SYNOPSIS: Irrational exuberance in the stock market and irrational government policy

In late 1999 -- about the time when George W. Bush first announced his tax-cut plan -- I had lunch at a beer-and-pizza joint, the sort of place that has a TV over the bar where the patrons can watch ESPN. But the TV wasn't tuned to ESPN -- it was showing CNBC. I thought to myself, "This will end badly." And it has.

The Dow first passed 10,000 in 1999. Although the index briefly dropped below that milestone in early 2000, that decline didn't really count -- it was a perverse side-effect of truly irrational exuberance, as investors deserted the boring old Dow for the Nasdaq. Last week, on the other hand, was the real thing: a broad market decline carried the Dow past 10,000 in the wrong direction. The era of the stock-market bubble has now well and truly ended. But what a mess that bubble has left behind!

By now the direct economic impact of the bubble is a familiar story. During the years of booming stock prices, which were closely linked to euphoria about the "new economy," businesses invested frantically, sinking vast sums into information technology. Now, of course, many of those businesses realize that they invested far too much. And the overhang of excess capacity is likely to keep business investment depressed for years.

That's not an encouraging thought. But the direct economic consequences of the bubble are only half the story. The bubble also had a dire effect on our national politics.

After all, it wasn't an accident that the Bush tax plan was proposed just before the bubble popped. There was an intimate relationship between stock-market mania and tax-cut mania, a relationship that ran in both directions.

On one side, in the late 1990's the right-wing media were enthusiastic stock boosters. The editorial page of The Wall Street Journal, in particular, was extremely fond of crank theories about stock valuation, as long as they pointed upward. Remember "Dow 36,000"? And anyone who pointed out that such theories rested on fuzzy math, and suggested that the stocks could not be counted on to deliver high returns forever, was clearly a dangerous leftist -- after all, the stock market is the purest expression of capitalism, so anyone who doubts that market must be anti-capitalist, right?

But the more important causation ran the other way: the stock bubble, alas, provided an environment in which deeply irresponsible policy proposals temporarily looked plausible.

It's important to realize how much of the late lamented budget surplus was the result of the bull market. Tax rates didn't increase between 1994 and 2000, but tax receipts as a share of G.D.P. surged, largely because of the extra taxes paid on all those capital gains. The result was a false sense that there was plenty of money in hand, that big tax cuts would fit comfortably into the budget. And the Bush tax plan was formulated when such delusions were at their height.

Now reality has started to sink in. Unfortunately, though the new realism may have come soon enough to prevent a disaster on Social Security -- for Mr. Bush's other signature policy proposal was also based on the delusions of a bubble economy -- it has come too late to prevent a disastrous tax cut.

Of course, you might wonder why Mr. Bush himself didn't have second thoughts -- why he thought that the exact same tax plan he proposed in the feverish bull-market days of late 1999 was still appropriate in the post-bubble economy of 2001. And his officials surely knew that tax receipts were dropping like a stone even as they were reassuring a docile Congress that everything was just fine.

But one thing we have learned about this administration is that it never responds to altered circumstances by changing its plans; all it does is change the sales pitch. So the tax cut was relabeled as a recession-fighting measure, a task for which it is peculiarly ill-suited. For that matter, the administration hasn't given up on Social Security privatization, either. Now that it can no longer entice people with visions of stock-market sugar plums, it has decided to scare them with imaginary crises instead.

In any case, immense damage has already been done. The stock-market bubble led to bad political decisions as well as bad business decisions; and we'll be paying the price for many years to come.

Originally published in The New York Times, 9.2.01