August 06, 2004

Why Oh Why Are We Ruled by These Fools? (Fiscal Policy Edition)

In light of the disappointing state of the labor market today, it is interesting to ask why George W. Bush did not buy us effective labor-market insurance. Why did he not set in motion in late 2002 a real and effective employment stimulus package? Instead, he chose a "Jobs and Growth" plan that got us much less employment bang for added deficit buck than it should have, all the while pretending that a cut in taxes on dividends was a cost-effective short-run employment-generating fiscal stimulus.

Given that the Federal Reserve was effectively out of ammunition as of late 2002, an effective stimulus package--insurance against further bad labor market news--seemed to me then and seems to me now to be a no-brainer. And the shortcomings of the Bush administration's dividend tax reduction "Jobs and Growth" plan as a short-term employment-generating fiscal stimulus were no secret to anyone outside the White House.

As regular readers of this weblog know, Ron Suskind's (2004) The Price of Loyalty contains a contemporary stenographic transcript of what appears to have been the key meeting in the fall of 2002. (Note, however, that the meeting may have been totally irrelevant to Bush's decision: behind the scenes, Cheney was a strong advocate of reductions in dividend taxes.) Here's a condensed summary:

Paul O'Neill opposes any further reductions in current taxes: he is worried about the long-run budget balance and about funding future changes in Social Security, and thinks the economy and the labor market will recover on their own.

George W. Bush still does not understand that his staff's plans for Social Security "reform" are *expensive.*

George W. Bush's advisors are allowing him to believe that his record on spending restraint is "mixed" rather than "awful."

Glenn Hubbard wants an end to the double-taxation of dividends to make the economy's allocation of capital lest wasteful, and also doesn't believe that the administration should even be thinking about short-run fiscal stimulus.

Keith Hennessey wants to claim that a reduction in the double-taxation of dividends will be an effective short-run stimulus.

Mitch Daniels fails to fulfill the OMB Director's job of being the person who worries the most about budget imbalances.

Larry Lindsey claims that the reduction in the double-taxation of dividends is an effective insurance policy against further bad macroeconomic news.

Bush worries about the unfairness of a further reduction in current taxes on the rich.

Glenn Hubbard tries to reinforce Bush's belief that the rich are the Good People.

Lindsey and Hubbard try to push Bush's hot buttons.

Karl Rove tries to push Bush's hot buttons.

Paul O'Neill proposes a tax reduction--the permanent expensing of corporate investment--that promises to do more to boost investment, demand, and employment in the short run. But sees that Bush is confused. Karl Rove supports O'Neill, but Bush is still confused.

Glenn Hubbard tries to table Paul O'Neill's proposal.

Josh Bolten supports Hubbard by misleading Bush about the likely effects of deficits on interest rates. Hubbard agrees.

Dan Bartlett worries about state governors.

Andy Card demands action--he doesn't seem to care what kind of action.

Glenn Hubbard claims that reductions in dividend taxes will boost stock prices and repair corporate balance sheets.

Paul O'Neill points out that the reduction in dividend taxes will do little to boost aggregate demand.

Bush seems confused.

Karl Rove talks about political tactics.

Mitch Daniels suggests that they do everything considered: reducing current tax rates, expensing corporate investment, and reducing taxes on current dividends.

Bush is happy: "Thank you for all the briefing materials, this was good research. So when do we roll this out?"

Karl Rove looks at Bush with pride.

Mitch Daniels is still of two minds: "'Not a typical Republican package', he muttered. 'Definitely not'."

Five things about this meeting are worthy of note:

  • The deficit-hawk faction is missing in action. Paul O'Neill gets effective support from neither OMB Director Mitch Daniels nor Deputy Chief of Staff Josh Bolten. Nobody wants to point out to Bush how lousy his administration's record on spending restraint is. These make it inevitable that there will be... not a tax cut, but a tax shift... a reduction in current taxes and a concommitant increase in future taxes when the bills come due.

  • Glenn Hubbard is uninterested in whether the "tax shift" is an effective short-run employment-generating stimulus: he believes a reduction in the double taxation of dividends pays powerful long-run benefits by improving the economy's allocation of capital, and that's what he is going to push for.

