THE economic recovery program outlined in President Bush's State of the Union address is a stew of contradictory ingredients. It is unlikely either to power an economic recovery or calm financial markets -- but it could still enjoy a perverse success as politics.
On the one hand, Mr. Bush relies on liberal Keynesian "counter-cyclical" means to stimulate the economy. These include reducing the withholding tax taken out of paychecks, cutting a variety of other taxes, providing a tax credit for first-time home buyers and accelerating previously approved federal spending projects. If enacted, this program would have a mildly tonic effect, but at the price of increasing the federal deficit. If a larger deficit resulted in higher interest rates, the program would be self-defeating.
On the other hand, Mr. Bush turns to conservative supply-side nostrums, of the sort that were largely discredited in the great experiment of the 1980s. The chief of these is a steep cut in the capital-gains tax rate, on the theory that lower capital-gains taxes will induce more private investment. But even in supply-side terms, a larger deficit produced by tax breaks will soak up private savings and leave less private capital to be invested.
Another tax proposal, to reverse some of the 1986 tax reforms regarding real estate, is also dubious economics. Tax changes in 1978 and 1981 had increased already excessive deductions for purely paper losses on real estate deals. This stimulated overbuilding; the subsequent restriction of these tax preferences the 1986 tax reform act contributed to the real estate crash. But more tax preferences to revive overbuilding of real estate is the last thing the economy needs to become more competitive.
With all of these tax breaks increasing the deficit, President Bush is playing high-stakes poker with money markets. The Federal Reserve Board has cut short-term interest rates (and might make further cuts). For a while, long-term rates (which are set by market forces) followed suit, which is good news for businesses, prospective home buyers and homeowners refinancing mortgages. Lower long-term rates provide genuine economic stimulus.
Investors have reacted to the lower interest rates by moving money out of bonds and savings accounts and into stocks, which has driven the stock market up some 400 points. But the market is very nervous. Lately, long-term interest rates have begun rising again, and this is a sign that the market worries that the size of the deficit signals a risk of greater inflation and higher interest rates over the long term. If the effect of a bigger budget deficit is to frighten Wall Street, the drop in the stock market could be even more abrupt than the recent rise.
The president's health-insurance proposal would have the government pay low-income families up to $3,750 a year through a tax credit, to enable them to buy health insurance. But this is absurd, if not cynical. Most low-income families don't pay anything like $3,750 in taxes.
Whether the Bush package succeeds as politics depends in part on the Democrats. Ultimately, of course, the test of success is whether such a program works economically, and there is good reason to be skeptical that it could. But the Democrats could throw the president a political lifeline.
Democratic legislators will be torn between their wish to distance themselves from the president's blueprint, and their desire to be seen by voters as helping to work for an economic recovery. When President Bush demanded that Congress act on his plan by March 20, he was playing on that ambivalence.
If the Democrats are shrewd, they will design their own economic recovery blueprint and highlight their differences with the president. Any legislative program would have to be the result of a genuine compromise on both sides.
Here, however, the Democrats are weakened by likely defections in their own ranks. Sen. Lloyd Bentsen of Texas, the Finance Committee chairman, shares many of Mr. Bush's views on tax preferences. He could well support variations on several of the president's tax-cut proposals. "Lots of our people have friends in the real estate business," said an assistant to another ranking Senate Democrat.
If a Senate vote on the Bush package were held right now, the president could probably cobble together a narrow bipartisan majority for most of it. Although it hasn't been announced yet, Senate Majority Leader George Mitchell will soon name Mr. Bentsen to chair an anti-recession task force to draft a Democratic package. That does not bode particularly well for the Senate Democrats' ability to differentiate their product from the president's. A premature compromise would blur partisan responsibility for both a weak economy and a weak cure.
It remains to be seen whether this will occur, though the risk is there. House Speaker Tom Foley sounded more partisan than usual in his response to the State of the Union address. And as presidential politics loom larger, Democratic legislators will be under pressure from the party's presidential field not to cave in to a program that is too Republican or too likely to rescue the president in 1992 at a cost of longer-term damage to the economy. But if Congress does the president's bidding, as it has so often in the recent past, it is another sign that Democrats still lack either the political or economic competence to govern.
Robert Kuttner writes regularly on economic matters.