What Next?
James K. Galbraith

The compromises necessary to pass the recovery bill in the Senate damaged it in several ways.  The overall size of the package was reduced, evidently for the cosmetic purpose of keeping the top-line number below $800 billion.  And funds urgently needed to stabilize state and local governments and for construction were cut back, along with the credit against the payroll tax – evidently to make room for a rollback of the alternative minimum tax, a step with a strong political constituency but a weak economic rationale.

In my local paper Thursday morning, I read of $20 million that will be cut from our city budget next year, including a day labor center, public library hours, and overtime for the police force.  Cuts like that – and in many places they are far deeper than here –  are going on everywhere, and the bill as passed will help but it will not stop them.  Contrary to Grover Norquist's comment in this space, police, libraries and day labor are part of the productive economy, as much as anything else.

It is difficult to know what the so-called moderate Senators were thinking.  Do they have special insight into this crisis? Do they have their own forecasters, with deep understanding and good track records in these matters? Do they have their own models? Do they have, in other words, any ground for believing that less than $800 billion, spread over two years, will be enough to bring the economy back?  If so, they weren't saying so, so far as I could tell. 

We have a bill.  In the most likely case, it will slow the collapse but not stop or reverse it.  And it will come into effect alongside a bank rescue plan  that stands very little chance of reviving the credit markets.  So we have one part of a recovery plan that is helpful but probably insufficient, and another part that most likely will not work at all.  The prospects for an early exit from the slump are therefore not encouraging, just yet.

What is to be done?  On the fiscal front, for the moment,  nothing more. There seems to be no alternative now to waiting for events.  Notwithstanding job losses at half a million a month for three months -- almost the workforce of the state of Maine, three times over -- Olympia Snowe and Susan Collins seem to need better evidence than they've seen so far. In four to six months, if job losses don't reverse, the country will demand more action.

If that's correct, the gaps and hesitations in this recovery bill should be the first things we repair.   To wit:

    – make aid to states and localities flexible and open-ended.  The goal should be to stop all cuts in public services and layoffs of staff.  States and localities should be offered a simple deal: no service cuts and no changes in tax rates. In exchange, the federal government will cover the gap in their revenue for the duration. Alternatively, the federal government could simply offer general revenue sharing on a per capita basis.

    – establish and fund a full-fledged National Infrastructure Fund with the capacity to finance and to coordinate public investment projects on an ongoing basis.  Congress would therefore largely delegate decisions over the type of local capital investment, including school construction which was cut from the Senate bill for no defensible reason.

    – increase Social Security benefits across the board. The purchasing power of the elderly as a group is now gravely eroded by the collapse of stock market values, and the policymaking community needs to realize that the grand experiment in funding retirements via the stock market is ending.  For the future we will need more Social Security, not less. And that means that the historic political link between Social Security benefits and the revenues from the payroll tax should be suspended.

    – declare a full payroll tax holiday for the duration of the crisis. A holiday has advantages over the credit scheme,  as it can be implemented at once for all workers and employers.  The holiday could be made subject to a trigger, so that when the economy does begin to recover rapidly, part of the tax can be restored.
 
    – pursue the foreclosure moratorium just announced, establishing the equivalent of a Home Owners Loan Corporation to deal with troubled mortgages, via renegotiation or conversion to rentals.  This can be done, largely, through Fannie Mae, Freddie Mac and the Federal Reserve Board, but it will require sufficient staff to inspect and supervise mortgages at the retail level. Apart from this, and the ongoing nationalization of commercial paper markets,  there isn't much more to expect from the Federal Reserve at this point.

It would be useful for friends of these ideas, in Congress and in the public interest community, to establish working groups to build support for them during the months ahead, if and as the crisis deepens.

Meanwhile, the most urgent need is for the Treasury department to re-examine the basic premise of its plans for the banking system.  Present plans provide unjustifiable guarantees for bad assets, bank shareholders and the incumbent management, at huge taxpayer expense, with no prospect that normal credit relationships will be restored.  So long as this is the case, the scale of taxpayer losses and the necessary scale of the next fiscal recovery plan will grow and grow. 
 