  • Larry Lindsey and Keith Hennessy are willing to let Bush believe that a reduction in taxes on current dividends is an effective short-run employment-generating stimulus.

  • Nobody else in the room has a clue. (That's if the decision was made in the room. If the decision was really made earlier in a private meeting between Bush and Cheney, than nobody in the room had a clue.)

  • Nobody in the room has the mission of making sure that Bush hears what a President needs to hear in order to make the right decision.

You can say that it is not really Bush's fault: that he is getting bad advice from manipulative advisors. But remember that the Czar (or is it the Vice-Czar?) hires the cossacks.

Here's a fuller account from Ron Suskind's (2004) The Price of Loyalty:


p. 295 ff: November 26, 2002: in the White House's Roosevelt Conference Room:

The President... sat down. "All right, how are we doing?"

[Larry] Lindsey began, "I'm reminded, looking at the table, of a joke I heard from Prime Minister Koizumi of Japan, that he gets two opinions from each economist, and since, Mr. President, you have five economic advisers--"

"What are you talking about?" snapped Bush.

"Yes, sir. Your economic team agrees on the key elements of an economic growth and jobs package: reduce the double taxation of dividends, accelerate the rate cuts, and provide more epensing of investment losses. Let me now turn to Secretary O'Neill."

O'Neill shuffled some papers--thinking maybe Larry [Lindsey] and the President weren't getting on so well after all. But now that he knew about Cheney's [support for further large-scale tax cuts], it didn't much matter where Larry [Lindsey] was.

"... On balance, I am more optimistic about the U.S. economy than the group, and I remind you that I was right last year, and we've mostly been right this year in our real-time forecasts. And that leads me to believe we don't need a major, expensive stimulus package.... I am concerned that what we do now not tie our hands on major tax reform or on creating Social Security private accounts. And when I look at what we have got here, in this package of proposals, I am dubious that we can get anything enacted in time to do much good."

Bush looked at him quizzically. "What is your point about Social Security private accounts?"

"There will be a transition cost, Mr. President," O'Neill explained, surprised. "Perhaps a trillion dollars over many years. This will be more difficult to do with large budget deficits. It will also be difficult to keep Congress in check."

"We have had some success on the spending side, but also some setbacks," Bush said.

Gazing down the row, Bush now looked at [Glenn] Hubbard.... "I don't think of this as a stimulus package, but a growth package," Hubbard said. "The economy is facing headwinds.... The third quarter numbers were strong, but they borrowed from the fourth quarter..."

"Do we have to give it back?" Bush quipped, getting off a good one to big laughs.

Then to Keith Hennessey: "The priority should be eliminating double taxation of dividends. I think that the revenue loss will be much smaller than the static estimate," Hennessey said.... "We should also include more expensing of investments and accelerating the rate cuts. I think of this as an insurance policy, not against a double dip back into recession, but against 1 percent slower growth in each of the next two years."...

The Commerce Secretary echoed much of what had been said.... As usual, not a real discussion, O'Neill thought as he looked over at [Mitch] Daniels.... He knew Daniels was focused on the perils of rising deficits, but it would take gumption to air those concerns in a room full of tax cut ideologues.

"I think we need to balance concerns," Daniels said.... "You need to be out front on the economy, but I am concerned that this package may not do it. The budget hole is getting deeper... we are projecting deficits all the way to the end of your second term." From across the table came glares from the entire Bush political team. Daniels paused.... "Ummmm. On balance, then, I think we need to do a package... accelerate the rate cuts and the double taxsation of dividends..." O'Neill looked with astonishment at Daniels... turn 180 degrees in midsentence.

Lindsey jumped in. "Mr. President, this is an insurance policy, and it is a bad time to go uninsured. With the world economy as it is, the United States is the only game in town."

Bush looked with disdain at Lindsey and went in another direction. "We are slowing from third to fourth quarter, but O'Neill hasn't been wrong yet. Why have nominal wages stopped growing?" The answer was complex... the kind of academic discussion the President generally abhorred. But... Bush seemed to be encouraging unscripted exchanges.... "What we are proposing is good long-run tax policy," Lindsey said in a non sequitur, trying to get the President back on track.

