Economic Reporting Review
By Dean Baker
January 13, 2003

OUTSTANDING STORIES OF THE WEEK

Financial Dominoes and Dividend Taxes
Floyd Norris
New York Times, January 7, 2003, Page C1

This article discusses some of the ways in which investors might seek to game the dividend tax break being proposed by President Bush. For example, an investor could borrow money to buy stock and deduct the interest paid on the loan from her taxes. But the dividends paid on the stock would be tax free. There are a wide variety of other mechanisms that individuals and firms will be able to use to exploit this dividend tax break. This is why economists usually advocate taxing all forms of income at the same rate, regardless of the source.

Apartment Market Is Softest in Years
Neil Irwin
Washington Post, January 6, 2003, Page E1

This article discusses the weakness in the Washington area rental market. This weakness has led landlords to offer sharp reductions in rent, even as homeownership prices have continued to rise. This sort of divergence cannot be sustained, as landlords will eventually convert rental units to condominiums if the sale market remains strong.

Spending on Health Care Increased Sharply in 2001
Robert Pear
New York Times, January 8, 2003, Page A12

This article reports the findings of a government study that found that health care costs increased by 8.7 percent in the United States in 2001. The article notes that the United States spends a far larger share of its income on health care than other rich countries, even though a large segment of the U.S. population is uninsured, while other countries have universal coverage.

At A Texas Foundry, An Indifference to Life
David Barstow and Lowell Bergman
New York Times, January 8, 2003, Page A1

This article is the first of a three-part series examining the working conditions in iron and steel foundries operated by McWane Incorporated, one of the largest manufacturers of cast-iron pipes in the world. The article documents numerous examples of safety violations that have led to a large numbers of the on-the-job injuries and deaths.

The Dividend Tax Break

Bush Will Propose Larger Stimulus
Jonathan Weisman and Mike Allen
Washington Post, January 7, 2003, Page A1

The Politics of Portfolios
Richard W. Stevenson
New York Times, January 7, 2003, Page A1

White House Aides Launch a Defense of Bush Tax Plan
Edmund L. Andrews
New York Times, January 7, 2003, Page A1

The Majority Starts a Step Behind
David Firestone and Sheryl Gay Stolberg
New York Times, January 7, 2003, Page A14

These articles discuss President Bush's proposed dividend tax cut. All four of the articles assert that President Bush proposes to eliminate the taxation of dividends. This is not true. President Bush is only proposing to eliminate the taxation of dividends on stock held outside of retirement accounts. Dividends that are earned on stock held in retirement accounts - the vast majority of most investors' holdings - will still be taxed when workers withdraw their money. The taxation of these dividends is not affected by President Bush's plan.

The Post article and the article by Andrews both repeat without comment a claim by the White House that its tax break will "provide 92 million taxpayers with an average cut of $1,083." This manner of presenting the impact of the tax cut provides no information whatsoever about its distribution. For example, the statement would accurately describe a tax cut that gave $100,000 to 1 million rich people, and $1 to 91 million middle income taxpayers. The Andrews article, unlike the Post article, did include additional information about the distribution of the tax cut.

The Andrews article includes a chart that purports to show the distribution of the benefits of the dividend tax cut. The chart shows that richest 1 percent of the population will get roughly 42.3 percent of the benefits of the tax cut, based on the assumption that they hold about 30 percent of all stock. In fact, stockholding outside of pension funds is considerably more concentrated than this chart suggests. A recent study by M.I.T. Professor Jim Poterba found that 53.2 percent of stock outside of retirement accounts was held by the richest 1 percent (See "Stock Market Wealth and Consumption," James Poterba, Journal of Economic Perspectives, 2000 (Spring): 99-118). Their share of the dividend tax break would be considerably larger than this, since they face a higher tax rate, at present, than the rest of the population.

The Post article characterizes stock prices as being "depressed." Actually the current ratio of stock prices to trend corporate earnings is about 20 percent higher than its historic average.

Ending the Tax on Dividends: What, Why and How Much?
Daniel Altman
New York Times, January 7, 2003, Page C8

This article presents a series of questions and answers on the impact of President Bush's proposed dividend tax break. Some of the answers are contradictory. For example, the answer to one question about how the tax break will stimulate the economy hypothesizes that the $30 billion tax break will directly lead to an additional $20 billion in consumption, as consumers spend two thirds of this money. It then conjectures that it will indirectly generate another $40 billion in spending as a result of the fact that the tax cut will raise stock prices, and higher stock prices raise people's wealth. This higher wealth then leads to higher consumption. In total, the estimates used in the answer to this question imply a decline in national saving of $60 billion (government savings fall by $30 billion as a result of the tax cut, and private saving, on net, also falls by $30 billion).

