Robert Barro is a professor of economics at Harvard University and a senior fellow at the Hoover Institution.
Cambridge, Mass.
THE United States is in the third year of a grand experiment by the Obama administration to revive the economy through enormous borrowing and spending by the government, with the Federal Reserve playing a supporting role by keeping interest rates at record lows.
How is the experiment going? By the looks of it, not well.
The economy is growing much more slowly than in a typical recovery, housing prices remain depressed and the stock market has been in a slump â?? all troubling indicators that another recession may be on the way. Most worrisome is the anemic state of the labor market, underscored by the zero growth in the latest jobs report.
The poor results should not surprise us given the macroeconomic policies the government has pursued. I agree that the recession warranted fiscal deficits in 2008-10, but the vast increase of public debt since 2007 and the uncertainty about the countryâ??s long-run fiscal path mean that we no longer have the luxury of combating the weak economy with more deficits.
Todayâ??s priority has to be austerity, not stimulus, and it will not work to announce a new $450 billion jobs plan while promising vaguely to pay for it with fiscal restraint over the next 10 years, as Mr. Obama did in his address to Congress on Thursday. Given the low level of government credibility, fiscal discipline has to start now to be taken seriously. But we have to do even more: I propose a consumption tax, an idea that offends many conservatives, and elimination of the corporate income tax, a proposal that outrages many liberals.
These difficult steps would be far more effective than the presidentâ??s failed experiment. The administrationâ??s $800 billion stimulus program raised government demand for goods and services and was also intended to stimulate consumer demand. These interventions are usually described as Keynesian, but as John Maynard Keynes understood in his 1936 masterwork, â??The General Theory of Employment, Interest and Moneyâ? (the first economics book I read), the main driver of business cycles is investment. As is typical, the main decline in G.D.P. during the recession showed up in the form of reduced investment by businesses and households.
What drives investment? Stable expectations of a sound economic environment, including the long-run path of tax rates, regulations and so on. And employment is akin to investment in that hiring decisions take into account the long-run economic climate.
The lesson is that effective incentives for investment and employment require permanence and transparency. Measures that are transient or uncertain will be ineffective.
And yet these are precisely the kinds of policies the Obama administration has pursued: temporarily cutting the payroll tax rate, maintaining the marginal income-tax rates from the George W. Bush era while vowing to raise them in the future, holding off on clean-air regulations while promising to implement them later and enacting an ambitious overhaul of Wall Street regulations while leaving lots of rules undefined and ambiguous.
Is there a better way? I believe that a long-term fiscal plan for the country requires six big steps.
Three of them were identified by the Bowles-Simpson deficit reduction commission: reforming Social Security and Medicare by increasing ages of eligibility and shifting to an appropriate formula for indexing benefits to inflation; phasing out â??tax expendituresâ? like the deductions for mortgage interest, state and local taxes and employer-provided health care; and lowering the marginal income-tax rates for individuals.
I would add three more: reversing the vast and unwise increase in spending that occurred under Presidents Bush and Obama; introducing a tax on consumer spending, like the value-added tax (or VAT) common in other rich countries; and abolishing federal corporate taxes and estate taxes. All three measures would be enormously difficult â?? many say impossible â?? but crises are opportune times for these important, basic reforms.
Read Full Article »