Bush acted as if he hadn't heard him. "Are you proposing we accelerate all the tax cuts, or just for those in the middle? Won't the top-rate people benefit the most from eliminating the double taxation of dividends? Didn't we already give them a break at the top?"...

Hubbard: "Mr President, remember the high earners are where the entrepreneurs are."...

Bush seized on it. "This is about demand," he said. "I want this to work."

"It's also about the supply side," Lindsey said.

"Eliminating the double taxation of dividends is a game changer," Hubbard added. "Game changer" is one of Bush's favorite phrases.

Rove finally spoke up, a rare event in a meeting of this size. "You should be basing the package on principle--if double taxation of dividends is wrong, why... settle for just eliminating 50 percent...?" "Stick to principle" is another phrase that has a tonic effect on Bush....

Josh Bolten leapt into the fray. "This burns a big hole in the budget."...

Daniels, having changed direction only a few minutes back, now spoke as an ardent supply-sider. "Yes, but we get a lot back"...

O'Neill picked up... "The trouble with the double taxation is that... there's a strong chance it will all be dissipated.... He put forward an alternative: the permanent expensing of capital expenditures, which... prompts expenditures on capital goods that benefit the wider economy. He looked across the table and saw the President was befuddled. He quickly moved to hold the floor.... "We don't want to slam the door on our toes in the fourth quarter of 2004 after the current provisions expire."

Bush picked up on that last dangling reference to the date: "Just as long as we don't slam the door in the third quarter of 2004."

But Rove seemed intrigued by... expensing capital expenditures. "On the Hill, there is talk of a plan to change all the depreciable lives," he said, and then ticked off th enewly proposed intervals...

The President was now thoroughly lost. "What are you talking about?" he barked at Rove.

Hubbard moved to smooth things: "This should wait for a time when we do major tax reform."

Glenn thinks that a deficit of $200 billion pushes up interest rates by just three basis points [or .03 perent]," Josh Bolten interjected, bringing things back to the key issue of whether the dividend tax cut was affordable.

"That's right," Hubbard said. Sitting next to him, O'Neill shook his head. Greenspan and he had been running tables on the effects on deficits for years; that figure was wildly low.

Bush waved his arm dismissively. "Hold on. We're betting that revenue streams come back with growth and that we can hold the line on spending.... This focus on the top rate, is it a high priority? Again, won't the high end benefit most from the double-taxation elimination?"

No one seeme to want to reply. Eliminating the double taxation is a benefit heavily weighted to those who hold stock.... Of coures, the "high end" was the "base"--the income distribution of the proposed cuts was largely a political calculation searching for an economic rationale.... After a noticeable, pregnant pause, Dan Bartlett moved back to politics. "We are hearing from governors about state budgets."

Andy Card said, "We need a quick payoff, Mr. President."

Hubbard was intent that they not forget what had brought them here: "Elimination of the double taxation will boost stock prices and repair balance sheets."

Card jerked things back: "There is excess capacity, so why do we want to boost investment?"

O'Neill was pleasantly surprised. "Mr. President, the Business Round Table of the country's leading CEO's says the focus should be on boosting consumption demand.... I'm not sure that a tax cut that benefits mostly wealthy investors, many of whom will just push these gains into savings, will do much for demand."

Bush nodded.... The ideology of ongoing tax cuts seemed to make less sense.... Finally he spoke, haltingly. "The divided tax cut could repair corporate balance sheets," he said, feeling his way, "and that's a kind of growth package, isn't it?"...

Hubbard rushed to the President's aid. "Households who desire to save more can do so through higher stock prices."

Bolten attempted closure: "I think we have agreement.... Now, how big should the package be? How much extra... so we have something to give back in the legislative process?

The President didn't seem ready to close. "Didn't we do the investment package already? Wha twould you rather have? We went through this last year, are you telling me we did it wrong?"...

"There are headwinds," Hubbard said.

"Not additional headwinds," Bush countered. "They can say, 'They did it twice and it didn't work.' Why do we play our hand now, negotiate against ourselves? I want to stay with principle."

This seemed to be a cue to Rove.... Karl moved to tactics...

Daniels, still looking to redeem himself for his earlier deficit hawk comments, jumped to support Rove: "I suggest a $50 billion package--$50 billion a yeare--and that we go on the offensive, including accelerating the rate cuts, and expensing, and dividends."

