The Obama Watch

The Coming Crash of 2011

There will be naturally occurring economic growth this year -- but then Obama's neo-socialist, recovery delaying policies kick in for good and we better hope the rest is just his history.

By 2.10.10

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Americans no longer remember the concept of the "business cycle." For centuries, market economies have periodically turned down, and then turned back up. The recovery from such downturns is natural for a market economy. Every morning, at least some of the unemployed get up and look for work. Businessmen wake up and spend the day trying to restore their businesses to prosperity. As a result, market economies naturally come back to recovery. This is why the average recession in the U.S. since World War II has been only 10 months, with the longest, until now, being 16 months.

Bad economic policies can throw economies into downturns, and delay recoveries. Keynesian economics and rising effective tax rates produced four worsening inflation/recession cycles in and around the 1970s: 1969-1970, 1973-1974, 1979-1980, and 1982.

But Reaganomics was so successful that it all but abolished the business cycle for a generation. The economy took off at the end of 1982 on a 25-year economic boom interrupted by only two, short, shallow recessions in 1990-1991 and 2001. That is why today we no longer recognize the natural workings of the business cycle.

The current recession was officially scored by the National Bureau of Economic Research (NBER) as starting in December, 2007. It was caused by excessively loose Federal Reserve monetary policy from 2001 to 2006, and the liberal policies creating the subprime mortgage market, resulting in the catastrophic housing bubble.

As previously explained in this column, from the beginning the government tried to address the downturn with long ago failed, counterproductive, Keynesian economics, rather than Reagan's shockingly successful supply-side economics. First there was the Bush/Pelosi stimulus bill of February, 2008, since forgotten because it had no positive effects.

A year later, President Obama and Congressional Democrats came back with the almost $1 trillion stimulus bill, promising that it would stop unemployment from climbing above 8%. These bills both involved Keynesian economics because they tried to stimulate the economy through higher government deficits and spending. Even the "tax cuts" in those stimulus bills involved tax credits and rebates that effectively are the same as just more government spending, sending out government checks, rather than the tax rate reductions that were the focus of Reaganomics and supply-side theory, which fundamentally change economic incentives. The slow and weak recovery from the recession, which has lasted almost two years (a postwar record), shows yet again the failure of Keynesian economics, continuing a long, unbroken record of failure stretching back to the 1930s.

But the Obama Administration came into office knowing that the economy would ultimately recover as the business cycle turned up naturally, and planned to reap the political credit, enabling still greater leaps of neo-socialism. Internally, they are surprised and miffed that it has taken so long, not understanding that their own, blindly anti-market policies only delayed recovery.

The Plague of Left-Wing Propaganda

A plague of left-wing propagandists from such pustules as the George Soros-funded Center for American Progress are already feverishly at work attempting to obscure these economic realities. On a recent broadcast of the Larry Kudlow Show on CNBC, Art Laffer politely sat through an infantile lecture from Michael Linden, Associate Director for Tax and Budget Policy for the Center, claiming that Laffer had been "long discredited" in his argument that cuts in capital gains tax rates produce higher revenues.

But the truth is that over the past 40 years, every time capital gains tax rates have been cut, revenues have increased, and every time capital gains tax rates have been increased, revenues have declined.

In 1968, a 25% capital gains tax rate generated real capital gains tax revenues of $40.6 billion calculated in 2000 dollars. The capital gains tax rate was then raised 4 times in the next 7 years to 35%. By 1975, at the higher rate, capital gains revenues totaled $19.6 billion in constant 2000 dollars, less than half as much.

In 1978, the capital gains tax rate of 35% yielded $29.9 billion in 2000 dollars. The rate was then cut 3 times to 20% over the next 4 years. By 1986, the new rate, 43% lower than the 1978 rate, raised $92.9 billion in 2000 dollars, about three times as much.

The capital gains rate was raised by 40% the next year, to 28%. Capital gains revenues fell to $56.2 billion that year, and declined all the way to $34.6 billion by 1991.

In 1997, Congress cut the capital gains tax rate from 28% back down to 20%. Despite this almost 30% cut in the rate, capital gains revenues rose from $62 billion in 1996 to $109 billion in 1999. Revenues over the period 1997 to 2000 increased by 84% over the projections before the tax cut.

Finally, Congress cut the capital gains rate from 20% to 15% in 2003. Capital gains revenues doubled from 2003 to 2005, despite this 25% cut in the rate. Revenues increased by $133 billion during the years 2003 to 2006 as compared to pre-tax cut projections.

Other propagandists have compared the unemployment rate in President Reagan's second year in office to the rate under President Obama today. But they fail to account for the fact that Reagan slashed roaring inflation in half by 1982, and in half again by 1983. Prices had soared by 25% over the two years 1979 and 1980. But annual inflation fell to 6% by 1982, and to 3% by 1983. Find me the economics textbook that explains how that can be done without a temporary increase in unemployment. President Obama, by contrast, is today sowing the seeds for inflation, rather than conquering it. 

