Sunday, January 15, 2012

Obama compounds our short-term problems

Published in The Tennessean, Sunday, January 15, 2012

by Richard J. Grant

We know that federal budget deficits tend to rise during and immediately after recessions. This is not because they should or must according to any moral or inexorable law of nature. It is merely programmed into the current fiscal structure: unemployment rises and incomes fall along with production. This automatically increases government spending and reduces tax revenues.

These effects are usually compounded by a predictable political reaction, which most recently included the extension of unemployment benefits, increased government “stimulus” spending, and the reduction of payroll tax rates.

The political payoff from these reactions will certainly be greater than the real economic payoff. Extending unemployment benefits sounds compassionate, but it draws resources away from other uses and reduces both the incentive to work at finding a job and the likelihood that such job opportunities will be created.

So-called “stimulus” spending might be directed into beneficial infrastructure projects that reasonable people could agree to fund. But, as we have seen, it could just as easily be blown on speculative, too-clever-by-half attempts to create new industries ahead of their time. “Green energy” is one such area where government has demonstrated its incompetence and has probably retarded innovation in the energy sector.

Payroll taxes affect many people. They are low, flat taxes on a relatively stable tax base. Payroll tax revenues fall as employment falls, but they are not as sensitive to downturns as are other taxes on income and capital gains. Also, the reduction in revenues earmarked for Social Security will hasten the day when the trust fund reaches zero and Congress must make new appropriations to keep the checks coming to retirees.

We can forgive a newly elected politician for the automatic increases in the budget deficit that occur in his first year of office. What we can, and should, judge him on is the economic value added or destroyed by his own actions.

In a recent Wall Street Journal article, Austan Goolsbee, a University of Chicago economist and former chairman of President Obama's Council of Economic Advisers, criticizes the Republican presidential candidates for under-appreciating the automatic nature of deficit increases during a downturn. He notes that, “As the economy grows back to health, the government share of the economy will fall.”

But by making this point, he seems to miss the point. Although economic growth is positive, it is about half the long-term average rate. Twenty-eight years ago, after a similar recession, the economic growth rate was double the long-term average. That was during the equivalent period in President Ronald Reagan's first term. This difference is not an accident.

President Reagan knew the difference between reduced tax revenues and reduced tax rates. But Professor Goolsbee points to the recent low tax revenues and wonders why the GOP candidates are not “trumpeting the last three years as one of the greatest tax cutting periods of the century.” If President Obama understood this, he would have copied Reagan rather than attempting the opposite.

President Reagan knew that he was, and would be, plagued by short-term deficits. He focused, not on quick fixes, but on improvements that would be effective and would last. By his presidency’s end, top marginal income-tax rates were less than half what they had been. Economic activities were much freer from government interference and the economy grew accordingly.

After that, what president could complain about his “inheritance”?


Richard J. Grant is a Professor of Finance and Economics at Lipscomb University and a Senior Fellow at the Beacon Center of Tennessee. His column appears on Sundays.

E-mail: rjg@richardjgrant.com
Twitter: @RichardJGrant1

Copyright © Richard J Grant 2012