Washington Has the Wrong Medicine for Economic Stimulus
Since Sept. 11, investors have looked to Washington for leadership on three fronts: monetary, military and fiscal. Thus far, the Federal Reserve and the Pentagon have acquitted themselves admirably in meeting the first two challenges. The Fed aggressively slashed interest rates, and the military unleashed the fury of American air power on the Taliban.
But so far, all parties in Washington -- congressional Republicans and Democrats as well as the White House -- have failed to reach a consensus on a fiscal response. Instead, casting nonpartisanship to the wind, both sides have proposed incompatible, easily caricatured "economic stimulus" packages.
The Republican-controlled House passed, by the narrowest of partisan majorities, a bill larded with tax cuts for individuals and corporations. Among its most egregious measures: a refund of 15 years' worth of corporate alternative minimum taxes paid by remarkably profitable companies such as General Electric (GE) and IBM (IBM).
Meanwhile, Senate Democrats are pushing a package that relies on aid to unemployed workers and "investments" to get America rolling again. In the best tradition of senior Democrat Robert Byrd, senators have managed to pile on billions of dollars' worth of spending that has nothing to do with national security or stimulus, such as increased spending for Medicaid and assistance to bison ranchers.
One Place to AgreeAmid the bitter partisan dispute, the two sides do agree on at least one item. Any compromise bill will likely include a proposal to accelerate the rate at which businesses can depreciate investments on capital spending. "Republicans and Democrats generally agree that one of the best ways to use the tax code to boost economic activity is to allow businesses a faster write-off of their capital investments," The Wall Street Journal noted. "The hope is that companies will be enticed to make purchases they otherwise would defer." At first blush, this makes a certain amount of sense. After all, the current downturn was led by a decline in business spending and investment. But I can't help but think that this proposal, which the left-leaning group Citizens for Tax Justice suggests would cost $109 billion over three years, doesn't seem like the right medicine. After all, many sectors of the economy -- new and old -- are suffering from terrible overcapacity. And even if tweaking the tax code might theoretically encourage corporate America to rush out and make new investments, it isn't clear that the demands of business would. In the late 1990s, companies of all kinds bulked up, spurred by promises of a new era of growth, in which recessions would be banished and the Dow would rise to 36,000 sooner rather than later. Start-ups and established firms raised piles of debt and equity from the accommodating markets and used the cash to build mammoth business infrastructures. A slew of online retailers, aiming to emulate Amazon.com (AMZN), "got big fast." (Most got small even faster.) A dozen-odd wannabe fiber-optic titans invested billions to lay out hundreds of thousands of miles of cable. And so on, in virtually every sector. When growth failed to materialize as projected, however, corporate America was left with far too many plants, factories, warehouses and fiber. Nationwide, U.S. factory capacity utilization has sunk to levels not seen in nearly 20 years. In October, it stood at an anemic 75.5% Intel's (INTC) abandoned -- and uncompleted -- office tower in downtown Austin, Texas, stands as the most visible symbol of another form of excess capacity. According to the real estate firm Grubb & Ellis, the nationwide office vacancy rate has risen from 8.5% in the third quarter of 2000 to an estimated 13% in the third quarter of 2001. Vacancy rates for telecom hotels are substantially higher -- at about 38%. Last week, Qwest Communications (Q) told contractors to stop work on its fiber-optic network in an effort to cut costs. The move comes a year late and several billion dollars short. Apparently, CEO Joe Nacchio, an excess capacity poster child, realized that his 190,000 miles might be enough in an environment in which generous estimates hold that just 5% of capacity is being used.
Same Story, Every SectorEven Hollywood has fallen prey to the excess capacity bug. In the past few years, virtually every large movie theater chain -- Loews, Regal Cinemas, United Artists Theatre, Edwards Theaters Circuit, GC -- has filed for bankruptcy. The culprit? Excess capacity. Analysts say the industry needs to eliminate about 10,000 screens. In the wake of Sept. 11, most large airlines have reduced their capacity by nearly a quarter. Vast swaths of the Arizona desert have become large parking lots for idle jets. And even before Sept. 11, the excess capacity was evident in the retail space. Warner Brothers and Lechters are just two large chains that packed it in this year, concluding that too many stores were chasing too little business. Pick a sector, any sector, and you'll see the same story: semiconductors, automobiles, paper, aluminum, contract manufacturers, PCs, toys. Companies in every part of the country in every industry are idling, mothballing or simply closing plants. So let's say Congress allows companies to write down investments in new business infrastructure in a year or two, instead of five. In this environment, what will companies do with the cash freed up by accelerated depreciation? Will they purchase new servers from Sun (SUNW)? Buy more fiber-optic cable from Corning (GLW)? Construct new factories? Build new steel plants? Last spring, as the debate raged over President Bush's proposed tax plan, the White House and congressional Republicans persuaded corporate lobbyists to stay on the sidelines and not complicate matters by asking for tax breaks. So it is understandable that Republicans want to deliver for their compliant K Street allies. For their part, Democrats are eager to be seen as a party that is as sensitive to management as it is to labor. There's no question that including faster depreciation in the stimulus package may be good politics. But that doesn't make it good economics, or good business. Paul O'Neill, who was a well-regarded executive at Alcoa before he became a not-so-well-regarded Treasury secretary, may have put it best in his confirmation hearing. "I never made an investment based on the tax code," he said. "Good businesspeople don't do things because of inducements."
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