Fellow Shortrunners,

     This Tuesday, the President is set to unveil a stimulus package to the tune of $600 billion, a figure amounting to  nearly 6% the annual income of the entire United States.  Speculation suggests that proposals will include an acceleration of the enormous tax cut passed in 2001 and an elimination of the dividends tax.  Though it's too early to speculate, a large number of the proposals on the table seem to suggest that the stimulus package will likely come in the form of a tax cut rather than in increased government spending.  But what exactly should the government do, given the weak recovery of the US economy and ailing financial markets?

     If the package is aimed at stimulating economic growth, then a cut or abolition of the dividends tax is not likely to do very much good.  Dividend income makes up only a smidgen of total GDP, and a large portion of dividends go into retirement accounts or other funds where they may not encourage economic growth.  I have previously argued that taxing dividends is a bad thing, but for an entirely different reason.  If firms have a greater incentive to pay dividends (which some argue are now taxed 2x), then the stock market could once again use dividend payments as a measure of a firm's well-being.  Whether this would happen remains to be seen.  It is unlikely, as some hope, that reducing dividend taxes would encourage firms to do more equity financing through stock as opposed to debt because tax breaks still exist for firms to hold debt.  If the stimulus package is aimed at helping the stock market, a dividend tax cut might help but probably not to that large of an extent.

     Part of the justification behind further tax cuts has been that states are likely to have to raise taxes.  Balanced budget amendments have been plaguing state governments as revenue growth has slowed.  One way in which a stimulus package could be used would be to funnel funds directly to the states.  Provided that this money was not earmarked for new programs and initiatives, it could help states balance their budgets, preventing cutbacks in expenditure and in employment.  This would have a direct impact on economic growth.  It will be interesting to see to what extent state governments, almost all of which are facing budget shortfalls, will be beneficiaries of the stimulus package.

     Finally, one question will loom over any proposal.  Simply, is the stimulus really needed?  A number of recent economic figures have been weak.  Consumer confidence is plummeting and the labor market stubbornly refuses to improve.  But at the same time, interest rates are low, the federal government is already back in the red, and further spending could spark inflation.  Other figures are even suggesting that the economy's fundamentals are still running on all cylinders.  Specifically, the past two productivity and output figures have been stronger than expected.  Inflation seems tame for the moment and this week's ISM manufacturing report showed a healthy rebound.  All these suggest that the US economy may be on its way to recovery on its own.  Only time will tell if the government feels the same way.

Economic Releases

The data section provides charts and data for the most important economic indicators. 

Existing Home Sales: -3.5%
Release Date: 12/30

• Existing home sales shed 3.5% in November according to a release by the National Association of Realtors on Monday.  The decrease still leaves home sales at historically high paces.

Consumer Confidence: 80.3
Release Date: 12/31

• Adding to the confusion of a week with a number of conflicting releases indicating recovery and deterioration in the US economy was Tuesday's Conference Board release of consumer confidence.  Overall consumer confidence in the US fell to 80.3 from 84.9.  Analysts' predictions going into Tuesday had posited growth in the survey based index.  The Conference Board's consumer confidence index is the most influential survey of its type and the decrease will likely make a splash with policy makers.

ISM Manufacturing: 54.7%
Release Date: 1/02

• The Institute for Supply Management (formerly NAPM) reported that surveys of purchasing managers are suggesting that the overall climate in the manufacturing sector of the US recovered drastically in December.  The ISM Manufacturing index jumped from 49.2 in November (readings below 50 suggest contraction in the sector) to a healthy 54.7.  Nonetheless, most analysts will look for continued strong numbers before pronouncing the manufacturing sector as recovering.

Jobless Claims: 403,000
Release Date: 1/02

• Initial jobless claims rose back above 400,000 yet again last week, the BLS said Thursday.  The recently volatile index is suggesting a weak hiring climate and most economists currently see the labor market as acting as a drag on the overall economy by slowing demand, production, and income growth.

Construction Spending: 0.3%
Release Date: 1/03

• During November, construction spending in the US rose 0.3% on growing residential and government projects.  Strong housing demand is likely pulling in new construction projects and thus carrying this sector of the economy along its coattails. 

ECRI Weekly Leading Index: 117.6
Release Date: 1/03

• On Friday, the Economic Cycles Research Institute (ECRI) reported that the ECRI WLI fell to 117.6 from a downwardly revised 118.8 the previous week.  Economists for the ECRI cited a need for continued business confidence and noted the danger that supply shocks (such as an oil crisis; oil prices hit a two year high this week then began to taper off) could do to the recovering economy.  The Index's growth rate decelerated to -2.8%.

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Issue #134

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