However, the answer to the next question hypothesizes that the dividend tax cut will lead to increased savings, thereby stimulating more investment. It is likely that the amount of consumption resulting from the tax cut, both directly and indirectly, has been overestimated in the first answer; but unless it actually leads to a reduction in consumption (the opposite of stimulus), then the effect of the dividend tax cut will be to reduce saving and investment.

It's Not Easy to Make Dividends Tax-Free
Jonathan Weisman
Washington Post, January 9, 2003, Page A8

Bush's Plan Taxes Certain Dividends
Floyd Norris
New York Times, January 9, 2003, Page A1

These articles examine some of the complexities that result from President Bush's proposal to eliminate the taxation of dividends on stock held outside of retirement accounts. The proposal would only make dividends tax exempt if companies had already paid corporate tax on their profits. These articles note some of the difficulties in specifying the extent to which tax had been paid on the profits that generated specific dividend payments. It is important to note that profits, and tax liability, are often revised. This could create a situation in which a corporation pays dividends that are originally treated as tax exempt, because it had paid corporate income tax, but later become taxable, because revised earnings statements reduce or eliminate its tax liability. 

Few Officials At Companies Expect Surge in Dividends
David Leonhardt and Claudia H. Deutsch
New York Times, January 8, 2003, Page C1

This article reports the attitude towards President Bush's tax cut of corporate executives at several major firms that do not currently pay dividends. At one point it comments that dividends lost popularity in the nineties, based on a reduction in the dividend-to-price ratio. Actually, the percentage of profits paid out as dividends rose in the nineties, averaging more than 60 percent, compared to less than 50 percent in the sixties and seventies. The reason that the dividend-to-price ratio fell was that share prices rose far more rapidly than corporate earnings. A firm cannot pay out more in dividends simply because it has a high share price.

The Democratic Stimulus Package

Democrats Counter With Own Plan for the Economy
Juliet Eilperin and Dana Milbank
Washington Post, January 7, 2003, Page A1

Democrats in House Propose A Package Rivaling Bush's
Sheryl Gay Stolberg
New York Times, January 7, 2003, Page A7

These articles discuss the Democrats' proposed stimulus package. The Times article comments that "the package does not offer long-term solutions." It is not clear what long-term problems it is referring to in this statement. Stimulus packages are intended to address the problem of a temporary recession or slow growth. It would not make sense to have a long-term solution to a temporary weakness in the economy.

The Post article describes the Brookings Institution as "left-leaning." This is inaccurate. Its staff includes both Republicans and Democrats, the vast majority of whom would be placed in the political center.

The Post article also describes the differences between the President's plan and the Democratic proposal as being attributable to differences in philosophy. These proposals were crafted by politicians who were trying to appeal to certain interest groups. The article presents no evidence that political philosophy was an important factor in designing the proposals. 

Budget Deficits

A Republican Revolution? Not Likely
Helen Dewar and Juliet Eilperin
Washington Post, January 5, 2003, Page A4

This article examines the likely Republican agenda in the current session of Congress. It describes the nation's current situation at one point, noting the "grim realities of terrorism, war, a sluggish economy, and a return to budget deficits." While war, terrorism, and the economic hardships associated with a sluggish economy all imply significant human suffering, there is no obvious problem associated with the relatively modest budget deficits the nation is currently experiencing. In fact, the economy would be in significantly worse condition if the government were not presently running budget deficits.

Deficit Predictions Soar With Bush Stimulus Plan
Jonathan Weisman
Washington Post, January 10, 2003, Page A1

This article reports on several economists' projections of much larger deficits in the near future as a result of President Bush's tax cut and war-related military spending. At one point the article refers to claims by unnamed Bush administration economists that their tax package would create so much economic growth that it will generate enough tax revenue to bring the budget back into balance.

Even the most optimistic assessments of these polices would only claim that they could increase growth by 0.1 to 0.2 percentage points, annually. This would not be enough of an increase in the rate of growth to have any more than a marginal impact on the budget deficit. It is unlikely that any economist would consent to have his or her name associated with such an unrealistic claim.

