James Pethokoukis

Politics and policy from inside Washington

Imagining a V-shaped recovery and the 2010 midterms

Apr 12, 2010 17:39 UTC

Those who argue that Democrats might lose one or both houses of Congress are making an economic argument. Slow growth/high unemployment = angry, anti-incumbent voters. But what if the economy really perks up? First some analysis by Larry Kudlow:

Sometimes you have to take your political lenses out and look at the actual economic statistics in order to gauge whether we’re on the road to recovery or not. … No one has written more about the future tax-and-regulatory threats from the big-government assault of Obamanomics. But most of that is in the future. The current reality is that a strong rebound in corporate profits (the greatest and truest stimulus of all), ultra-easy money from the Fed, and some very small stimuli from government spending are all working to generate a cyclical recovery in a basically free-market economy that is a lot more resilient than capitalist critics would have us believe. So conservatives should not lose their cool and blow their credibility over a cyclical rebound that is backed by the statistics.

And now the econ team of Wesbury and Stein at First Trust Advisors:

Unfortunately, there is a group of people who still haven’t arrived at the station – mostly because they confuse politics with economic forecasting. Many Republicans and quite a few conservative television commentators are still trying to use the Clinton/Carville method of winning elections – “It’s the Economy, Stupid.” As a result, they keep telling anyone who will listen that the Obama agenda is going to kill the economy – RIGHT NOW.

But they will be wrong. It is true that more government spending and regulation, higher taxes, and government mandates will erode growth in the future. And it is true that recent growth in government will make it less likely the US will be the home of the next Apple iPad-type device. The fact of the matter is that big government and high tax rates hurt the entrepreneurial spirit and slow economic activity (see growth in Europe versus the U.S.).

But arguing that this recovery is not happening is a losing proposition. It is happening; And it’s V-shaped. We expected a V-shaped recovery as the panic ended, as monetary velocity returned and because Fed policy was easy.

Me: I think the key here is to see what happens with unemployment, incomes, housing and gas prices.  Certainly the economic consensus is for unemployment to stay above 9 percent. And my own analysis shows a big lag between an economic turn around and public perception. Perhaps the jobless rate will outperform on the upside as it has underperformed on the downside. One thing to keep an eye on is Obama’s approval rating which is now 45-48, according to Gallup.

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After FDR’s New Deal …

Apr 12, 2010 17:20 UTC

The death of FDR in 1944 meant no New Deal, The Sequel. What did happen? This (via the WSJ):

Instead, Congress reduced taxes. Income tax rates were cut across the board. FDR’s top marginal rate, 94% on all income over $200,000, was cut to 86.45%. The lowest rate was cut to 19% from 23%, and with a change in the amount of income exempt from taxation an estimated 12 million Americans were eliminated from the tax rolls entirely.

Corporate tax rates were trimmed and FDR’s “excess profits” tax was repealed, which meant that top marginal corporate tax rates effectively went to 38% from 90% after 1945.

Georgia Sen. Walter George, chairman of the Senate Finance Committee, defended the Revenue Act of 1945 with arguments that today we would call “supply-side economics.” If the tax bill “has the effect which it is hoped it will have,” George said, “it will so stimulate the expansion of business as to bring in a greater total revenue.”

Me: Research indicates that top U.S. tax rates are already on the wrong side of the Laffer Curve. And our corporate tax rates are highly uncompetitive internationally. All play into a New Normal thesis over the long term.

Is Elmendorf’s CBO too pessimistic or is Orszag’s OMB too optimistic?

Apr 12, 2010 17:01 UTC

White House budget chief Peter Orszag thinks his old colleagues at the Congressional Budget Office are being too pessimistic over the potential budget savings of healthcare reform (via The Hill):

“I think if anything, the deficit impact may well turn out to be larger than what was projected by the Congressional Budget Office for two reasons,” Orszag said at an event sponsored by the Economic Club of Washington. ”One, if you look at the history of projections on major pieces of legislation, they’ve tended to be too conservative rather than too optimistic,” he said. “And second, the scoring largely does not take into account this evolution toward paying for quality, which I think in this decade will begin to pay off.”

Me: Interesting, the International Monetary Fund thinks Orszag’s Office of Management and Budget might be too optimistic about its overall fiscal forecasts. This from the folks at e21:

The IMF working paper makes a compelling case that the Office of Management and Budget (OMB) uses unrealistically low interest rates in its forecasts of future debt and deficit levels, assumes too rapid a recovery, and overstates the speed at which countercyclical entitlement expenditures will fall in response to economic growth. As the IMF explains (page 14), “aging and health related spending are not the key drivers of this debt build-up.” Indeed, policy choices are.

Optimism is nothing new. As the IMF explains, “the past record of budget projections shows a strong tendency for ‘optimistic’ budget forecasts.” With the exception of 1993 to 1997, OMB projections have underestimated the growth of deficits and debt. What’s different about the Obama team’s projections is the magnitude of their optimism. The IMF estimates that to stabilize debt below 70% of GDP would require a fiscal adjustment of about 3.5% of GDP. In nominal terms, that would require some combination of spending cuts and tax increases equal to roughly $600 billion in 2014 alone.

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