Economic Growth in 2010

Just as President Obama's economic policies are the opposite of President Reagan's, his economic performance will be the opposite as well, as Art Laffer argues in his latest economic outlook report.

Economic growth will return throughout 2010, due to the natural economic recovery as discussed above, which this column predicted a year ago. President Obama often talks as if without his magic Keynesian fairy dust, the economy would continue to lose several hundred thousand jobs every month, until the total number of jobs fell to zero. Thinking people know nothing like that would ever happen. The reality is that the recovery has come too little, too late, as also discussed above.

For several reasons, this will be the best year economically of President Obama's reign. First, the deeper the downturn, the stronger the recovery, and this recession has been the worst since World War II. Given that, real economic growth this year could be expected to be 6% to 8%. The economy grew by almost 7% in Reagan's recovery in 1983 and 1984. But because of the counterproductive economic policies of President Obama and his neo-socialist Democrats, growth will only be half that. Moreover, as Laffer notes in his report, "this slingshot effect will long be a thing of the past by 2011."

Secondly, Federal Reserve policy has been enormously expansive, with the monetary base soaring by 150% over the past year. Interest rates have also been kept close to zero during this entire time. Basic textbook economics will tell you that this boosts the economy in the short term.

Thirdly, the broad tax rate increases scheduled for 2011 will cause producers to produce more in 2010 while they can still gain the relief of the lower rates. As Laffer writes, "Higher tax rates on January 1, 2011 will incentivize people to accelerate income out of 2011 and into 2010." As a result, "GDP growth in 2010 will be some 3% to 4% higher than it should otherwise be."

But I don't think unemployment will fall this year all the way to 7%, as Laffer suggests. I don't think it will fall below 9%.

Down the Roller Coaster in 2011

But, Laffer rightly continues, "when the U.S. economy comes to 2011, the train's going to come off the tracks."

Not only will the slingshot effect of recovery from the deep recession be over. The positive effect of the enormous Fed monetary expansion will be petering out. Monetary expansion does not create long-term economic growth. The Fed has to press the accelerator faster and faster to maintain the same stimulative effect. But if it does, then inflation starts to arise, accelerating faster and faster if the Fed continues. Indeed, the runaway expansion of the monetary base the Fed has already engineered will generate explosive inflation if the Fed does not pull it out in time.

But if the Fed pulls back, interest rates will start to rise sharply. The borrowing needs of Obama's record-shattering deficits will exacerbate this effect, as will the borrowing needs of a newly growing economy. Those higher interest rates will squelch the recovery. Or as Laffer says, "Any attempt to rein in excessive monetary expansion would lead to an immediate and precipitous economic collapse."

And we haven't even begun to talk about the tax rate increases of 2011. These purely ideological abuses of economic policy will end up punishing working people nationwide. The top income tax rate is scheduled to increase by close to 20%, the capital gains tax rate by at least 33%, and the top dividends tax rate by 164%. Further tax increases in the pending health care legislation would raise these tax rates still more. Laffer adds that starting at the end of 2010,

the U.S. will have a payroll tax rate increase, an estate tax increase, and income tax increases. There's also a tax increase coming in 2010 on carried interest [further discouraging investment]. This rate will rise from its current level of 15% to 35%, and then it will rise again in 2011. On state and local levels, there is also no government spending restraint and state tax rates are rising.

Also pending is an $800 billion cap and trade tax on energy, and high cost, unreliable energy is another prescription for economic failure.

"The rich" don't even have to pay these higher taxes for the higher rates to have a devastating effect on working people. Working people will suffer if investors just respond to the resulting incentives by pulling back their money, or sending it overseas for investment in friendlier economic climates, like India, Brazil, and China. That will result in fewer jobs, lower wages, higher unemployment, and slower economic growth or even decline in America.

Laffer explains just how devastating the resulting reversal from the artificially pumped up economy of 2010 can be, saying,

The tax boundary that will occur on January 1, 2011 tells me that GDP growth in 2010 will be some 6% to 8% higher than GDP growth in 2011. A year on year decline from trend of some 6% to 8% in GDP growth would represent a larger collapse than occurred in 2008 and early 2009.

Again, just the opposite of the long-term economic boom that followed the 1982 downturn when Reagan first slayed inflation, the flowering of growth in Obama's second year will be followed by long-term stagnation and economic decline for America, slaying the American Dream, until President Obama's neo-socialist economic policies are reversed.

The only hope for change the American people have now is to engineer a dramatic change in leadership in Washington in this year's elections. Only that can restore the prosperity policies necessary to avert the Coming Crash of 2011.

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About the Author
Peter Ferrara is Director of Entitlement and Budget Policy at the Heartland Institute, General Counsel of the American Civil Rights Union, Senior Fellow at the National Center for Policy Analysis, and Senior Policy Advisor on Entitlements and Budget Policy at the National Tax Limitation Foundation. He served in the White House Office of Policy Development under President Reagan, and as Associate Deputy Attorney General of the United States under President George H.W. Bush.