Rethinking Economic Policy
Economic policy moved to the fore last week as Democrats accused the Bush administration of mismanaging the economy. With elections less than a month away, both parties are trying to distinguish themselves with a domestic agenda that addresses the weakened economy. The renewed emphasis on economic policy is a welcome addition to the political debates that hopefully will spark a serious discussion about economic growth. Moving beyond election year sloganeering and political accusations, policymakers must address the fundamentals—simplifying the tax code and removing government impediments to economic growth.
Although Democrats have yet to unveil their economic plan, their discussions of economic stimulus typically revert back to self-serving Kenyesian notions of boosting demand through increased spending. Injecting more cash into the economy is viewed as a means of priming the pump and keeping the engines of production humming. This, in turn, keeps workers employed, who then spend their paychecks, which boosts demand for goods and services. Government spending is viewed as the quickest way to boost demand; tax cuts are not considered the best policy because taxpayers are viewed with suspicion—there is no guarantee that they will spend enough money if they receive a tax break.
While it is true that government will never be accused of this reluctance to spend money, advances in economic theory suggest that policies that focus exclusively on increasing demand while ignoring supply may not be the best route to a stronger economy. In fact, recent research by Professor Alberto Alesina of Harvard University and his colleagues suggests that traditional Keynesian remedies, in fact, may be detrimental to economic growth. Specifically, their study, published in the American Economic Review, finds that economic growth slowed during times when government grew and increased as government was pared back. Looking at economic activity across a number of nations, the authors find, “The fiscal stabilizations that have led to an increase in growth consist mainly of spending cuts, particularly in government wages and transfers, while those associated with a downturn in the economy are characterized by tax increases.”
Ignoring such data on economic activity and the importance of supply-side considerations, Congress has been on a yearlong spending spree, with handouts to everybody from airlines to farmers. If Daschle and the Democrats stick to their Keynesian guns, this years $153 billion increase in outlays, with increases in discretionary spending alone of more than $84 billion should be an ample injection of government spending. If they want to spend more because this is not the right kind of spending, they should explain to the voters why they steadfastly have spent taxpayer dollars on the wrong priorities.
Economic reform in the House, meanwhile, simply adds layers to the onion. Rather than tackle fundamental reform of the tax code, Rep. Bill Thomas (R-Calif.) is offering a mix of investor-friendly changes to the code and an extension of unemployment benefits. While Thomas is correct to focus on the detrimental impacts of taxing savings, the modest reforms are stop-gap measures at best. The United States tax code has a clear bias against savings and has become one of the most inefficient and expensive tax codes in the developed world.
Real economic reform must focus on stimulating both demand and supply. This requires a top-to-bottom reform of the sclerotic tax code and a careful review of government policies that may pose barriers to economic growth. A simpler tax code with a greater degree of certainty is no longer a luxury; it is a necessity in a world where capital is mobile and other nations have aggressively reformed their tax codes to encourage investment. Without reform, American businesses and workers will feel the pinch of global competition.
Looking beyond the tax code, a number of regulatory barriers continue to thwart the business community’s efforts to climb out of the economic slump. Archaic technology policies continue to stifle the expansion of broadband connections, and federal interventions into merger decisions hamper the development of new innovations and business models. Energy policies continue to stifle the development of domestic energy resources and Congress continues to pursue federal mandates on fuel and energy sources that do more to shore up monopolies than to help consumers or promote efficient energy use. All told, American consumers face a regulatory burden of more than $800 billion annually.
Fortunately, there is promising talk of reform. Treasury Secretary O’Neill has called the tax code an “abomination” and has made reform a top priority. A simpler and fairer tax code that eases the burden on taxpayers can have beneficial effects for both demand and supply. A serious push by the administration for fundamental tax reform would be an important step toward a stronger economy. At the same time, the administration needs to take a serious look at regulatory barriers and government policies that are hampering important sectors of our economy. A serious review of agency regulations and competition policy should identify ways to improve the business climate. The current economic malaise has raised fears among Americans that must be addressed, and politicians need to let voters know how they will address the problem—through more government and higher taxes, or through tax reform and more open markets.
