Which is better for the economy: a tax cut or an interest-rate cut?
Right now, interest-rate reductions win hands down, because they're already putting money into Americans' pockets and into the economy.
While Congress debates whether the tax cuts will be $1.2 trillion, or $1.6 trillion, or some other figure, Federal Reserve Chairman Board Alan Greenspan and his gang have delivered four interest-rate cuts totaling 2 percentage points since the first of the year.
President Bush's proposed tax package supposedly would have benefits worth about $1,600 a year to the typical middle-income family.
But let's consider what has happened to a family that's leveraged to the hilt. Let's say they occupy a home carrying a $150,000 adjustable-rate mortgage, they're in the market for a new car to replace an aging vehicle, and they have tapped their home-equity account for $20,000 or so for things like college tuition, home improvements, and perhaps an appliance or two.
The home-equity loan is pegged to the prime interest rate plus 0.5 percentage point or 1 percentage point. So, the four straight Fed cuts - including two “surprise” reductions - brought the home-equity rate down 2 full points, translating into an annual saving of $400. In other words, $400 more goes to pay down the debt instead of to pay interest.
As of last week, the average adjustable-rate mortgage was more then three-quarters of a percentage point lower than a year ago, making for the lowest rates since mid-1999. With the latest surprise Fed cut occurring in the middle of last week, the adjustable rates could go even lower. But even as it is, the $150,000 mortgage costs $1,125 a year less than it did a year ago. That's not a direct result of the Fed's actions, because adjustable-rate mortgages often are pegged to Treasury rates, but they usually follow, in rough fashion, general interest-rate trends.
Similarly, a car loan today carries a lower interest rate than a year ago - say 0.75 percentage point less on a typical credit-union loan. That translates into a $150-a-year saving on a $20,00 car.
So, let's see: $1,125, plus $400, plus $150 equals $1,675 - more than the promised tax-cut benefit - a little more money to spend, or a little money to invest. Or just a little more money to feel good about.
Many analysts and economist expect at least one more Fed rate cut this year, and possibly two. If that happened, the $1,675 annual interest savings could easily balloon to $2,500 or more for the highly leveraged family.
Interest-rate cuts especially benefit consumers whose stage of life involves mortgages, cars, and financing big-ticket expenditures.
But rate cuts also benefit millions of small-business owners, people who are considering buying homes, those who will be buying or leasing cars, and anybody who suddenly has to make an unplanned big-ticket purchase. If the water heater blows this week, it's less of a problem than it would have been in mid-2000.
While Congress considers a pie-in-the-sky tax cut that the nation may not be able to afford, the Greenspan gang has once again delivered. Let's hope the delivery was big enough and fast enough.
Homer Brickey is The Blade's senior business writer. E-mail him at email@example.com.
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