Global Policy Forum

By Henry C. K. Liu

The whole world has been hoping for a quick recovery of the US economy to lead it out of protracted economic doldrums and waiting for the US president to command the awesome power of his office toward that objective. The US$674 billion "growth and jobs" proposal unveiled on Tuesday by President George W Bush indicates that their wait is far from over.

After more than two years of slow domestic economic growth that began even before he came to office, Bush unveiled a proposal the centerpiece of which included eliminating double taxation on corporate dividends (dividends are now taxed at both the corporate level and the individual level), in a bold attempt to manage the economic debate in preparation for the 2004 presidential election campaign. Reinvoking dated 1980s supply-side theories to solidify his conservative political base, Bush's tax plan proposed giving stock owners $364 billion in tax breaks a year and boosting the size of the tax cuts already passed in 2001 by nearly $300 billion, but only 15 percent of which would be accelerated to impact the stalled economy in 2002.

The plan proposed no financial aid to the financially distressed states and localities. It offered only minor incentive for capital investment to small business. Some $64 billion is earmarked to accelerate cuts in income tax rates, $58 billion to speed up the removal of the "marriage penalty", $91 billion to hasten an increase in the child tax credit, $48 billion to accelerate the move of lower income taxpayers to the 10 percent bracket, $29 billion to prevent more people from facing the alternative minimum tax, and $16 billion in incentives for small business purchases.

The Wall Street Journal drew attention to the one-line specification from the Treasury to give shareholders a potential tax break on profits even when a company retains or reinvests profits rather than pay dividends. For every dollar of retained earnings, the shareholder would be allowed to exclude one dollar from taxable gain at the time the share is resold, either as income or capital gain. Thus the cost of the dividend-tax-exemption plan may be much larger than estimated.

The plan proposes moving up future tax-rate reductions adopted by the 2001 tax cut to be effective this year and retroactive to January 1, instead of their original phase-in dates of 2006 and 2008. The government would adjust income-tax withholding immediately after passage to augment taxpayer cash flow. Bush would also reduce the taxes paid by married two-income taxpayers this year instead of 2009 to relieve the marriage penalty and raise the child tax credit to $1,000 from $600 this year instead of 2010; refund checks for excess payroll withholdings would be issued this year. It would also move millions of US taxpayers into the lowest tax bracket of 10 percent this year instead of in 2008. Of the $674 billion package, all but $3.6 billion comes in the form of tax breaks; these other funds are for $3,000 accounts that unemployed workers can use to find new jobs. In addition, small businesses would be allowed to increase the amount of equipment purchases they can write off for tax purposes to $75,000 from $25,000.

Charges are already flying from Democrats that the Bush proposal was an unnecessary handout to the rich that would further increase federal deficits already under pressure from military spending while neglecting low-income people and providing insufficient short-term stimulus to boost the stagnant economy. House Democrats have proposed an alternative plan that would spend more than Bush would in the current year and spread it more evenly across income levels but would cost one-fifth as much over 10 years because its measures are temporary. Republicans answered with counter charges that the Democrats are promoting class warfare.

Congress, despite Republican control of both houses, is expected to push for a more egalitarian plan and companies, particularly those in the New Economy that do not declare dividends, will push for alternative tax breaks for big business.

Couched profusely in populist rhetoric that masked it conservative content, Bush described the $1.35 trillion 2001 tax cut as merely the beginning of his commitment to lower taxes. He recycled supply-side economics arguments that tax cuts would actually increase government receipts, based on Says' Law that supply creates its own demand, which only holds true under conditions of full employment, which conservatives conveniently ignore. Without full employment, tax cuts in favor of supply side-investment merely adds to overcapacity, a current curse that has stalled the global economy. A preliminary Brookings Institution analysis of the Bush plan shows that those earning more than $1 million annually would see their after-tax income increase by $88,873 on average, or 3.9 percent. Those earning below $40,000 would have average after-tax income increases of $400. John Snow, Treasury secretary nominee, stands to gain a tax windfall of more than $600,000 a year on dividends from his 2 percent stake in the transportation company he headed before coming to Washington, not even counting dividends from his holdings in other companies.

Bush aides described the president as wanting "to think big", opting to continue to press not just for the new and accelerated tax cuts as counter-cyclical measures, but for making the 2001 tax cuts permanent. The Bush plan accelerates everything in the 2001 plan except the estate tax and the two provisions aimed explicitly at the working poor: one would have increased the size of the child tax credit that poor families who pay no taxes could receive as a tax a refund and the other increased the earned income tax credit for poor married taxpayers.

Under the Bush plan, only $102 billion of tax breaks would reach taxpayers' pockets in the first 16 months of the plan. Of that, $20 billion is from the dividend tax cut, which investors generally would not reap until they file their tax returns in 2004.

Struggling state and local governments are disappointed that the expected $10 billion federal aid to help with budget deficits was missing from the Bush plan. The states would also lose up to $5 billion annually in dividend receipts now automatically calculated from federal returns. For many taxpayers, much of what the federal government gives back, the states and localities will take away.

The US unemployment rate in November was 6 percent, with 8.5 million idle workers. Bush's plan claims it will create 2.1 million jobs over three years, still leaving 6.4 million jobless three years from now.

It was unclear what effect the scrapping of dividend taxation would have on overseas institutional and individual holders of US stocks whose tax bills are governed by countries' tax treaties with the United States.

