The problem former President George W. Bush and his successor, Barack Obama, faced was major but well understood.
A massive drop in consumer demand was causing a downward economic spiral. The drop in demand caused manufacturers to reduce production. The drop in production caused layoffs, further reducing demand. Lower demand caused manufacturers to cut even more jobs.
Both presidents did the right thing, just not enough of it. Like every president confronted with a recession since the Great Depression, they implemented stimulus plans. The theory behind stimulus is to reverse the spiral. Government demand gives manufacturers a reason to increase production. As they increase production, they hire employees. Those employees have money, and they increase consumer demand. Eventually, consumer demand replaces the short-term jump in government demand.
The stimulus plans pushed through by the two presidents and approved by Congress worked. Unemployment would be higher today had the expenditures not been made. They were insufficient, however, to reverse the spiral. Both presidents underestimated the extent of the collapse in consumer demand.
If politicians were working for the people, not against them, that would not have been a major mistake. Obama tried to increase the stimulus several times, most dramatically with the American Jobs Act, which he unsuccessfully introduced in a joint session of Congress in September 2011.
Obama lost any ability to implement a stimulus plan after January 2010, when Massachusetts elected GOP Sen. Scott Brown to replace Democrat Ted Kennedy after his death. A combination of Kennedy’s illness and a delay in the swearing-in of Sen. Al Franken, D-Minn., meant that Democrats only had an effective filibuster-proof majority for about 14 weeks of Obama’s term.
Why did Republicans block efforts at a stimulus? There are two possibilities.
One was referenced by Senate Minority Leader Mitch McConnell, R-Ky., in November 2010: “The single most important thing we want to achieve is for President Obama to be a one-term president.”
Incumbents who preside over poor economies generally lose reelection. Stimulus was the best tool for improving the economy, and the GOP prevented Obama from using it.
The other reason the GOP might have blocked Obama’s efforts to expand the stimulus is the deficit.
While economist John Maynard Keynes recommended government spending — and an increase in the deficit — to escape a recession, he also recommended surpluses in times of prosperity. With good results, our government has followed his instructions on spending our way out of recessions. It has not, however, followed his advice on reducing the deficit in times of prosperity. Thus the U.S. deficit is at unprecedented levels.
This creates a dilemma. On the one hand, the most effective way to reduce the deficit is to stimulate the economy, thus increasing tax revenue and reducing welfare expenditures. On the other hand, some fear that raising the deficit any higher will cause its own problems.
The GOP has, of course, presented the deficit as its explanation for blocking Obama’s stimulus measures.
Recent evidence suggests that McConnell’s one-term explanation is the driving force.
When the federal government does not use stimulus spending to reverse a recessionary spiral, it also has the tool of quantitative easing by the Federal Reserve. It’s a less effective tool than stimulus, but it helps. Yet the GOP howled in protest last week when the Fed announced it would increase quantitative easing in an effort to reduce unemployment. If their goal was to improve the economy, but to do so without increasing the deficit, the GOP should have welcomed the Fed’s move.
The Congressional Research Service suggested another way out of the economic mess last week. What if there was a way to increase spending — thus stimulating the economy — without increasing the deficit?
For good reason, raising taxes is not viewed as a good way to finance stimulus measures. Higher taxes tend to reduce economic activity, mainly because they reduce disposable income.
What the CRS concluded, however, is that over the last 65 years, there has been no correlation between the top marginal tax rate and economic growth. This is vitally important because today’s top marginal tax rate — due to the Bush tax cuts — is 35 percent. During the years studied by the CRS, the rate had been as high as 90 percent. Nobody wants to raise rates anywhere close to 90 percent, but the study suggests a modest increase on the wealthiest Americans — to the pre-Bush 39.6 percent level — would not hurt the economy.
This should be great news for the GOP. We can stimulate the economy and reduce unemployment, and we can do so without increasing the deficit. We simply finance the stimulus with a modest increase in the top marginal tax rate. The GOP response, however, is that returning rates to pre-Bush levels would hurt “job creators.”
The indication is that McConnell’s plan is on track. The U.S. economy is hurting, and the GOP hopes Americans will blame it on Obama in November. Except for the detail of 12 million unemployed Americans, it was a brilliant strategy.