The past few days have been a bloodbath in many of the world's stock markets, and it's likely that the stimulus packages proposed, and the general assumption that current tax rates will be repealed were a leading causes of it. With the concerns about potential recession, there's nothing more dangerous than short-term spending that attempts to cure symptoms and not solve problems. The Fed hit the panic button this morning by cutting 75 basis points. The vague stimulus packages proposed are about 1% of GDP, and would be in the form of tax rebates. There is also talk of accelerated depreciation for business investment, and the extension of unemployment benefits. These have never done anything stimulative but can make economic slowdowns longer, but they show “concern” and that someone is “doing something.” The lack of clarity in political posturing did not help anyone's confidence. Here are my comments about what a real stimulus package would be. Extending unemployment benefits only increases the length of unemployment problems, as workers wait longer for the “right job” rather than going to work sooner and changing jobs later. A real stimulus plan would recognize that consumer and business decisions are based on long term thinking. Milton Friedman postulated the “permanent income hypothesis” decades ago, which stated that consumers make decisions about spending based on long-term expectations about their income, not by short-term changes. Businesses do the same thing: it takes three to seven years to build a production plant from design to completion. The sales process for capital equipment is often 18 to 24 months. These time horizons are little changed by rebates. Current tax rates should be extended; there is a paralysis created when those making substantial capital investments when it cannot be determined what tax rates will be on capital and the income generated by those investments. This is one of the little-reported factors in this economic slowdown. There is a general perception that all tax rates will return to levels prior to 2002 no matter which party is elected to the White House. Riskier investments become heavily discounted because companies must assume higher future tax rates in their calculations; now those calculations have to assume higher inflation rates as well. When companies calculate these net present value analyses, riskier investments cannot pass muster, but conservative, “safe” investments do. This penalizes entrepreneurial risk-taking, which is so critical for innovation and technological leaps forward. One target should be the permanent elimination of the alternative minimum tax which penalizes workers in older and more established metropolitan areas with higher local and state taxes. It forces even low wage workers to leave these areas because the capital needed to invest in local businesses (held by higher income workers and small business owners who are S corporations) leaves for more welcome climates. It also causes older workers to flee those areas upon retirement; people over 65 years of age hold approximately two-thirds of U.S. wealth: it's called savings. With lifespans increasing for these workers, that permanent income has to last longer, and the penalty of the AMT on these savers is something to be avoided, as they realize there is a good chance that their money has to last them to the age of 90. It wasn't long ago that financial advisors used the age of 80 for their retirement planning. Accelerated depreciation is a shell game. Since one cannot depreciate an asset for more than its value upon purchase, moving the amounts around to some years rather than another, does little. There are already accelerated depreciation schemes (sum of the years' digits, double declining balance) allowed by the IRS. Accelerated depreciation only works in high inflation environments. Even though we are entering one, it does not change the fact that capital investments made by businesses are based on expectations of increasing future revenues and profits that result from those investments. Depreciation schemes do little to affect those expectations. The standard deduction should be tripled for a single person from $5450 to about $16,500. Low wage workers and part time workers pay 15.3% in Social Security and Medicare taxes from the first dollar they make. Half of it comes out of their paycheck. The other half they never see, ending up being diverted from their pockets and supposedly “paid by the employer.” In various analyses of the tax code, there are many workers who work up to the limit allowed before they are subject to federal income tax. There are workers who then seek cash jobs (“off the books”) after that point. These workers would seek additional work knowing they would not be taxed on it. The earned income tax credit, designed to counteract the penalty of the Social Security and Medicare taxes, is one of the most abused elements of the tax code, no matter how well-intentioned. Better to get people off the Federal tax codes completely than force them to even have them apply for this tax credit; about 25% of the credits go unclaimed. The cost in time and money to file is usually the reason for not filing for it. Don't be surprised if protectionist measures creep into any stimulus package, supposedly to “level the playing field.” These will limit trade in other goods and delay recovery in employment as they usually do. This is politically popular in a Presidential election year when economic history and sense takes quite a beating. The dollar will not be helped by a stimulus. The Fed will keep lowering rates, and the dollar will keep losing value because the money supply will not match the growth in goods and services available in the marketplace. Japan is a good example of what can happen. For years, their rough equivalent of Fed rates was at or near 0%, and they have had a recession for around 15 years, resisting the reduction of tax rates. The subprime crisis is being blamed for everything; the lack of discipline in lending is not. Strangely, unemployment rates may hold up better in this slowdown as households with debt become less selective about job-seeking in an effort to pay down their obligations. It may actually be hard to label this as a true recession because of this. Another victim of these last few days is the “de-coupling” hypothesis. Here, the assumption is that emerging and other economies would be able to withstand a U.S. slowdown. The global economy is just that, and it is highly connected with greater interdependence. The idea of de-coupling was wrong to begin with. What is really happening is that, in time, the economic relationships are changing and are becoming more diversified. The old saying “when the U.S. catches a cold, the world gets the flu” is becoming less true. Rising wealth around the world will slow down but not disappear. The rise of free markets in much of the emerging world is barely 25 years old, and it is only now that these markets have any significant heft and dynamism. While these economies can do better than they did before, and sustain growth rates higher than established economies, no one country is separate. Trade is essential for all economies, and the connections between all economies will create a resilience in the world economy, but no de-coupling is possible, and to believe that it was actually possible is the real problem. The desire to provide a stimulus for this year just relieves some symptoms but does not address the issue of longer term decisions that affect the economy in a deeper and more meaningful way.