The Economy is Finally Showing Signs of Life: Don't Sabotage it!

Finally, the economy is showing strong signs that the six-year slump may be coming to an end.   236,000 people found work in February, far more than economists had expected, and the unemployment rate is 7.7%, the lowest level in four years.

Rising house prices and a booming stock market are driving up household net worth, which should boost spending.  The housing sector is  rebounding.  Corporations are sitting on a huge pile of cash, which means that there’s lots of room for investment and hiring once businesses are convinced that the recovery is for real.

With all this good news, why would Washington want to throw sand in the gears of the economy?  But it is, big time.

The deal to avert the fiscal cliff let payroll taxes rise by 2 percentage points, which cut household after-tax incomes and is depressing consumer spending.  The insane sequester will hurt the economy by reducing federal workers’ pay  and reducing employment as federal hiring comes to a standstill and contractors have to lay off workers (or cancel hiring plans).

There is a time to cut government spending, but it’s not now.

There is, however, a potential bipartisan path out of this morass. Republicans and Democrats are each right about some big things that seem to divide them.  Democrats are right that taxes will need to increase.  The retirement of the baby boomers means that there will be unprecedented demands on government.  The tax level that sort of worked for the past 30 years won’t be adequate to pay the Social Security, Medicare, and Medicaid (which covers half of nursing home care) that we’ve promised baby boomers, even under the most optimistic assumptions about cost controls.  And Republicans are right that we must slow the out-of-control growth of entitlement spending–especially for government healthcare programs.

The President has signaled willingness to take on entitlement reform, over objections of some of his caucus.  He should be able to win over a substantial number of Democrats with a simple argument:  if we do not control health care spending, it will crowd out everything else that government does.

The GOP has  dug their heels on additional tax revenues, but tax reform that curtailed tax expenditures, cut tax rates, and raised net revenues still seems like a possibility.  Republicans really should favor this.  Spending programs administered by the IRS do as much to increase the size and scope of government as direct spending programs, and deserve the same level of scrutiny.

Serious tax reform would take a couple of years, but that is a plus.  If the economy keeps recovering, modest revenue  increases starting in 2015 would be well timed.  Similarly, the effects of serious entitlement reform would take many years to have much effect on the budget, but they will solve the real budget problem, which is long term (and won’t hamper the economic recovery).

Congress should cancel the irrational sequester and instead enact policies that could help speed up the recovery.  Congress and the President should agree to pair tax reform with entitlement reform and get down to work on both.

Or law makers can  continue to sabotage the economy and hope the other side gets blamed for the resulting economic carnage.

I know the smart money is on the latter outcome, but I’m hoping that for once smart policy will prevail.

Len Burman is coauthor with Joel Slemrod of Taxes in America:  What Everyone Needs to Know.

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Could Obama v. Romney Debate Push us Back Into Recession?

With the recovery from the deepest economic downturn since the Great Depression still very much a work in progress, it is natural that the presidential candidates tout their own economic credentials and attack their opponents’. The only problem is that the overheated rhetoric might itself be bad for the economy.

Recall that recessions and recoveries are dependent on what Keynes called “animal spirits,” which can provoke waves of self-fulfilling optimism or pessimism. For example, in Keynes’s time, if a bank failed and depositors thought it an isolated event, it was.  Other banks would do just fine. If depositors thought the failure signaled  systemic failure, though, they’d want to withdraw their deposits and the resulting bank run sank even the most prudent financial institution.  Pessimism, too, is self-fulfilling. (Deposit insurance was put in place in the 1930s to prevent bank runs, by guaranteeing most deposits, and that, combined with the Glass-Steagall regulations that prevented banks from gambling with their insured deposits, worked well until the regulations were repealed and bankers went wild.)

Recessions and recoveries also depend on confidence.  If households and businesses believed that the economy was on track for solid growth, firms would invest and hire more and consumers would be willing to spend more, unburdened by the fear of imminent job loss. The prospect of higher interest rates would encourage more people to buy homes, cars, or other big-ticket items.  The boost in hiring and spending would reinforce households’ and firms’ expectations and they’d ramp up economic activity even more.  State and local tax revenues would surge, and governments would start hiring back some of the workers they have had to lay off in the past couple of years, and the newly employed workers would spend more money.  Optimism would be self-fulfilling.

But pessimism is also self-reinforcing. If businesses and consumers are pessimistic or highly uncertain, they’re less likely to hire, invest, and spend, which means that more firms shut down or lay off workers, which boost unemployment and further depresses confidence.  If most Americans were convinced we were headed back into recession, we would be.

Which brings me to the election campaign… President Obama and Governor Romney are both doing a fabulous job of explaining why the other would be incompetent to manage the economy.  Anyone paying attention who believes the rhetoric of either candidate would be forgiven for guessing that economic disaster is a 50-50 proposition (given that the polls are about evenly split). Given how salient negative political messages seem to be, independents might place the odds even higher.  And this will only get worse as we get nearer the election and candidates and super-PACs inundate us with attack ads focusing on the economy.

This is certainly not a recipe for appeasing the animal spirits.  That said, I have no idea how important this insight is.  Only a handful of presidential elections have occurred during recessions since World War II and none has been as bad as this one.  In at least some prior elections, friendly legislatures have been more inclined to enact policies to mitigate the effect of the recession, while the House and a disabling minority in the Senate seem bent on undermining this president’s programs.

If it’s true that election rhetoric hurts the economy and if the conventional wisdom is right that the economy will decide the election, then this is good for Mitt Romney. Let’s hope President Obama is wrong about what that would mean for the economy.

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