The media and political pundits refuse to see this gap between the state’s budget and its ability to pay as an essential issue. It is. (This is not to say structural reform is not needed. I would support, for example, reforming some of the unintended ill-effects of Proposition 13 that weakened local government and left control of the budget to Sacramento.)
But the fundamental problem remains. California’s economy–once wondrously diverse with aerospace, high-tech, agriculture and international trade–has run aground. Burdened by taxes and ever-growing regulation, the state is routinely rated by executives as having among the worst business climates in the nation. No surprise, then, that California’s jobs engine has sputtered, and it may be heading toward 15% unemployment.
Politics and policy from inside Washington
From economist Robert Brusca:
Note as VP Joe Biden is pondering the success of the Obama stimulus plan and Laura D’Andrea Tyson is recommending a course of ‘seconds’ before we finish ‘firsts’ Germany is posting strong orders growth. The WORLD economy is reviving. Germany may not be shot out of a cannon but its message is clear. … Adding another stimulus program on top of the already in train program would not be a good fit because the attempt to do it would result all the same delays and pork as the last one. … The plan is working as it was supposed to. It’s just the wrong plan and it’s huge.
Great catch by my guy Andy Busch, superstrategist at BMO Capital markets in Chicago. While Laura Tyson’s remarks about a secoond stimulus package are getting all the play, she also had a lot to say about the dollar:
If that comment by Tyson wasn’t disturbing enough, she went on to say that the US dollar ought to decline in the longer-term on a trade weighted basis. Tyson believes the US should focus on generating exports and that a lower US dollar would aid in this venture. While the FX markets ignored her commentary, I would wager that China and Russia did not. Given that she was speaking in Singapore and in their backyard, I would say they must feel their worst fears are getting confirmed.First, she’s advocating expanding the fiscal deficit beyond it’s current distended fiscal bloat. Second, she saying the US should devalue its currency and therefore the value of the government bonds as well. For a foreign holder of US dollars and US government securities, could you have possibly said anything worse? Maybe, she could have said that the health care bill will put a 4% surcharge tax on wage earners over $200k. Oops, that’s what’s being floated by Congressional Democrats now.As the summer wears on and discontent grows, I expect calls will be louder and louder for additional stimulus from Congressional Democrats to put more Americans to work. I also expect the bond market to become more volatile as the Congressional Budget Office calculates the effects of health care, energy, and the current spending on the deficit. If more Obama officials talk down the US dollar, we’ll create the risk of a fall exit that will neither create jobs nor boost the economy.
OK, so Laura Tyson thinks a second stimulus might be a good idea. Will the White House go for it The economic logic of such a package might seem compelling. The original $787 billion spending measure was deemed appropriate by the White House for an economy where the unemployment rate was predicted to approach 9 percent in early 2010 if no new fiscal actions were taken.
Of course, the U.S. jobless rate is already at 9.5 percent and President Obama himself predicts a 10 percent rate by year end. Admitting the obvious, Vice President Joe Biden told ABC News that the administration “misread how bad the economy was.”
No shame there, really. Most of Wall Street and the Federal Reserve also underestimated the depth of the recession. But if the disease is worse than first thought, then shouldn’t the treatment be more aggressive?
Maybe not. Anyone want to predict how those killjoy bond vigilantes would react to a second U.S. stimulus plan — say, $500 billion or so in new federal aid to cash-strapped states and cities? Recall that some analysts interpreted the sharp backup in bond yields from mid-March to mid-June as a sign fixed-income investors were getting spooked about the potential inflationary implications of rising U.S. debt.
Now explaining market movements over a short period of time is a tricky proposition at best. But it’s certainly not a stretch to assume that at some point rising debt will cause bond investors to demand higher yields. Indeed, a 2003 Federal Reserve study found that interest rates “rise by about 25 basis points in response to a percentage point increase in the projected deficit-to-GDP ratio, and by about 4 basis points in response to a percentage point increase in the projected debt-to-GDP ratio.”
Don’t bet much that White House economic adviser Larry Summers and budget chief Peter Orszag aren’t aware of that study or the risk that higher yields could suffocate an embryonic economic recovery. No wonder the administration says it is taking a wait-and-see approach as stimulus spending from the existing package “ramps up” this summer and fall.
And the politics of a second stimulus plan are just as dicey for Team Obama as the economics.
Obama was elected to fix the economy. So calling for a “do-over” on his signature economic initiative might call into question the administration’s economic competence. (Republicans are already touting Biden’s admission as proof of that.) Although the administration’s forecast was similar to the prevailing consensus, there were certainly gloomier voices out there, such as Paul Krugman and Nouriel Roubini.
Some might question why the administration didn’t push for an even bigger stimulus package just in case the bears were right. Sure the politics would have been difficult, maybe even impossible. But the White House almost surely could have passed a similarly sized stimulus package that was more front-loaded to boost growth in 2009. (Probably not a bad idea given the adverse relationship between rising unemployment and mortgage defaults.)
