No time to be timid — tax cuts and spending hikes

Jamie Dettmer | Contributor

“The movers and shakers of our society seem…oblivious to the terrible destruction wrought by the economic storm that has roared through America.” Thus writes the New York Times’ Bob Herbert, who notes in a weekend column that “nearly 44 million people were living in poverty last year, which is more than 14 percent of the population. That is an increase of 4 million over the previous year, the highest percentage in 15 years.”

And as for the middle-class, Herbert observes, they have “hobbled for years with the stagnant incomes that accompany extreme employment insecurity” and are now in retreat. The economic fear stalking America goes far to explain the severe fall in popularity of President Obama and the rise of the Tea Party.

For all of my fears of the social conservatism that is veined through the Tea Party movement, the public focus for most Tea Partiers is on the economy. But their economic solutions are not the right ones.

Understandably, they blame government. It was government that gave us the runaway juggernauts of Fannie Mae and Freddie Mac; it was homeownership encouragement from both sides of the political aisle that gave us the subprime fiasco; and it was the administration of George W. Bush that believed “deficits don’t matter” and presided over the greatest splurge of public spending since Lyndon Johnson.

So, why trust government now? For the Tea Partiers it is time to get back to basics — to the U.S. Constitution, to balanced budgets, to limited government. All noble aims. For many of them, though, read “no government” when they say limited government. But this isn’t the time to say “no government” — we need it to sort out the mess it co-authored.

Unfortunately, in the same way that Tea Partiers are going back to basics and mistaking the skyrocketing deficit as the problem, so various policymaking elites are returning to unsophisticated positions. Free market advocates are becoming more uncompromising; Keynesians more Keynesian. All are over-focused on ideology.

In this fevered political environment the administration is more timid than it should be. The U.S. needs another fiscal stimulus. Yes, this would add to the federal deficit, but when you have cancer, to survive you need to take some poisons as therapy. Convalescence can come later.

For Republicans — and the Tea Partiers — that is heresy. For them, “big government” explains the economy’s weakness, and high unemployment is evidence that the President’s fiscal stimulus failed. But this is wrong. As the Economist magazine notes, “the notion that high joblessness ‘proves’ that (the) stimulus failed is simply wrong. The mechanics of a financial bust suggest that without a fiscal boost the recession would have been much worse.”

There is growing confidence that America will escape a double-dip recession, but that is far from certain. The jobs market remains in a slump, the recovery is anemic, property prices continue to fall, and a further wave of home foreclosures is in the cards.

In 1937-38, fiscal and monetary contraction killed dead a recovery, sending the economy back into a prolonged slump that didn’t end until World War II.  And as Arthur Laffer argued in a Wall Street Journal op-ed earlier this year, tax hikes had much to do with the problem. “The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity.”

That lesson seems belatedly to have been absorbed by Obama aides, who are now supporting the idea of extending the Bush tax cuts, except for the top two percent of earners.

But this crisis is not a normal cyclical one. There are serious structural aspects to it, as the PIMCO chief executive Mohamed El-Erian has been maintaining. His point?  Policymakers must implement a “structural vision to accompany their current cyclical focus. Measures are needed to address key issues, which include the change in drivers of growth and employment creation; the high risk of skill erosion and lost labor productivity; financial deleveraging in the private sector; debt overhangs; the uncertain regulatory environment; and the unacceptably high risks facing the most vulnerable segments of society.”

El-Erian’s recommendations include “pro-growth tax reform, housing finance reform, increased infrastructure investments, greater support for education and research, job retraining programs, removal of outdated interstate competition barriers and stronger social safety nets.”

Yes, in short, a stimulus from tax cuts that can help encourage consumption and unleash animal spirits AND more public spending to get things moving more.

For the Democrats, tax cuts — especially for the wealthy — are anathema. But the U.S. needs to grow its way back into prosperity. For Republicans and Tea Partiers, more government spending is just an excuse for “big government.” Of course, federal deficits will need to be curbed in the long run — preferably starting within a couple of years.

Let’s go back to El-Erian’s point about there being a structural part to this crisis and observe the labor market.

According to the GOP Nevada Senate candidate Sharron Angle, people who receive unemployment assistance are “spoiled.” In short, they should just get a job. Easier said than done. Americans have been used to employment snapping back after recessions. But there is clear evidence now that it isn’t just weak demand that’s responsible for stubborn unemployment but something more structural.

For example, unemployment has not fallen as much as it should have because many jobseekers do not have the skills needed by employers. This has nothing to do with being “spoiled.” Half of the eight million jobs lost in the recession were in construction and manufacturing. Many of those workers are unable to slot into jobs in education, say, or health services. Add to that the difficulty workers have now in re-locating because they owe more on mortgages than their homes are worth.

Looser monetary policy will not alleviate this problem. Libertarians argue that government should have no role in trying to sort this out. But the free market will be too slow.

So far, no single growth engine has emerged to pull the U.S. towards strong recovery. Consumer spending and business investment have been too weak. President Obama’s hope that the country can export its way to strong recovery looks forlorn. For that to happen, America’s trading partners need to be buying American goods. They aren’t. China and India are eager to head off inflation and are tightening. European countries are cutting spending and raising taxes. But unlike those European countries, the U.S. has some leeway to increase public spending — the yield on 10-year Treasury bonds remains below 4%, well down from the 8% of 1990, and inflation remains weak.

So government has to try to accelerate growth — through tax cuts, payroll tax holidays and further government spending. The debt can be addressed down the road when growth increases along with tax revenues.

Jamie Dettmer is a former political writer for The Times and The Sunday Telegraph. He blogs at www.jamiedettmer.com.

Tags : arthur laffer barack obama deficit economics fannie mae fiscal policy freddie mac george w bush great depression keynesian economics macroeconomics public finance recessions republican party sharron angle tax cut tea party tea party protests unemployment
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