Why the tax rebates won't work

By Jon Markman

Investors expecting a boost for the economy in the second half of this year from $168 billion in emergency tax rebates are due for a crude awakening.

New research suggests that most of the money originally expected to go to the likes of Wal-Mart Stores (WMT, news, msgs), Ford Motor (F, news, msgs) and Starwood Hotels (HOT, news, msgs) to ward off a recession will go straight to Saudi Arabia, Canada and Nigeria as consumers see an ever-larger share of their wallets sucked into their vehicles' gas tanks.

And, as the tax rebate bonanza disappears into an acrid cloud of carbon vapor, more than likely so, too, will the recent rally in stocks as corporate earnings fail to materially rebound from their worst nine-month stretch since 2001.

Unless federal authorities can come up with fresh ways of flooding money into the economy, it is quite possible that by the time we're in the thick of another earnings season in six weeks, we'll look back on May as the good old days when the market was down only 5% for the year.

As it turns out, the Federal Reserve already has a new weapon in its arsenal, one that is helping to counterbalance the damage done by fuel prices. The question is whether it can do enough to keep the economy -- and the stock market -- afloat.

In the tank

Here's how I figure it: The United States uses around 21 million barrels of oil a day, most of which is imported from other countries. When the tax rebates were conceived late last year, the benchmark rate for crude oil was $85 a barrel. So figure that Americans were spending $1.78 billion a day for oil when the rebate plan was launched in Congress.

Now fast-forward to this month, when rebate checks are actually going out. Crude oil has reached $135 a barrel, making our oil habit cost around $2.83 billion a day. That's a difference of $1.05 billion a day, and it has to come from somewhere.

The rebate was supposed to put money in middle-income citizens' hands for immediate use. Yet in several nationwide surveys, Americans said they planned to save 40% of their rebates or use the money to pay down debts. That left only $100.8 billion to be splurged on new televisions, iPods, Nikes and travel, which, even at its best, is not a whole lot in a $12 trillion economy.

Now higher energy prices are putting those objectives in peril. With $1 billion a day more going toward fuel payments than tax rebate planners had expected, virtually all the extra money provided by rebate checks will be poured into gas tanks in 100 days. That's roughly the first week of August, right in the middle of second-quarter earnings reporting season and third-quarter sales season. So much for the second-half boost in revenue that's supposed to cure U.S. retailers' and manufacturers' blues.

If that doesn't sound grim enough, the second quarter is already deteriorating for U.S. businesses a great deal faster than anyone had imagined. And investment analysts are having a hard time keeping up with the decline, adding to the risk of dangerous downside surprises in July.

For a glimpse into how thin the coming earnings season could be, consider that on Jan. 1, analysts estimated that first-quarter earnings growth for S&P 500 Index ($INX) companies would clock in at 5.7%. By April 1, their estimates for the first quarter had fallen to a negative 11%. Yet it turned out that was still too optimistic, as first-quarter earnings fell 17.5%.

It was the first time large U.S. companies had suffered three straight quarters of earnings contraction since early 2002. A ton of that decline involved the financial companies, at which, according to analyst Thomson First Call, aggregated net income plunged by $32 billion. However, retailers and industrial companies were also deeply in the hole.

With that in mind, now consider that estimated "growth" for the second quarter now stands at a negative 7%. Just two months ago, the expectation was for a 2% contraction. So figure expectations for contraction will likely fall to the 10% range by July 1 and then sink from there to as low as 20% as fuel and raw material costs snag a larger and larger portion of the amount of money that individuals and companies had once planned to spend on goods and services.

The Fed's new money machine

Is all lost? Not necessarily, for we should never underestimate the cunning of politicians backed against a wall in an election year. Both Democrats in Congress and Republicans in the White House have their reasons for adding artificial sweetener to the economy to enhance their vote-getting bids.

Continued: The Fed's stealthy plan

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