What’s more, pushing a second stimulus package would drain energy away from the healthcare and climate change. An administration defeat on one or more of these key issues would certainly leave Democrats weakened heading into the 2010 election. And passing a second stimulus in late 2009 or early 2010 might not provide much of an economic boost before the midterms anyway.
So forget a second stimulus. Boxed in both economically and politically, the administration can do little more than pray those delicate green shoots quickly turn into green stalks.
Vice President Joe Biden now admits the Obama administration “misread” just how bad the economy really was back in January. No apologies necessary. The Federal Reserve and most of Wall Street also blew it. But what Team Obama might want to apologize for is pushing an $800 billion stimulus/recovery/reinvestment/spending package that will do little to either boost the economy in the short run (quite obvious now) or improve America’s long-term global competitiveness (obvious later). Now with unemployment soaring toward double digits (even though the White House said the stimulus plan would keep it under 8 percent), there is talk of a second stimulus plan. More union-friendly infrastructure spending that will take months to implement? A massive aid package that would reward fiscally irresponsible states and cities? Ugh. Here are five intriguing ideas Obama passed on that he might want to reconsider for a second stimulus:
1) An investment stimulus plan. Economists say America needs to consume less and build more. So why not cut capital gains and corporate income taxes? Mark Bloomfield, president of the American Council for Capital Formation suggests a sliding tax rate. The longer an asset is held, the lower the tax rate — with a zero rate for assets held more than five years. This would encourage investors to move from cash back into stocks. A stronger stock market would be a huge boost to business and consumer confidence, as well as to long-term entrepreneurial activity. Corporate taxes are just as harmful. Their existence means earnings are taxed twice, as profit and as dividend income. Moreover, 70 percent of the corporate tax burden is suffered by workers in the form of lower wages. And since the U.S. rate is higher than every other major economy other than Japan, America is at a competitive disadvantage, made worse by the Obama administration’s aim to make foreign profits by American companies get taxed at high U.S. rates.
2) A worker stimulus plan. For the same amount of money as Obama’s original plan, workers could have received a massive tax cut. For $800 billion, combined Social Security and Medicare taxes could have been slashed by 6 percentage points, or 40 percent. That would have put $1,500 in the paycheck of a worker making $50,000 and, according to a study by former White House economist Lawrence Lindsey, increased employment by 4 million jobs in 2009. If you want more of something, tax it less. This plan would lower the taxation of labor, so America would get more of it.
3) A housing stimulus plan. Home prices are still falling and defaults still rising, with rising unemployment creating a vicious negative feedback loop. Since the downturn started with housing, maybe that is where it should end. Glenn Hubbard, dean of the Columbia Business School, and Columbia economics professor Christoper Mayer have suggested that the White House and Congress allow all mortgages on primary residences to be refinanced into 30-year, fixed-rate mortgages at 5.25 percent. In another version, investment strategist Ed Yardeni and Carl Goldsmith of Delta Asset Management have proposed fully nationalizing Fannie Mae and Freddie Mac. Once that is done, the two entities could borrow at the same low rates as the U.S. Treasury. Then, Fannie and Freddie could offer 30-year, fixed-rate mortgages at 4 percent to all qualified borrowers to buy a new or existing home.
4) A deficit hawk stimulus plan. Want to restore investor confidence in America? One way would be to get entitlements under control so bond investors wouldn’t fret about Uncle Sam inflating its way out of its debt woes or even defaulting. In theory, this would bring down real long-term interest rates and boost economic growth. The simplest move would be to do something about Social Security. An analysis run by Andrew Biggs of the American Enterprise Institute found that if a) Social Security benefits were linked to inflation rather than wages as of 2012 and b) the currently legislated retirement age was increased to 67, then allowed to keep increasing to 70 by the 2040s, the program’s long-term, present-value deficit of $5.7 trillion would turn into a $4.3 trillion surplus. That is a $10 trillion swing. Investors would be much impressed both by the move toward fiscal soundness and the evidence that America will not let itself turn into California.
5) A do-nothing stimulus plan. No $500 billion pricey second stimulus/recovery/reinvestment/spending plan. No $1.3 trillion healthcare plan. No competitiveness-killing cap-and-trade plan. No tax hikes at the end of 2010. Economy heal thyself (with some help from the Fed). And no spending the other 90 percent of the $800 billion first stimulus package. Hey, you’ve got to admire its simplicity. It would also show stock/debt/currency investors that Americans aren’t going to totally freak out over a recession by putting in place spending programs and patterns that will be hard to remove.
As for me, I would prefer doing both #1 and #4. They would help the economy’s long-term competitiveness and growth potential while restoring confidence today. That is a winning formula Team Obama might want to take a look at it.