French Working Hours

Shortened Workweek Shortens French Tempers
Craig S. Smith
New York Times, January 10, 2003, Page A3

This article discusses French attitudes towards their 35hour workweek, which has been legally mandated since 2000. The article notes several problems associated with the law, and then comments that it is unlikely to be repealed, adding "the reason has more to do with sociology than economics." It then presents several reasons why French people seem to prefer more leisure over additional income. This is economics. The article is pointing out that French people apparently value leisure more than income. If this is the case, then it is sound economics to implement policies that provide them with large amounts of leisure. It would be bad economics to introduce policies that raised income without regard to the value that the French place on their lost leisure.

The I.M.F. and Argentina

I.M.F. Still Sees 3.7% Growth This Year
Keith Bradsher
New York Times, January 9, 2003, Page W1

This article reports on a speech by Thomas Dawson, the I.M.F.'s chief spokesperson. At one point it refers to comments made by Mr. Dawson, in which he said that Argentina would have been able to keep its currency pegged to the dollar if it had kept a balanced budget. After the collapse of Argentina's peg in December of 2001, it was widely regarded by economists as having been a disastrous policy. At the time, the I.M.F. denied any responsibility for the peg, insisting that Argentina had decided on the policy in spite of the I.M.F.'s advice. Mr. Dawson's comments suggest that the I.M.F. is now reversing its view of the Argentine currency peg.

It is also worth noting that Argentina's deficit in 2001 was entirely attributable to its decision to privatize its Social Security program, at the urging of the World Bank. If Social Security taxes were still being paid to the government, instead of being paid into individual accounts, its budget would have been balanced in 2001 [http://www.cepr.net/argentina_and_ss_privatization.htm].

Gephardt Presidential Campaign

Veteran Lawmaker Is Restyling Himself As Can-Do Candidate
Katharine Q. Seelye
New York Times, January 6, 2003, Page A14

This article discusses the presidential prospects of Missouri congressman Richard Gephardt. At one point the article refers to a series of programs that Mr. Gephardt is proposing. It notes that the programs are not well defined. It then adds, "also unformed is how he would pay for all of these programs." It is very rare for articles to note that politicians have not devised methods of paying for their plans. For example, few of the articles discussing President Bush's tax cut proposals or his military build-up point out that he has not explained how he will pay for these policies.

Since the programs are ill-defined at this point, it is also not clear that they will require additional revenue. The programs may turn out to be largely symbolic gestures, similar to the ones instituted during the Clinton administration. In this case, the effect on the budget would be trivial, and paying for the programs would not be an issue. 

The Economy

For '03 Economy, Cautious Hopes
John M. Berry
Washington Post, January 5, 2003, Page H1

This lengthy article discusses the economy's prospects in 2003. It makes no mention of either the housing bubble or the dollar bubble. The housing bubble has led home sale prices to outpace the overall rate of inflation by more than 30 percentage points over the last seven years, creating nearly $3 trillion of bubble wealth. The dollar bubble has led to a large increase in the current account deficit, which is now running at a rate of more than $500 billion a year. The bursting of one or both of these bubbles would have an enormous impact on the economy. Ignoring these bubbles at the start of 2003 is comparable to ignoring the stock bubble when discussing the economy's prospects in 2000 or 2001.

The Budget

Bush Touts 9% Rise in Funds for Poor Students
Mike Allen
Washington Post, January 5, 2003, Page A6

Bush to Seek 9% Increase in Aid to Poor Students
Reuters
New York Times, January 5, 2003, Page A16

Lid Put on Domestic Spending
Dan Morgan
Washington Post, January 6, 2003, Page A1

These articles discuss President Bush's plans for the fiscal 2004 budget. The articles include a number of references to the amounts of money that President Bush is proposing to spend on various programs. For example, the Times article reports that he proposes to spend $12.3 billion in 2004 on an aid program for poor children. Very few readers have a clear sense of the total size of the budget, so it is unlikely that they will be able to determine the significance of this sum.

It would be helpful to express budget amounts either as share of the total spending or in relation to the population being served. For example, the spending on this program is equal to approximately 0.6 percent of projected spending in 2004. If there are 5 million children in the targeted population, then the proposal implies spending an average of just under $2,300 per child.

The article by Morgan asserts that domestic discretionary spending "rose by about 40 percent in President Bill Clinton's second term." Actually domestic discretionary spending rose by 25 percent during this period, from $256.6 billion in 1997 to $320.8 billion in 2001. If this growth in spending is adjusted for inflation, which is the only meaningful way to evaluate it, then the increase over these four years was less than 15 percent.

In Clinton's first term, spending just keep pace with inflation. Ordinarily, it is reasonable to expect that government spending will grow at rate similar to the rate the economy grows. As a share of GDP, domestic discretionary spending fell by approximately 0.2 percentage points during the Clinton presidency