Washington, Jan. 8 (Bloomberg) -- President George W. Bush's call for a $670 billion tax cut over the next decade revived a Reagan-era debate about whether lower taxes help the economy or hurt it by expanding the budget deficit. In his plan to end taxes on dividends, give businesses more incentive to invest and accelerate income tax cuts, Bush said the role of government ``is not to manage or control the economy from Washington.'' The remarks echoed the 1980s supply-side theories President Ronald Reagan used to support his own tax cuts, allowing the budget deficit to reach 5 percent of the economy, compared with 1.5 percent for the 2002 budget year. Democrats and some economists said such a strategy would do little to boost the economy in 2003 and would hurt it beyond this year by raising the budget deficit from last fiscal year's $159 billion to a record $300 billion or more. That may drive up borrowing costs for mortgages, cars and corporations.
``We have a very short memory,'' said Robert Reischauer, former director of the Congressional Budget Office. ``Politicians really did pay a huge price in the actions they took in their efforts to reduce the large deficits we had.'' Bush administration officials and some investors say the package would generate 2.1 million jobs, faster growth and more tax receipts by encouraging capital and stock investments. ``In periods when the economy is operating below potential it's appropriate to run deficits,'' said Richard Clarida, chief economist at the Treasury. ``The key to providing the opportunity to get back to surpluses is to have a strong, growing economy.'' The differences pave the way to a debate in Congress over whether to pass Bush's plan or adopt parts of a smaller package proposed by House Democrats. Bush will have to compromise with Democrats in the Senate, where Republicans hold 51 seats, shy of the 60 they need to avoid delays.
Raising Deficits
A swollen deficit forces the government to sell more debt, prompting other bond issuers to raise yields to attract buyers. Some economists say that may lead to higher interest rates on mortgages and other consumer loans, as well as erase the increases in gross domestic product of 0.4 percent this year and 1 percent next year that the White House expects to generate. The plan ``is going to create deficits -- deep deficits, out five and 10 years from now -- that are unmanageable for the economy,'' Senator Jon Corzine, a New Jersey Democrat and former chairman of Goldman, Sachs & Co., said in a Bloomberg Television interview yesterday.
Growth Slows
The president is trying to prop up a U.S. economy that probably grew at an annual rate of 1.5 percent in the final three months of last year, the median of 71 forecasts in a Bloomberg News survey last month. That's about a third of the average 4 percent annual growth rate of 1996-2000, and the slowdown is partly to blame for the $159 billion deficit in fiscal 2002 after four years of surpluses. While the Congressional Budget Office in August forecast a $145 billion deficit for the year that started Oct. 1, private forecasts by Barclay's Capital and Moody's Investors Service put the deficit at $300 billion or more. They include the cost of a war with Iraq, which White House estimates at about the same as the $61 billion spent on the 1991 Persian Gulf conflict. Merrill Lynch & Co., the biggest security firm by capital, today increased its budget deficit estimate to $300 billion next year from a previous forecast of $225 billion, citing Bush's proposal as reason for the revision. That would exceed the $290 billion gap of 1992 in the last year of the administration of the president's father, George H.W. Bush, which set a record for the post World War II era. Following a recession and the Persian Gulf war, the yield on 10-year Treasuries that year reached a high of 7.7 percent in 1992, when mortgage rates peaked at 9 percent.
`Blow Out the Deficit'
Proponents of the plan say a $300 billion shortfall would amount to about 2.6 percent of what likely will be an $11.6 trillion U.S. economy by the end of fiscal 2003, according to economists surveyed by Bloomberg News. That compares with 4.8 percent of GDP deficit in a recovery from recession in 1992 and 5 percent during a recovery that began in 1983. ``The Bush plan will definitely blow out the budget deficit,'' said Sharon Lee Stark, a fixed-income strategist at Legg Mason Wood Walker in Baltimore who predicts the yield on the benchmark 10-year Treasury note to reach 5 percent by year's end from about 4 percent today. The yield on the benchmark 10-year Treasury bond rose from 3.81 percent at the end of last year to 3.98 percent as of 5:31 p.m. in New York today. The bond price rose about 1/4 point for the day and the Standard & Poor's 500 Stock Index fell 13 points, or 1.4 percent. Some investors said that while Bush's plan may raise Treasury yields, any increase would be related to the higher GDP it would prompt rather than larger deficits. Economic growth has had more of an effect on interest rates than fiscal policy, they said.
Interest Rates
``It will raise rates, but only to the extent that it stimulates GDP as the projected deficits are not particularly large,'' said Paul DeRosa, a partner at Mt. Lucas Management Co. and former head of proprietary bond trading for Citigroup Inc.'s Citibank in the 1980s. Brookings Institution economist Peter Orszag calculates that Bush's plan may add a half percentage point to long-term interest rates. That would add about $50 a month to the cost of a $200,000, 30-year fixed-rate mortgage. The average rate on such mortgages rose last week to 5.85 percent from 5.69 percent, the lowest since the Mortgage Bankers Association started keeping records in 1990. ``The administration has failed to report the tax increase they're causing by pushing up interest rates,'' said Orszag, a former economic adviser to President Bill Clinton. ``The plan digs a budget hole beyond 2003 and that will hurt the economy.''
Reaganomics vs. Rubinomics
Glenn Hubbard, chairman of Bush's Council of Economic Advisers, rejected as ``nonsense'' the suggestion that higher deficits will boost interest rates, dubbing the notion ``Rubinomics'' after Clinton administration Treasury Secretary Robert Rubin, who argued such a relationship exists. Hubbard's office said in a statement that historical data indicated a $1 rise in gross domestic product generates 20 cents of tax revenue. Bear, Stearns & Co. economists including John Ryding said in a report today they are ``growing increasingly positive'' on the outlook for this year based on earlier economic data for December, gold and dollar prices, and the tax-cut plan. ``It is simply bad economics, in our opinion, to demonize the Bush tax-cut plan on the grounds that it will grow the deficit,'' they wrote. Lobbying from large U.S. corporations in favor of the Bush plan has already begun. The Washington-based Business Roundtable, a group comprised of U.S. chief executives, has already made passage of the stimulus plan its biggest priority for 2003. ``We're always concerned about the budget deficit, and for us that's a spending issue,'' John Castellani, president of the group. ``If it stimulates economic growth both in the short term and the long term, then it'll produce the kind of economy that'll produce the revenues that'll cause the deficit to disappear.'' //www.quote.bloomberg.com