No Promise in Pusillanimity

Paul O’Neill and Lawrence Lindsey’s terms of service to the Bush administration ended unceremoniously last Friday with the pair’s resignations, announced a few hours apart. On Monday, Bush announced the appointment of former CSE Board member John Snow to become the 73rd Secretary of the Treasury, pending Senate approval. As of writing, former co-chairman of Goldman Sachs, Stephen Friedman, is expected to replace Lindsey as head of the National Economic Counsel.

First impressions of a Treasury Department under the direction of a Secretary Snow provide cause for optimism. John Snow has been an advocate of tax cuts and served on the “National Commission on Economic Growth and Tax Reform,” or “Kemp Commission,” which recommended a flat tax to replace the existing tax code. He was also exposed to the excesses of economic and antitrust regulation as chief executive and chairman of rail conglomerate CSX. CSX confronted hostile antitrust review in its merger with Conrail and stared down the specter of rate regulation promoted by “captive shippers” who sought to reduce their distribution costs via federal intervention.

On top of this invaluable real-world experience, Snow possesses impressive academic credentials, boasting a Ph.D in economics from the University of Virginia and a law degree from the George Washington University.

Stephen Friedman, on the other hand, is a less compelling choice. He is currently vice chairman of the Concord Coalition, which bills itself as a voice of fiscal discipline, but mischaracterizes support for excessively high taxes on capital, labor, and other productive endeavors as being “disciplined.” Stephen Moore, of the Club for Growth, criticized Friedman as being “hypersensitive about budget deficits,” a trait common among investment bankers whose primary fiscal policy concern is its effect on long term interest rates and bond yields.

Friedman worked intimately at Goldman Sachs with Robert Rubin and Sen. Jon Corzine (D-N.J.), both Democrats who believe that budget surpluses promote economic growth. Corzine has described Friedman as “capable” and “intellectually disciplined” and implied that Friedman shared his views on fiscal austerity and would be a check on the administration’s tax-cutters.

If this is true, it would be unfortunate. Although Rubin and his Democratic protégés continue to parrot the “deficits drive up interest rates” crowding out theory, the evidence is simply not in their corner. Today, 30-year Treasury notes yield only 2.13 percent more than their inflation-indexed counterparts. This means that inflation expectations are very low, as investors are willing to pay high prices for a fixed income stream exposed to inflation despite forecasts of structural deficits of over $300 billion. Rubin’s deficit theory is a conclusion in search of evidence.

Whatever his opinion of the macroeconomic effects of the federal government’s fiscal policy stance, Friedman has earned a reputation as an excellent coordinator and consensus-builder, qualities demanded by his prospective White House job. As co-chairman of Goldman, Friedman was forced to blend the various viewpoints of his associates to map strategies. The success of the private investment-banking firm, which went public after his departure, engenders confidence in his ability to make decisions and get coworkers on the same page. If he brings the Goldman skills, sans the Goldman deficit sensitivity, he could be an excellent choice.

Ultimately, both men will be judged on the economy’s performance over the next two years. While fiscal policy has severe limitations in its ability to provide a short-term economic boost, lower rates on capital, labor, and income can provide incentives to the productive sectors of the economy to boost output.

Some sectors – most notably telecommunications – face overcapacity and enormous debt burdens that preclude expansion, but others, including America’s small businesses whose owners are situated in the higher income tax brackets, are sensitive to tax rates. A capital gains, payroll, and income tax cut would reduce the amount of revenue new capacity must generate to make small businesses’ investment worthwhile.

Democrats will oppose any effort to cut capital gains or income taxes in the next Congress, while furtively hoping that the economy stagnates to improve the chances of their presidential candidate in 2004. Whatever the electoral outcome, the president’s new economic officials should see the Democratic opposition for what it is and be bold. It is not the time to offer tepid initiatives to find common ground, but rather to use their considerable skills to marshal public opinion for a new round of tax cuts.

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