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Here's a program of recommendations ATR put out earlier today:

1.        Cut the top personal income tax rate from 35% to 25%

2.      Cut the corporate income tax rate from 35% to 25%

3.       Cut the capital gains and dividends rate from 15% to 0%

4.      Move to full business expensing of all business investments

5.       Stop double-taxing U.S. employers on their income earned overseas

6.       Kill the Death Tax

7.       Kill the Alternative Minimum Tax (AMT)

8.       Cut the payroll and self-employment tax rate in half, from 15.3% to 7.5%

9.       Cap government spending to the pre-Bush level of 18% of GDP

10.    Require full government transparency to ensure that taxpayer money is not wasted

The key macro-economic policy question right now would seem to be not so much whether an US$800 billion fiscal stimulus package is sufficient to jump start a faltering US economy. Rather it is whether the fiscal stimulus package is (a) sufficiently front-loaded and (b) sufficiently well -designed to provide the immediate support so desperately needed by a US economy caught in the grips of a downward spiral. Sadly, the stimulus package presently wending its way through Congress appears to be sorely wanting on both counts, which makes it very difficult to be optimistic about its prospects for eventual success.

            The all too apparent deterioration in the US economy over the past few months, as evidenced for example by employment now declining by more than 500,000 jobs a month, would suggest the need for powerful and immediate policy support. Yet the Congressional Budget Office estimates that at best only around US$170 billion of the US$800 billion fiscal stimulus package would find its way into the economy before September 30, 2009. Worse still, almost 40 percent of the package takes the form of tax cuts, many of which are all too similar to those that proved to be rather ineffective in 2008, while too much of the spending package is on infrastructural spending that by its very nature is very slow acting.

            With the prospect for only limited fiscal policy support in 2009, there would seem to be increased urgency for the Federal Reserve to be more aggressive in the implementation of its recently announced zero-interest-rate-policy. This would seem to be especially the case at a time when the economy is confronted by the all too real threat of deflation. Beyond purchasing mortgage-backed securities, the obvious place for the Federal Reserve to start would be to buy long-dated government securities, whose yields have backed up by around a full percentage point over the past few weeks. The Federal Reserve might also consider buying government inflation linked bonds (TIPS) as a means of clearly signaling its determination to avoid deflation from taking hold.

            More important than monetary policy is the need for bold measures that would mend the country’s broken financial system. Here too the indications from the new Administration are not very encouraging. For rather than considering radical policy action like that successfully pursued by Sweden in resolving its banking crisis in the early 1990s, the new Administration seems to be going down the Japanese route of keeping alive Zombie institutions through a combination of liquidity support, bank guarantees, and capital infusions.

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  Taking $800 billion out of the productive economy through higher taxes and/or higher levels of debt and spending that money in places chosen by politicians will make America poorer, reduce the total number of jobs, lower incomes and slow economic growth compared to doing nothing.

            If congress forceably takes money out of the economy and puts it back in based on political decisions it will make us poorer and kill jobs.

            What to do as an encore? 

            Go to confession. Ask for forgiveness.  Claim you were drinking heavily.  Plead temporary Insanity.

            All these would work better if Congress hadn’t done such a “stimulus” package a year ago and again with the TARP bailout.

            The third time one tries the same thing makes it hard to claim ignorance.  Still we are ahead of Japan and Argentina which did this for the decade of the 1990s in Japan’s case and several decades in Argentina’s.  How did it work for them.

            Now that the horse is (assumed) out of the barn, perhaps the best that can be done is insist on full transparency and a ban on congressmen and their families and staff going on the payroll of those entities they “stimulated.”  And that lovely cash should not be allowed to flow to ACORN or other groups that play politics.

            Should congress want economic growth and a better stock market?  Make the 15% capital gains and dividend tax rates permanent.  Allow companies to expense new investment, cut the corporate capital gains tax rate which stands at 35% to 15%, allow repatriation of overseas earnings with a 5% vig for the government rather than one as high as 35%.  Get out of the way of people who actually create jobs and wealth.  Privatize Fannie Mae and Freddie Mac and undo the damage of Sarbanes-Oxley and the “Community Reinvestment Act.  Begin to undo the damage you have done the economy before you ask how to help again.

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