The president seemed relieved, as though the key issues had been considered. "Thank you for all the briefing materials, this was good research. So when do we roll this out?"...

"Good, what I am hearing is that we roll out in mid-December," President Bush said as he began to stand.

Rove looked at the President with pride. "Stick to principle," he said.

On O'Neill's left, Daniels was still of two minds. "Not a typical Republican package," he muttered. "Definitely not."

Posted by DeLong at August 6, 2004 07:03 PM | TrackBack | | Other weblogs commenting on this post
Comments

Don't we get what we deserve? The apparent inability of Bush to get beyond global black and white philosophical positions allows the conversation and decision making to be decisive and firm and at the same point fails to consider the real world impcts of shades of gray.

Unfortunately, in the real world the shades of gray are where we live and feel the impact of these "strong" decisons that Bush was manipulated into taking by the advisors he selected.

I think the outcome is due to his inability or lack of effort to understand the actual impact of the decisons and their many reverberating waves. Ultimately he selected his advisors and they deserve each other.

Like a child - knows what he wants gets it then can't believe the consequences of incredibly poor decison making process.

Posted by: pfknc on August 6, 2004 07:38 PM

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While I am among those who have been continually irritated by Bush's infantile dialog, his myopic domestic policies, and his disastrous foreign policies, I am starting to feel sorry for him. In January of 2005, when he is unemployed again, he will be viewed by just about everyone in the world as a boneheaded screw up. In that regard, it will be no different than how he has been for most of the rest of his adult life. Who can fail to feel just a little bit sorry for a guy put up to do a job that he doesn't have to capacity to succeed at?

We shouldn't be angry with him. We should feel sorry for him. He clearly was not anywhere near being up to the job of POTUS.

Posted by: non economist on August 6, 2004 07:44 PM

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I would consider Cheney less of a vice Czar and more of a Rasputin. Then again Rove is Rasputin and so is Wolfowitz and ...

I recall my simple defence against con jobs like Hubbards
1) what is the back of the envelope estimate of the effect of that on (something comprehensible like employment on July 30 2004 or GNP in the first half of 2004).

If there isn't a string of numbers which add and multiply out right, the economist is totally bluffing.

The fact is that, even assuming that an increase in stock prices due to an end to double taxation of dividends has the same effect on investment as any other increase in stock prices (it wouldn't if anyone were rational), the effect is small as stock prices are not very useful in predicting anything.

Hubbard's line would be that things are different for some reason, but first he would have to say an order of magnitude different and second he would have to have done the arithmetic (which I'm sure he hadn't).

A story without numbers has no place in the policy debate. Even the innumerate can have the numbers recorded and checked by someone numerate.

Posted by: Robert Waldmann on August 6, 2004 07:46 PM

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I would consider Cheney less of a vice Czar and more of a Rasputin. Then again Rove is Rasputin and so is Wolfowitz and ...

I recall my simple defence against con jobs like Hubbards
1) what is the back of the envelope estimate of the effect of that on (something comprehensible like employment on July 30 2004 or GNP in the first half of 2004).

If there isn't a string of numbers which add and multiply out right, the economist is totally bluffing.

The fact is that, even assuming that an increase in stock prices due to an end to double taxation of dividends has the same effect on investment as any other increase in stock prices (it wouldn't if anyone were rational), the effect is small as stock prices are not very useful in predicting anything.

Hubbard's line would be that things are different for some reason, but first he would have to say an order of magnitude different and second he would have to have done the arithmetic (which I'm sure he hadn't).

A story without numbers has no place in the policy debate. Even the innumerate can have the numbers recorded and checked by someone numerate.

Posted by: Robert Waldmann on August 6, 2004 07:47 PM

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It was Bush's decision to bet the 'economic farm' on his often repeated and willfully obtuse message: "We cut taxes! Everything will be fine!"

A major reason for the Bush economic malaise is that Bush's tax cuts ( mainly for wealthy ) did not work. In the short term, tax cuts bolster demand/spending but unless the fundamental problem of job growth/employment is fixed consumer demand/spending recedes like we're now seeing.

Bush has demonstrated ideological paralysis with no REAL solutions to improving US economy other than 'colluding' with Greenspan to have artificially low interest rates for 3 years which allowed home building and cash availability thru refinancing.

