“The problem for the President [when crafting economic policy] is that there are tensions among these problems.
Accelerating GDP and job growth requires big fiscal or monetary stimulus. The Fed has the dial set to 11, so fiscal stimulus is all that’s left. As a policy matter, a big new stimulus program would substantially further increase at least the short-term deficit and take at least a few months to even begin to have an impact. As a political matter, the Administration has poorly managed stimulus implementation and communications to the point that even they are afraid of the word “stimulus.” The President’s communications and political advisors are, I imagine, groaning at the thought of the President’s policy answer to slow job growth being another stimulus. Then again, they’re probably panicked about another year of 9+% unemployment.
Getting serious about budget deficits requires some combination of big spending cuts and/or big tax increases.
• While Congressional Republicans are almost never able to muster the votes for big spending cuts, at least they’re generally willing to talk about them as the preferred solution. (How’s that for faint praise?) I have seen no indication that the President or any of his allies (except House Majority Leader Steny Hoyer) are willing to significantly slow the growth of spending. To have a measurable effect on the long run spending problem, one has to address demographics and health care cost growth in Medicare and Medicaid. But Director [Peter] Orszag routinely ignores demographics in his presentations, arguing the long-run problem is only about health care costs. The President and his allies have lowered their long-term fiscal goal for health care reform to only slight improvements in our deficit picture. Even those small improvements are contingent on wildly optimistic assumptions about future Congressional behavior.
• That leaves tax increases. The Administration already has baked into their projections revenue gains from allowing the top rates and capital tax rates to rise. Getting a lot more revenue (measured in percentage points of GDP) requires either returning to pre-Reagan tax rates or a new source of revenue. Q1: Will the President propose a new value-added tax (VAT), which would raise taxes on all consumers and break the President’s pledge? Q2: Will he instead propose a new business activity tax (BAT) which would have similar effects but which he could claim taxes businesses rather than individuals?
• As worried as the President’s Congressional allies might be about the policy and political impacts of dangerous deficits, it’s hard to imagine them preferring to spend election year 2010 pushing for big spending cuts or big tax increases. I imagine they’ll be looking for ways to punt.
The scheduled automatic tax increases pose another conundrum. On the one hand, they need the revenues to prevent future deficits from being even worse than projected. On the other, if the economy is still soft at the end of 2010, tax increases are counterproductive. …
Within the White House the budget process is almost certainly driving these decisions. In my experience, most big Presidential budget decisions take place in November and December, to be rolled out in the State of the Union address and the release of the President’s Budget in the first week of February.”
Keith Hennessey, “The President’s 2010 challenges: Jobs, deficits, and taxes”, KeithHennssey (3 December 2009).
http://keithhennessey.com/2009/12/03/2010-challenges/
Keith Hennessey was Assistant to the President for Economic Policy and Director of the National Economic Council under President George W. Bush. It is the position now held by Lawrence Summers under President Barack Obama. His blog was recently named by the Wall Street Journal as one of its “Top 25 Economics Blogs”.
The economic situation before the country and the President may be summarized as follows: The real economy remains in a precarious state at what is hoped is the start of at least a weak recovery, with growth forecast by the Administration to reach a pace of 2 to 3 percent next year; Unemployment is at 10 per cent of the labor force and expected to remain above 9 per cent through 2010; Inflation is low, but an upturn in the world economy could spark international commodity price inflation, which could be transmitted to the domestic economy, especially given the excess reserves in the banking system and even a weak upturn at home; Bank failures continue to describe the state of the country’s banking system; The dollar is sinking on foreign exchange markets; and The Administration projects a budget deficit for 2010 equal to almost 10½ of the GDP with an unsustainable average budget deficit exceeding 5 per cent of the GDP for the foreseeable future.
The Administration’s forecasts for a recovery and the deficit are predicated on optimistic assumptions. Those prepared outside the Administration are more pessimistic and while a second deep recession -- a recession within a recession -- is not predicted at this time neither can it be ruled out and it could be triggered at any time by developments in financial markets that remain in turmoil at home and abroad.
Into this mix of troubles can be added the uncertainties and irrationalities of the President’s own policy aspirations. The health care and energy legislation that have been proposed continue -- nay, accelerate -- the policy drift toward unbridled government spending that has described most of the post-World War II period. His policy priorities, like those of his predecessors, only worsen the fiscal and trade imbalances that must be eliminated to restore the possibilities for rapid growth to the U.S. economy and with it the world economy. While wanting to help the economy, his policies only make things worse.
Given the immensity of the crisis that befell not just the U.S. economy but the world economy, one would have thought that policy makers would understand that short-term fixes to a financial calamity in one country, even one as large as the United States, cannot restore the foundations of a worldwide prosperity that have been eroding for decades. The world now requires -- this country especially -- a fundamental adjustment of its patterns of production, spending and international trade that can sustain themselves without causing huge deficits and surpluses in government and external accounts. There is nothing in the policy alternatives summarized by Mr. Hennessey, as he points out, which really address longer-term problems.
Even more incomprehensible is continuing down a policy road of unrestrained spending that is the very cause of the internal and external deficits at the root of the crisis in which we find ourselves.
Mr. Hennessey has set forth the nasty policy choices now before the President. Let me suggest that unless the President and the Congress abandon the policy priorities they have championed since his inauguration, the long-term performance of the economy will continue to deteriorate and the policy dilemmas the country faces in the future will become even more nasty .
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