax Cut?" Business Week, 5 February 2001.

Letter to the Editor, Business Week:

In the recent issue of Business Week, one article promotes the idea of a $48 billion income tax credit against payroll taxes ("Why Not a Payroll Tax Cut?"), while another ("Can Rate Cuts Do the Job?", by Rich Miller and Ann Therese Palmer) wonders whether monetary easing, alone, can cushion the hard landing that lurks over the horizon.

The short answer is that neither of these will be sufficient to prevent a deep and protracted recession. The Clinton expansion was fueled by unprecedented private sector deficit spending (right now, the private sector is spending in excess of its income by a record 8% of income) and borrowing. As households and firms bring spending into line with income, a demand gap of at least $450 billion per year will be created. Thus, the size of the tax cut that will be required annually is at least $450 billion dollars-ten times the amount mentioned in your tax-cut article. Further, while it is true that lower interest rates will save consumers some mortgage servicing costs -- $12 billion this year -- this pales by comparison with what is required.

In any case, given the federal budget surplus and the trade deficit (which are huge leakages that are not likely to be reduced without significant policy changes), the Fed could revive the expansion only by inducing households and firms to embark on another unsustainable borrowing frenzy. In conclusion, there really is no alternative to a huge fiscal adjustment. Senator Lieberman and others are on the right track when he argues a payroll tax cut is the way to put more money into the hands of working Americans. But they need to think on a grander scale.

L. Randall Wray
Professor of Economics
University of Missouri - Kansas City
211 Haag Hall, 5100 Rockhill Road
Kansas City, MO 64110
phone 816-235-5687, fax 816-235-5263