Even with this Bush has FAILED to stimulate a healthly sustainable US economy togehter with respectable job growth.

The Net Net on jobs and the economy

Jobs - first Pres since Herbert Hoover to have a net negative in jobs over 4 yrs.

Economy - A record 445 billion-dollar budget deficit in 2004 on top of a 375 billion dollar deficit in 2003. The George W. Bush legacy here is 4 years to create a MOUNTAIN OF DEBT.

He made his bed and now has to sleep it it. This a major reason why he will lose.

Posted by: standa on August 6, 2004 07:58 PM

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You seem to think that this meeting was, in some sense, ABOUT economic policy. It was not. It was about rewarding/stoking/inflaming the Republican base, or bases. That is all that anything is about in this Administration. And, yes, before you ask, "anything" includes all foreign policy, military actions, etc.

Posted by: Frank Wilhoit on August 6, 2004 08:00 PM

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Brad, when you "ask why George W. Bush did not buy us effective labor-market insurance. Why did he not set in motion in late 2002 a real and effective employment stimulus package?" you assume (1) that George W. Bush *can* buy effective labor-market insurance (objectively possible but not necessarily likely) and (2) that George W. Bush would *want* to buy effective labor-market insurance.

If George W. Bush were to locate and obtain effective labor-market insurance, he would lose his problem (economic woe) and thus his solution (tax cuts). If Bush were to solve his problem, he would run out of opportunities to apply his solution - so long as he doesn't address the real roots of economic woe, he can keep cutting taxes.

Posted by: Chris on August 6, 2004 08:43 PM

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The answer to Brad's question is that "It never occurred to them that it might be a good idea."

Bush is a clueless chump who has absolutely no idea wtf they are talking about. None of his advisors seem to think that employment will not recover on its own, including O'Neill. So they are really no help.

When Clinton went into the WH, there was no network, no email and everything was done on typewriters and not computers. Partly, BushCo is too old school to recognize the fundamental changes in the economy, One would think that O'Neill would have a better appreciation for productivity increases after ALCOA. But he does not.

However, no one stands up for the unemployed (mostly Democrats anyway) and thinks they have concerns that need to be addressed. Most economists are surprised that productivity increases have been so much higher than expected. It does not fit the patterns of the past. So- GET USED TO IT. High productivity increases are the current wave. Use current productivity increases in your models and your predictions will improve.

BTW, the economy is performing well enough. The job market sucks. These guys are clueless about the modern environment. Change and competition. If government cannot equip its labor force with appropriate education and skills to meet the change and competition, the labor force will be left behind. Bush and Co don't get it.

Posted by: bakho on August 6, 2004 09:03 PM

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I understand where all the actors are coming from except for Lindsey.
"Larry Lindsey claims that the reduction in the double-taxation of dividends is an effective insurance policy against further bad macroeconomic news."
"Larry Lindsey and Keith Hennessy are willing to let Bush believe that a reduction in taxes on current dividends is an effective short-run employment-generating stimulus."

I thought Lindsey was a professional economist. Does he believe what he's saying? If so, is his judgment defensible? If not, why is he saying it?

Posted by: Puzzled on August 6, 2004 09:06 PM

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"We shouldn't be angry with him. We should feel sorry for him. He clearly was not anywhere near being up to the job of POTUS."

Let me get this straight. You're feeling sorry for a guy who slid by his whole life on his family name, who got rich on his family name, and who will still be rich on his family name after this fiasco ends?

Look, if you're not up for a job where your mistakes have serious consequences for, say, EVERYONE ELSE IN THE WORLD, you ought to know that about yourself and not seek that job.

I don't feel sorry for him. He'll never really feel the effects of any of his actions. When he gets out of office, even if he never gets another job in his life (not bloody likely -- someone will pay him a million a year for his rolodex), he'll still be better off than something like 99.9999% of the people whose lives he changed for the worse while he had the power.

You want to feel sorry for someone, feel sorry for the families of the soldiers and civilians he got killed, or for all of the people likely to work more unpaid overtime (if they can find a job) thanks to his economic policies, or for the young women in Africa who got AIDS because it was more important for him to pander to the Christian Right than it was to actually provide condoms to women in developing countries.

