The Obama Watch

Stimulus Malpractice and the Trillion Dollar Deficit

The President-elect's Keynesian extravaganza won't get the economy booming again.

By 12.3.08

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In the 1980s, Reaganomics produced $200 billion deficits "as far as the eye can see," the saying went. Actually, those deficits continued until the country elected Republican Congressional majorities in 1994. Within a few years, the continued $200 billion deficits under Clinton were turned around by Gingrich and those majorities into $200 billion surpluses, using sharp spending restraint and pro-growth tax cuts.

But the Left, as represented by the so-called Mainstream Media (what now should be called the party-controlled press), pounded away day after day for years about the supposed horrors of those Reagan deficits and the certain calamities they would produce. As a result, the party-controlled press missed entirely the economics story of the century, the world-changing Reagan boom, resulting from the most successful economics experiment in history.

Roaring inflation that increased prices by 25% during 1979 and 1980 was reduced by Reaganomics to 6.2% by 1982 and to 3.2% by 1983. The rise in unemployment starting in the 1970s peaked at over 10% in 1982, before Reaganomics reduced it to 5.3% by 1989. The Reagan defense buildup, which contributed to the deficits, led to the collapse of the Soviet Union, with Margaret Thatcher so rightly commenting, "Reagan won the Cold War without firing a shot."

But none of this seemed to matter to the party-controlled press. All that mattered to it were the $200 billion deficits.

Now President-elect Barack Obama is reportedly preparing a budget with a deficit of $1 trillion. While the weak economy is reducing federal revenues, the enormous, unprecedented size of that deficit is primarily due to the Obama/Democrat stimulus package of $500 billion or even $800 billion, according to some reports. Expect to hear from the party-controlled press how that trillion dollar deficit is now all good and wonderful.


The Emperor Has No Clothes
The stimulus package is based on wave after wave of increased government spending for bailouts, infrastructure, and all sorts of government aid. Even the tax cuts that may be included are tax credits, which are effectively the same as government grants as far as the economic incentives produced, particularly when most of the credits would go to people who pay little or nothing in federal income taxes.

This "stimulus" package is not going to produce economic recovery. Economic prosperity is not based on government spending. It is produced by incentives for economically productive activity, such as saving, investment, entrepreneurship, starting or expanding businesses, job creation, and work, along with other pro-growth policies (the rule of law, property rights, freedom of contract, sound money, free trade). Those incentives are strengthened by tax rate cuts, reduced regulatory costs, and other measures that increase the reward, and hence the incentive, for productive activity.

Taking hundreds of billions out of the economy through government borrowing and then spending it does nothing to improve the economy on net. It does nothing to improve incentives for economically productive activity. That is why Obama's trillion dollar deficit is not going to get America booming again. If the government spending is financed by taxes rather than borrowing, the effect is worse, because the taxes worsen incentives.

Obama's massive government spending stimulus strategy takes us backward all the way to the 1930s, when President Roosevelt tried it. It failed, as shown by Amity Shlaes in her brilliant recent book about the history of the Great Depression, The Forgotten Man. As Shlaes wrote in the Wall Street Journal just last week, by 1938, six years into the New Deal, unemployment was still 20%. She adds, "Even late in 1939, total hours worked by the adult population was down by a fifth from the 1929 level."

The new rage today is government spending to hire workers to build and restore infrastructure, such as roads, bridges, highways, airports. As if workers just wouldn't be able to find a job anywhere unless the government hired them to build something. When Roosevelt tried that in the 1930s, unemployment was over 14% for 10 years, and had reached 25% or more. Millions of workers really couldn't find a job anywhere else. Unemployment today is 6.5%, and it has been over 6% for all of three months.

More recently, Japan adopted an aggressive infrastructure building program to counter its deep economic slump in the 1990s. It had the same experience as America under Roosevelt in the 1930s, the sad economy continued for more than 10 years.

Government spending for infrastructure can do some good on net. Improved transportation networks can add to economic growth, for example. But borrowing hundreds of billions out of the private sector to finance runaway infrastructure spending is not a viable strategy for promoting robust general economic growth. Some new jobs might be created, but at the expense of other jobs that would have been created elsewhere if the capital had been left in the private sector.


Worst Treasury Secretary in History
America had its own recent experience with a government spending stimulus package, apparently now all but forgotten. Roughly a year ago, the Bush Administration cut a deal with Congressional Democrats for a supposed stimulus package of over $100 billion primarily based on cash grants for all taxpayers. These cash grants involved no reductions in tax rates, and no improved incentives. I wrote at the time that this was an abrupt departure from supply-side economics, and was not going to work. On one of those White House cheerleading conference calls held regularly to promote the Bush agenda among conservative activists, I asked some brain dead senior White House economist what they were going to do after this failed. He said, "The economists I respect don't think this will fail."

