The Boston Globe

How to Wage War and Help Economy

The United States now faces two economic challenges: how to hasten recovery from a severe recession and how to pay for a long and costly campaign against terrorists. The two problems call for two solutions. Short-run tax and spending measures to boost private and public spending will help fight the recession. Long-run belt-tightening will help pay for the antiterrorist campaign and avoid returning the nation to an era of growth-retarding federal deficits.

Unfortunately, the House of Representatives seems to be on its way to passing large and permanent tax cuts, largely for business and upper-income individuals, that will loosen our fiscal belts a few more notches.

All doubt that the nation is in recession vanished with the destruction of the World Trade Center and damage to the Pentagon. If households curtail consumption even modestly, the recession will be deep. If the loss of consumption ripples through to jobs, incomes, and investment, the recession could be extremely painful.

The policy goal should be to keep the recession brief and shallow. The way to do so is to quickly spur household consumption and business investment. Eventually, the Federal Reserve's expansionary monetary policy is likely to stimulate both consumption and investment. But monetary policy is slow to act. Meanwhile, fiscal policy tax cuts and spending increases can boost spending, but they can do so only if personal tax cuts are aimed at people who spend most of what they receive and if business tax cuts are linked to investments put in place within the next 12 to 18 months.

This goal to raise spending now means that cuts in capital gains taxes or in corporate tax rates should take second place to accelerated depreciation or deductions linked to new investment. It also means that investment incentives should not apply to investments put in place two or three years in the future. And it means that personal tax cuts should be temporary and go to low- and moderate-income families who spend most of their incomes.

Over the longer term, the fiscal challenge can be encapsulated in a simple slogan: "Fight the terrorists first." In 1999, as the prospect of fiscal surpluses emerged, President Clinton stopped large tax cuts with the slogan: "Save Social Security first." This year a new president reversed that priority, placing tax cuts ahead of Social Security reform. The horrific events of Sept. 11 have put before us an even more compelling challenge than reforming the nation's basic pension program.

While near-term deficits will help offset cuts in private spending, long-term deficits slow growth by absorbing private saving and lowering investment. Less investment slows introduction of new technology and reduces economic growth. Deficits mean that funds from the general budget are unavailable either to close projected Social Security deficits or to ease the transition to individual accounts. They absorb funds that could be used to pay for a prescription drug benefit for the elderly and disabled, to modernize our transportation system, or do much of anything else.

Fighting terrorists costs money—lots of it. Money for arms. Money to shore up damaged industries. Money to help workers displaced by economic dislocation. Money to invest in buildings and equipment necessary to sustain growth of the economy that will support the antiterrorist effort.

Whatever tax cut the United States could afford last May, it can afford less today. A tax cut in the short run will help keep Americans at work. Over the longer term, Americans must cinch up their belts and consume a bit less. That means higher, not lower, taxes. It means that the permanent tax-rate cuts enacted in May scheduled to take effect in 2004 should not be accelerated. They should be suspended or scaled back. The phased repeal of the estate tax should be canceled. The idea that very rich heirs should inherit millions or even billions tax free while other Americans are making sacrifices is offensive. Other tax reductions should be put on hold until the United States wins what is bound to be a long and costly struggle.

These principles mean that most of the draft tax cut legislation recently approved by the House Ways and Means Committee in the name of fighting the recession is ill considered. It would accelerate tax cuts for the well-to-do that should be suspended. It would provide business tax cuts that would encourage investment mostly after the current recession has ended. It would bestow windfalls on owners of capital.

The Ways and Means bill is a Faustian bargain, buying a dollop of needed short-term stimulus with tens of billions of dollars of future deficits. Nonetheless, the GOP majority in the House seems committed to passing the bill in more or less its current form.

The Senate should reject this bill and start anew.

Its guiding principle can be simple fiscal stimulus now to speed economic recovery and belt-tightening until we have paid for and won the fight against the terrorists.