Cut Interest, Taxes and Regulation to Save High-Tech Economy

The big news in technology as the year comes to an end is the sickening decline of the Nasdaq—from an all-time high of 5048 on March 10 to a 2233 last Wednesday—a drop of more than half.

What's going on? First, politics.

I issued a special "Investor Alert" in late March here on TechCentralStation warning that high-technology stocks were being hurt by increased government intervention. I cited, especially, the decision by the Justice Department to push for a breakup of Microsoft, the growing desire by politicians to use the Internet as a new source of tax revenues, and the threat of a rollback of the Telecom Act of 1996, hindering the spread of broadband services.

The worst threats to high technology are proceeding swiftly to reality (the remonopolization of telecommunications is worse than even I had expected), and we may end up with my worst fear—a regulatory recession.

The Commerce Department reported Thursday that growth for the third quarter was just 2.2 percent—down by more than half from the average of the preceding year. Worse may be yet to come. My colleague at the American Enterprise Institute, the highly regarded economist John Makin, says that we are already in a recession.

I am not so sure about that, but clearly the economy is slowing. It needs three things to revive it: immediate rate cuts by the Federal Reserve, a significant tax reduction (or better yet, reform), and a new direction on regulatory policy from George W. Bush's incoming administration.

Last week, the Fed's Open Market Committee decided to keep short-term interest rates at 6.5 percent—absurdly high. Its only concession to a slowing economy was that statement that "the committee consequently believes that the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future."

If the economy falls into recession, the Fed will bear much of the blame. It raised rates six times over a year beginning June 1999, a total of 1.75 percentage points. Meanwhile, oil prices tripled. That combination is the stuff of recessions—even without the attack by government on technology.

Oil price rises, as Kevin Hassett has pointed out on TechCentralStation, have a depressive, not inflationary, effect on an economy. It is true the Fed didn't see the oil rise coming, but it should have taken steps immediately—in early fall at least—to lighten the drag. Now, even if the Fed does lower rates, we are faced with the possibility of too little, too late. On taxes: This country needs broad tax reform to encourage savings and investment. The best answer is a consumption-based flat tax, that is: no taxes at all on income that is used for savings, no deductions or loopholes, and a single rate for all, after a generous exemption. More likely, what we will get is an elimination of the marriage penalty and the estate tax. Neither is very important when it comes to spurring more work or investment.

Larry Lindsey, Bush's top economic advisor during the campaign, has been pushing for a marginal rate cut (a trimming of the percentage that everyone pays in taxes on income), in part to spur a sluggish economy by inducing consumers to spend more. That's fine, but the long-term goal should be the one I outlined above.

Finally, on regulation, Bush's victory provides some hope. The key is for the new president to use his political capital wisely in the appointment process, naming true free-marketeers to posts at the Federal Communications Commission, the Federal Trade Commission, the Food and Drug Administration and the like.

What's needed in the agencies are true believers in deregulation. For example, the next head of the FCC should be dedicated to doing away with the commission, just as the government eliminated the Federal Aviation Administration and the Interstate Commerce Commission.

The only regulator named so far is Christine Todd Whitman, the New Jersey governor, who will head the Environmental Protection Agency. I'm a fan, but I'm not sure where she stands on critical issues such as the disastrous Kyoto strictures on global warming. First thing she should do is read our dispatches from The Hague.

Tommy Thompson, governor of Wisconsin, is an excellent choice as head of HHS, and I'm especially pleased to see Gov. Jim Gilmore of Virginia moving into national office as head of the Republican Party. Here's a man who understands that the way to allow technology to thrive is to get government out of the way.

Will we see that kind of change next year? Here's hoping…