While Bush aims to think big, his tax plan shows that he is wearing his ideological thinking cap. The US tax system is irrational and unfair. It acts as a structural obstacle to economic growth. Everyone agrees on the need for tax reform; the dispute is only on how the tax system should be reformed.

Yet the US economy is stalled because of overcapacity fueled by debt, a condition also found almost everywhere else around the world. And in the United States, the complex tax regime affects the rules of economic behavior in unique and peculiar ways that encourages debt. On this issue, the Bush plan said little.

Bush's critics are also missing the central issue of fair credit allocation, and instead frame the debate on whether the rich should get more or less tax relief than the poor. The real issue is that the government needs to deliver purchasing power to those who will promptly spend the money consuming the surplus products the world needs to produce to get out of a structural economic crisis. Giving money to those who will only invest it for more productive capacity will only exacerbate the current overcapacity problem. Yet the ideologies of neo-liberal market fundamentalism and sound money prevent any consideration for government intervention on demand management. Market forces as currently constituted by the existing tax and trade regimes tend to depress aggregate demand by treating unemployment and low wages as desirable prescriptions for inflation that threaten profit, even in the face of global deflation and overcapacity. Thus the economies of the world, both advanced and developing, are locked in a downward spiral, causing the global economy as a whole to shrink.

The US dollar is facing a much-delayed exchange-rate correction, but it is misleading to conclude that this is the beginning of a collapse of the dollar. A correction of the dollar up to 20 percent in relations to select foreign currencies would have positive temporary effects on current account balances in trade, but it will not solve the structural problems in world trade. Tokyo and Washington are jointly pushing for a Plaza Accord type move against China to push up the yuan, on the theory that China is exporting deflation, a view China rejects. The low prices of Chinese exports is the direct result of low Chinese wages and land rents. There is logic in the argument that China needs to continue its policy of rising wages to deal with domestic deflation. But the Chinese trade surplus from its export to the United States has a quadrupling effect on added US gross domestic product (GDP). In other words, for every dollar of US trade deficit in favor of China, the US economy registers $4 of additional GDP in value-adding services, such as marketing, distribution and retail markup, trade and consumer financing, etc. It is arguable that global deflation is not caused by any one currency being periodically and temporarily overvalued, or that competitive devaluation or upward valuation could solve the global deflation problem.

But for dollar hegemony, a term describing the undeserved role of the dollar as a preferred reserve currency for international trade and finance, the US trade deficit is not much different that that of most of the Third World. The Washington Consensus, which the United States preaches and which the International Monetary Fund (IMF) implements, prescribes combinations of monetary and fiscal policies to deal with trade deficit that include high interest rates to reflect the real cost of borrowing, and tax hikes and other austerity programs to dampen demand. But the US is exempt from such "stabilization" programs because of dollar hegemony.

Trade is shrinking because the process of transferring wealth from the poor to the rich through trade has run dry both domestically and internationally after a decade. Trade will have to reverse course and begin creating wealth rather than merely transferring it. The easiest place to start creating wealth is where poverty rules. In a poor land, even unsophisticated, simple ideas can create wealth because there is no downside on real poverty. The reason wealth is not created today in the world's poor regions is because of the exploitative structure of the current trade regime. Neo-liberal market fundamentalism never understood that poverty hurts everyone, not just the poor.

The reason world trade has been shrinking in the past few years may be that trade as currently structured transfers wealth from the less developed economies to the advanced economies, and from the poor to the rich within national borders, a double-barreled dwindling game. What is needed is to shift trade from being a game in which every nation competes in predatory exporting to earn dollars by lowering wages, to trade being a game to create wealth in all national economies through economic and human development. This means that trade should be structured to support economic development to raise wages everywhere, not to depress wages to compete for larger export share. This means trade incentives should be focused more on education, health, and social development, rather than exclusively focusing on low-cost manufacturing. The advanced economies should export their wealth-creating technologies to the less developed economies to enable them to create wealth locally through domestic development, not to export low-price goods and commodities to enrich the advanced economies. The advanced economies will have to be prepared to transfer technology and knowledge, forgoing exorbitantly priced intellectual property rights, accept smaller profit margins, leaving more generated wealth in the less developed economies, but because the world economy will then grow faster, even a smaller profit margin will yield higher profit for the advanced economies.

If the United States takes the lead in the progressive restructuring of trade, it will defuse the growing anti-US feelings among the world's exploited poor, defuse tendencies for destructive terrorism and reduce the need for anti-terrorism expenditures. The question is not so much the appropriate exchange value of the dollar or the yen or the yuan, which is merely a temporary technical misalignment issue. A multi-currency world trade regime will allow economies to focus more on domestic development. The exchange value of the dollar is not as important an issue as the dollar's dominant position as a reserve currency for world trade and finance, which tilts trade as a vehicle to forcibly transfer global wealth to the issuer of the dollar, namely the United States. Nor is it a question of the technical aspects of domestic tax polices. The issue is the need for full employment and rising policies world wide that would eliminate global production overcapacity. If government can live with zero interest rates, why is it so difficult to live with zero unemployment?

The world is at a very dangerous moment in its history, caused by violent political fallouts from the destructive economic impacts of neo-liberal trade globalization. The United States needs to shift direction and help the world create wealth that is shared more equitably, both within US borders and internationally. In the end, the US will benefit more as the leading economy of a more prosperous and peaceful world. That would be thinking big.

Henry C K Liu is chairman of the New York-based Liu Investment Group.

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