Burn, baby, burn
Tax rebate and cut, Fed easing could ignite economy
By Marshall Loeb, CBS.MarketWatch.com
Last Update: 1:00 AM ET July 5, 2001
NEW YORK (CBS.MW) -- What will happen to the economy now? Watch for a hot summer.
During August and September, the economy will feel the greatest concentration of fiscal and monetary stimulus in memory. Says Jon Lonski, chief economist at Moody's Investors Services: "It's not too often that both of these remedies are applied to the U.S. economy."
While growth may remain temporarily sluggish, three major forces will serve to lift the economy over the long term:
* Tax rebate checks will hit mailboxes. The mailing begins July 23 and will run through September 30. Virtually every person who files federal income taxes will get a check: Up to $300 for singles, $500 for heads of household, and $600 for married people filing jointly.
* Tax rates will be cut. All rates went down 1 percentage point as of July 1. It will take a while for corporate payroll departments to feed the new rates into their computers, so many employees won't see their cuts show up in their paychecks until August. Because half of this year is already behind us, the actual decline in our payroll withholding for the rest of this year will be one-half of one percentage point. The savings for any individual will be modest, but multiplied by all the scores of millions of taxpayers, it provide some stimulus for the economy.
Here are examples of rebates calculated by Weikart Tax Associates of New York City:
Jean and Jim earn a joint taxable income of $100,000. Between now and this year's end, their taxes will decline by $112, and their take-home pay will increase by $19 a month. Next year, their total tax reduction will be $224.
Tom and Theresa have a joint taxable income of $50,000. Their tax savings between now and this year's end will be $42, and their take-home pay will go up by $7 a month. Next year, their total tax reduction will be $84.
Mary is a single taxpayer with a taxable income of $20,000. She'll save about $16 this year, and take home about $3 a month more. Next year her total savings will be about $32.
* Pocketbook effects of the Fed's aggressive money-easing will take hold-and spread.
The Fed's six reductions since January have knocked the key federal funds rate down to its lowest level -- 3.75 percent -- since 1994. At the same time, the money supply, the so-called M2, is growing at its fastest rate -- 11 percent -- since 1983-84.
The rate cuts and the expansion in the money supply take time to filter through the economy. Some of the rate reductions are felt immediately, notably the prime rate charged to top borrowers for business investment, and the rates on automobile and home-equity loans. Rates on some other loans take up to six or twelve months to be felt, but they will grow in force during the summer and later on. Says Moody's Lonski: "We have the financial fuel to fund a rejuvenation of the economy."
Largely because interest rates have gone down so much, Lonski points out, consumers' applications to refinance their mortgages have jumped fivefold this year. One result: The savings in their mortgage rates will give Americans still more money to spend.
"By the end of the summer, the increase in household cash flow because of mortgage refinancing will lift consumer spending," Lonski says.
"August will be a turning point," adds Lynn Reasor, chief economist of Bank of America. "Lower gasoline prices will encourage Americans to take longer vacation trips. Retailers will heavily market their back-to-school sales. And people will very quickly spend their tax rebate checks."
Another little-recognized factor: Affluent people will see their Social Security payroll taxes temporarily decline, and their disposable income rise. Here's the reason:
The tax is 6.65% on the first $80,400 in wages-or a maximum $5,347 a year. If you earn, say, $100,000. Your payroll withholding will be $554 a month, and you will reach your annual maximum tax around the middle of October. For roughly the remaining ten weeks of the year, you will be hit with no further Social Security payroll deductions, and you will gain the equivalent of a $554 a-month tax cut-most of which you probably will spend, further stimulating the economy.
It's the combination of all those forces that lead David Jones, chief economist of Aubrey Lanston & Co., a world-wide investment bank, to forecast: "We've probably seen the worst of the economic slowdown. This year's third quarter will be last of four straight slow-growth quarters-at an annual rate of one to one and one-half percent. After that, we'll have a gradual but uneven recovery, though we may not get back to our speed limit of between three and one-half and four percent growth until the second half of next year."
Marshall Loeb, former editor of Fortune, Money, and The Columbia Journalism Review, writes "Your Dollars" exclusively for CBS.MarketWatch.com
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