Posted by: paperwight on August 6, 2004 09:09 PM

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Just to echo Paperwight: to say that we should feel sorry for Bush because he was "put up for" a job he was not qualified to perform makes it sound as though he had nothing to do with deciding to run. But of course he decided to run. He may not have known that he wasn't up to the job. He might be on some level a passive person who is most comfortable taking direction. But he is also a grownup, and when a grownup allows himself to be a genuinely thought-less person, and THEN decides that God thinks he should be President, he should be held accountable for his successes or failures

Posted by: hilzoy on August 6, 2004 10:05 PM

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"a reduction in current taxes and a concommitant increase in future taxes when the bills come due."

Well barro would tell us that rational economic actors would expect that increases would eventually occur. So therefore, we have a measure of rationality - the percentage of deficit tax reductions that go into buying government bonds to pay the future tax increases that every rational economic actor expects.

Posted by: Stirling Newberry on August 6, 2004 10:09 PM

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"a reduction in current taxes and a concommitant increase in future taxes when the bills come due."

Well barro would tell us that rational economic actors would expect that increases would eventually occur. So therefore, we have a measure of rationality - the percentage of deficit tax reductions that go into buying government bonds to pay the future tax increases that every rational economic actor expects.

Posted by: Stirling Newberry on August 6, 2004 10:10 PM

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Good article with good facts but naive analysis.

1) Was the Fed out of ammo? Are interest rates the only lever? I thought they could jigger the
money supply and issue advice other than "Turn the SS lockbox upside and shake?" or "Get an ARM."

2) It is touchingly naive to believe that the Fed's mission to optimize the economy involves making the pot as large as possible. Otherwise, inflation would be 3.5-4.5% all the time to counteract compound interest.

3) Would someone please explain how double taxation is eliminated by having end recipients pay 0 while not letting pass thru entities expense dividends like interest? If this is
an ignorant comment please help me. Not that I believe the case that dividends are doubly taxed is airtight.

Posted by: Craig Nelson on August 7, 2004 01:08 AM

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Craig's point notwithstanding, (which certainly suggests a less pure motivation), doesn't the dividend tax reform succeed in achieveing better capital allocation? Microsofts diividends being a case in point.

That being granted, it is the failure to plan how to pay for it that is the real mistake and the failure of the policy makers to address the cost of such changes that is the real problem.

Posted by: Jack on August 7, 2004 02:10 AM

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They should have had a film crew on hand for those meetings. That shit is as funny as "The Office".

Posted by: Clayton on August 7, 2004 02:29 AM

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The whole sequence sounds to me like a typical management meeting where the underlings already know where the chief is going and are just putting on a show to validate his ego. The decision on what to do (enrich the wealthy at all costs) was made years before this meeting. It's probably on the job application form for Republican presidents.

Posted by: Tim H. on August 7, 2004 06:01 AM

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Bush hypes the terror threat for political advantage, and gratuitously creates new enemies in Iraq. This keeps oil prices high, businesses reluctant to hire, and retards economic growth. Bush is undermining himself because he is too goddamn dumb to understand this.

Posted by: Bob H on August 7, 2004 06:23 AM

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Bush has to worry that his pauperization of the US will so weaken the country that it will be forced to offer him up to a World Court. Not a big worry true, but something for him to obsess on.

See Milosavitch.

Posted by: Eli Rabett on August 7, 2004 09:36 AM

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Pretty amatueurish as an economist here, but does anyone else think that the reduced tax rate on dividends could drive up borrowing costs for state and municipal governments?

I know that munis compete for capital with dividend-paying equities. Isn't that "triple tax free" juice a little less sweet compared to 15% taxed dividends than to ordinary-income-taxed dividends? Seems to me that these issuers would have to raise the rate they're offering to draw the same level of investment, increasing their costs.

Just wondering...

Posted by: Septimus on August 7, 2004 07:17 PM

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Another, perhaps loaded, question.

Does anyone know what % of tax-favored dividend paying shares are owned outside of tax-favored wrappers like IRAs or qualified plans?

IOW, is the real macorefficiency affect from lower dividend taxation (or elimination of "double taxation") as great as advertised?

Posted by: Septimus on August 7, 2004 07:22 PM

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