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State of the Union 2005, the Economic Dimension

Author: Roger M. Kubarych
February 3, 2005
Council on Foreign Relations Press


Alan Greenspan would never consciously upstage President Bush. So there was never much doubt that the Fed would do the expected (and write the expected) following this week’s two-day FOMC meeting. That meant another 25 basis point increase in the Federal funds rate on Wednesday, to 2 ½%, and familiar language that repeated almost word for word what the central bank had said at the last FOMC meeting in December. However, the Fed chairman will have plenty of chances to recapture the limelight, with two speeches and two Congressional testimonies scheduled over the next couple of weeks.

A few hours after the Fed announcement, President Bush entered the Capital, shook hands with some Democrats as well as Republicans, and then laid out his intentions for his second term with vigor and a certain self-confidence that was often lacking during the election campaign. The Republican Party holds sizable majorities in Congress. Supported by rising incomes and huge increases in home values, the US economy is moving ahead strongly. Economic growth of 3% or maybe more is likely to persist in 2005, even though the Federal Reserve is bound to hike short-term interest rates by another 1% or so. To White House strategists these are ideal conditions for pushing ahead with ambitious economic policy initiatives. All are controversial, even within the Republican majority. Here are the ones President Bush decided to feature in his State of the Union address:

Priority 1: Social Security restructuring. At a minimum, this must include some form of partial privatization, the President insisted. Otherwise, he had no finished plan to propose. Instead, he said he was willing to listen to any good ideas, mentioning favorably some past suggestions made by Democrats like former President Clinton and now-deceased Senator Moynihan. The problem with Social Security is not an immediate crisis. There is none. But over time, as in other industrialized countries, demographic trends will reduce the ratio of workers to retired people – from a little over three workers per retiree today to below two workers per retiree when all the baby-boomers have retired. So pay-as-you-go programs such as Social Security will either have to find new sources of revenue or cut benefits. Bush didn’t quite admit this. But young Americans take for granted that they won’t collect the same generous benefits their parents and grandparents will get. Privatization essentially means offering to everyone the opportunity to make some investments with tax advantages, now enjoyed by half the population through 401k accounts or other pension plans. Democrats resist for two reasons: they would prefer to fix the long-term problem by increasing taxes on wealthy individuals and they realize that investors tend to vote Republican. Many Republicans who accept the Bush argument fear that Democrats can exploit the issue successfully in next year’s mid-term Congressional elections. Prospects: good if the White House is willing to compromise; otherwise a radical proposal will languish, despite its high priority on the Bush II agenda.

Priority 2: Income tax reform. Supply-siders since the Reagan era have yearned for a flatter income tax rate structure as well as simplification of the messy US system. Something like this was accomplished in 1986, when both tax deductions and tax rates were cut. But Republicans found out to their dismay that it was easy for Democrats to restore higher marginal tax rates but impossible for them to restore terminated tax breaks. Plus business lobbyists prefer the current system, since they know how to use it to their advantage. Prospects: very unlikely. The President merely said that he has appointed a bipartisan panel to examine the tax code from top to bottom. “And when their recommendations are delivered, you and I will work together to give this nation a tax code that is pro-growth, easy to understand, and fair to all.” Good luck. But just raising the issue will allow new ideas to infiltrate the debate. In particular, some members of Congress will support a national consumption tax to take some burden off the income tax. That is a debate that the US needs to have, since the US tax structure tilts against saving and in favor of spending. Eventually that must change.

Priority 3: Tort reform. The number one priority of the business community is to stop class action lawsuits and to roll back punitive damage awards that juries inflict on businesses unlucky enough to lose a product liability case, for example, asbestos and tobacco. Medical malpractice suits rouse the same passions among doctors. They have the President’s full support. However, trial lawyers are the number one source of financial support for Democrats nowadays. Together, they have successfully blocked tort reform for years. Prospects: best in some time, given the Republican Congressional majorities. But a lot of Republicans come from states in which lawsuits against the rich and powerful have populist appeal. So any progress will come only after considerable wrangling.

Three other priorities, though lower down the list, bear watching.

One is immigration reform. The Wall Street Journal editorial pages, plus many US businesses, favor liberalization through a guest-worker program, which the Bush administration also favors. The speech offered some pretty strong language: “We should not be content with laws that punish hardworking people who want only to provide for their families, and deny businesses willing workers, and invite chaos at our border.”

The issue used to split the Democrats, because labor unions normally opposed reform. But some union leaders are coming around to a more liberal position. Republicans are split on the issue, too, because grass-roots opposition to more immigrants is still formidable. So the speech stopped short of supporting an amnesty for illegal immigrants already in the country, something that the Republican heartland cannot abide. Prospects: uncertain.

Two is energy policy. The Bush platform is to drill more and regulate less. He also proposes funding for developing technology for hydrogen-fueled cars, cleaner burning coal, and renewable sources such as ethanol. Farmers like that last item. Democrats also favor government spending on renewable energy, hydrogen technologies, and cleaner coal. But they much prefer higher taxes or other forms of rationing, for instance tougher mileage standards for autos. But they aren’t going to get that. Prospects: some useful compromises under the slogan of US energy independence.

Three is health care. The Bush goal is to make health care more affordable, and give families greater access to coverage as well as more control over their health decisions. He is asking Congress for tax credits to help low-income workers buy insurance, a community health center in poor areas of the country, improved information technology to prevent medical errors and needless costs, association health plans for small businesses and their employees (a major goal of small business lobbyists), and expanded health savings accounts (a Bush innovation with Reaganite intellectual roots).

What got subordinated to these higher priorities? For one thing, the trade deficit never got mentioned at all. Bush II does not think curbing the trade deficit deserves much priority. But the administration will favor some combination of a weaker dollar, removal of barriers to US exports, and urging other countries to stimulate faster economic growth. Democrats are more worried about the trade deficit but offer no real alternative.

Finally, the President started his speech by repeating his campaign promise of halving the Federal budget government deficit by 2009 through domestic spending cuts. But with all the new programs that have been or may be legislated, the chances of that are pretty small. One might be forgiven for concluding that lowering the Federal government budget deficit is simply not a Bush II priority!

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