During the US presidential campaigning, neither candidate was about to let the financial crisis dictate a wholesale remake of his economic platform. As the markets crashed and the recession rolled in, every promise stood, however ancient its provenance, as though nothing had changed and dealing with the crisis was a separate issue. It took Barack Obama three days – from the election result to his first press conference– to think again.
At said conference, the president-elect declined to confirm that he would raise top tax rates soon. Is he wondering if John McCain, his Republican opponent, was right, and this is no time to be raising anybody’s taxes? Mr Obama also said that his promised tax cuts for “95 per cent of working families” should be seen as part of a new fiscal stimulus. Previously, he had not mentioned this as a reason for cutting taxes. On the contrary, he had emphasised that his plan was roughly revenue neutral, implying that any stimulus would be second order.
A question too complicated for campaign speeches, and which neither side even wanted to think about, now needs an answer. How can the next administration reconcile its longer-term goals for the economy with the imperatives of the economic crisis? Getting this right will not be easy, but is the key to success or failure in Mr Obama’s presidency.
One danger lies in failing to think clearly about short term and long term. In the short term, a further big fiscal stimulus is needed. In the long term, the budget deficit will have to be cut not merely from where it will be after this new boost has been delivered, but from where it stands already. If these goals get blurred together, as they are likely to, the country will get the worst of both worlds: the short-term stimulus will be too small and the long-term consolidation will be too slow.
Discussions about the next fiscal stimulus have started, and figures as low as $100bn (€78bn, £64bn) – smaller than the first stimulus, enacted last spring – are being talked about. That is much less than 1 per cent of gross domestic product. Current data on the state of the economy are much too alarming for this kind of timidity. A stimulus in the order of $500bn is required. This rightly arouses concerns about the long-term fiscal outlook. The answer is not to scale back the stimulus but to make it, so far as possible, self-correcting over the course of the cycle.
One-shot tax rebates fit the bill. The first stimulus took this form, and it worked fairly well. The problem is that under present circumstances too much of a rebate gets saved rather than spent.
Lower tax rates, as opposed to rebates, are worse in this regard because they are not self-correcting. Ask President George W. Bush. His tax cuts were scheduled to expire in 2010 – not because he wanted this to happen, but because it disguised a deteriorating fiscal outlook. One thing Mr Obama and Mr McCain agreed on was that the Bush tax cuts should be maintained (for 95 per cent of working households, at any rate).
Mr Obama will most likely keep his promise to cut most households’ taxes (relative to what current law provides, plus some extra relief for the working poor). This is helpful for the economy in the short term and he will regard it as a political necessity in any case. Yet the fact remains that this will undermine the long-term fiscal position. Care must be taken not to let the rest of any stimulus compound the problem.
With this in mind, the next fiscal plan should lean heavily on temporary spending. More generous unemployment assistance scores highest. This mostly feeds through to consumption, and automatically does so at the right time. It helps the people who most need help. Later, when unemployment falls, the demands on the public purse fall with it.
Assuming this recession may be prolonged, infrastructure spending also scores well. It directly supports low-wage employment in the hard-hit construction industry. So long as the projects are desirable on their merits, they are valuable as public investments. And once you have built a bridge (preferably to somewhere), you do not have to keep building it. Turning off the tap is relatively easy.
On the spending side, expanded entitlements are a long-term hazard unless the revenues needed to pay for them are enacted at the same time. A red flag should go up if Mr Obama proposes to regard new subsidies for healthcare as part of his stimulus. However desirable they might be on their merits, they would be an ongoing fiscal burden, regardless of the state of the economy. The means to pay for them need to be designed alongside.
The greatest danger of all is that the valid case for a strong stimulus takes under its wing spending proposals that create an ongoing obligation, have no true investment rationale, and represent a waste of public money now and in the future.
The bail-out currently being sought by the big US carmakers falls squarely into this category. Managers and unions have conspired for years to drive US-owned, US-based car manufacturing into the ground. Now they seek public subsidy to pay for investments they should have undertaken in any case, and to sustain wages and benefits that comparably qualified workers in other industries cannot hope to enjoy.
Why a worker in a US-owned car factory deserves more generous treatment than any other kind of US worker escapes me. Asking those other workers to pay for these privileges seems to add insult to injury. Perhaps President Obama will be able to explain.
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