It’s hard to make the case that major reductions in government spending in the near term will result in more economic growth. Most who advocate that approach also want the dollar to strengthen in value. The few countries that are cited as reducing government spending and achieving short-term economic growth benefitted from a weaker country and increased exports to a strong global economy (for example, Canada in the early 1990s). Given weakness in the global economy, it’s hard to see how a stronger dollar (and thus more expensive exports) combined with major, immediate reductions in government spending will lead to more economic growth in the near term.
Time to criticize the other side. The first round of stimulus tended to focus on temporary increases in demand (cash for clunkers, short-term tax cuts to encourage spending, etc.). Thus, when the stimulus ended, so did it’s effect. Given that it was clear to many economists that this would be an extended recession/period of economic weakness given that it was due to a financial crisis, short-term increases in demand were ineffective (more government debt without much economic benefit).
What about the balance between encouraging growth and containing the national debt? It’s a tricky balance. The national debt is a major medium-term problem, but the record-low interest rates on government bonds indicates that global investors are not worried about the credit-worthiness of the US (at least for now).
Given the above, there is room for policies that encourage economic growth accompanied by concrete plans to reduce the deficit over time. The policies should both encourage demand in the short term while enhancing long-term economic growth and the underlying strength of the US economy.
· Tax reform, both corporate and individual, that eliminates most deductions/loopholes while reducing tax rates could increase revenue somewhat while encouraging economic growth. Note: many conservative economists, such as the chair of Reagan’s council of economic advisors, Martin Feldstein, consider many of the loopholes to be a hidden form of spending and thus eliminating them would not be tax increases but eliminating tax expenditures (see WSJ article).
· Spending on needed infrastructure improvements could lead to construction jobs while making the economy more efficient. Rather than spreading the money across congressional districts, identifying the top priorities for the nation could be more efficient (electric grid, ports, etc.). Dare I suggest a commission develop the priorities since most citizens lack faith in the government to choose the right priorities?
· A temporary reduction in both the employee and employer portion of the payroll tax won’t have much long-term benefit, but could provide workers with extra after-tax income while also temporarily reducing the cost of employing workers. The self-employed would particularly benefit as they pay both portions of the payroll tax. Reducing both portions by 2% would result in a 4% reduction in tax rates for the self-employed and help some small businesses.
· The primary reform for long-term deficit reduction would involve reforming entitlements, since they are the major reason for future increases in the national debt. It gets complex, but reforms should include means testing of Medicare and making it more market-oriented; also adjusting increases in social security benefits by the inflation method preferred by economists for other purposes (it gets technical, but it’s called a chain-weighted index and has been around for quite a while; not a trick designed recently). This would reduce the deficit by hundreds of billions of dollars over the next decade while using a more accurate measure of inflation.
Of course there are other things, but this is a start: encourage demand and economic efficiency while also getting the deficit under control over time. This wouldn’t result in an economic boom, but provide both short-term and long-term help to the economy given the economic environment in which we’re operating.