In retrospect, the economists he respects need some after-school tutoring, and I am available at the right price. The intellectual collapse represented by this exchange is one indicator of why George W. Bush will leave the presidency with approval numbers in the Nixon range. That first stimulus package has now proved to be a colossal waste of money, and the Bush Administration's chief economic policymaker, Treasury Secretary Henry Paulson, has wrongly escaped responsibility for this utter failure, and the disastrously changed course of the Bush Administration's entire economic policy over the past year and a half.

The failure of that first stimulus package, and the departure from supply-side economics it represented, in fact is what took us down the road eventually to the much more disastrous and calamitous $700 billion bailout, which has left federal economic policy lost in unchartered waters. Paulson, in fact, should go down as the worst Treasury Secretary in U.S. history, and, as the full magnitude of the current economic downturn becomes apparent, that may be widely recognized.

What Paulson and Bush should have done a year ago is go to Congressional Democrats, and the country, with the argument that the economy was weakening rapidly, and another strong dose of pro-growth economic policies was urgently needed, just like the tax cuts adopted in 2001 and 2003 quickly turned around the then developing recession. They should have called for making the Bush tax cuts permanent, and for cutting the outdated and uncompetitive federal corporate tax rate of 35% to 25%.

The Democrats may well have gone along, to avoid being tagged with responsibility for an economic downturn going into the election. Even Charlie Rangel, the ultraliberal chairman of the House Ways and Means Committee, was supporting a reduction in the federal corporate income tax rate at the time. The resulting boom in the real sectors of the economy would have washed over the deep troubles of the financial sector due to the collapse of housing prices, just as the savings and loan crisis of the late 1980s did not stop the astounding Reagan economic boom that effectively went on for 25 years.

If the Democrats had refused to go along, then just think of how different the politics of the past year would have been. The failure to see this opportunity, and save the economy from all the ensuing suffering, is again due to the intellectual failings of Henry Paulson. No doubt, he understands how to make hundreds of millions for himself on Wall Street. But as for national economic policy, I could find high school football coaches who would do better.

That first Paulson stimulus package was strongly supported by both Senators Barack Obama and Hillary Clinton as well, who were calling for even more of the same. The thinking behind that policy, and the much bigger stimulus packages Obama and the Democrats now support, is based on outdated, old-fashioned, discredited Keynesian economics. Keynesian doctrine holds that the way to boost economic growth is for the government to run a deficit, which will supposedly boost overall spending in the economy, which is supposedly the way to spark economic growth. (Notice how this doctrine has been hidden in the closet for the last 30 years, when harsh criticism of the federal deficit was politically useful in bludgeoning supply-side tax cuts, and stopping even further supply-side reforms.)

Keynesian doctrine bloomed in the 1930s, and was the intellectual foundation for the failed New Deal. It nevertheless was thoroughly embraced by liberal academia, because it was so politically useful in promoting big government. The thorough and repeated conservative, free market critiques of the doctrine were mostly ignored. Keynesian doctrine was finally fully discredited in the 1970s, when deficits seemed only to help promote inflation, rather than economic growth. Now the supposedly change Democrats are taking us back to the future, way back, 80 years backward.

No doubt, there will be some natural tendency towards economic recovery, probably not until 2010. But it will be muted, depending on how much of the liberal/left agenda is enacted. If taxes are increased on higher income savers and investors, as Obama has proposed, and the Democrats fully indulge their global warming fantasies and impose massive new regulatory costs on the economy, along with central economic planning energy policies, and the unions are given carte blanche, including protectionism, any recovery is going to be mostly short-circuited and short-lived, with the eventual downside unlimited. With supply-side economics out, brain dead Keynesian economics in, and all of these potential policy disasters set in motion, the best long-term prospect is stagnation and lagging living standards.

To really get America booming again, we should first make the Bush tax cuts permanent. The federal corporate tax rate again needs to be reduced to 25%. We should also cut the middle class income tax rate of 25% to 15%, resulting in a flat tax of 15% or less for 90% of taxpayers. Along with policies to produce low-cost reliable energy supplies for the economy, a return to sound long-term monetary policies, and some additional reductions in unnecessary regulatory costs (see Sarbanes-Oxley and mark to market accounting regulations), this would restore the 25-year Reagan boom.

Republicans need to loudly reject the Democrat Keynesian witch's brew, and loudly advance these pro-growth policies. If they do so, they may return to power sooner than now seems possible. If reality drives the Democrats out of their policy nostalgia for the 1930s and 1960s and towards this pro-growth agenda, they may succeed far more for far longer than now seems possible.

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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.