James Pethokoukis

The great Lawrence Kudlow tells a hard truth, I think, about the economy and the day after tomorrow:

The threat of higher payroll taxes and energy costs is more than enough to deter new hiring. Taxes on upper-end investors are going to rise, too, and there may be a health-care surtax on top of that. And don’t forget that small businesses pay the top personal tax rate, which is going up. Oh, and how about the recent minimum-wage hike? Yet another business cost.

So while the government doles out money for transfer payments and one-time temporary tax credits, the ensuing increase in the private-sector tax-and-financing burden becomes a complete deterrent to new job creation, as well as capital formation.

We’re going to recover. Improved ISM reports for manufacturing and services, along with better profitability for big corporations, suggest we’re looking at a mild, V-shaped recovery of 3 percent. But it will be a jobless recovery.

At the end of the 2000 film “The Perfect Storm”, a Gloucester swordfish boat captain (played by George Clooney) finally accepts that his crew won’t escape a monster hurricane in the North Atlantic. “She’s not gonna let us out,” he says as the trapped vessel moves from the eye of the storm and back into the raging winds.

The White House economic team can probably relate. The nation’s unemployment rate jumped to 9.7 percent in August, said the Labor Department, after dipping to 9.4 percent in July. “That drop in July had been too good to be true,” sighed Nigel Gault, the chief U.S. economist at IHS Global Insight. Merely the eye of the storm, perhaps.

To be sure, the pace of monthly job losses is abating, falling to 216,000 compared with a high of 741,000 in January. It now also seems unlikely that the unemployment rate will hit a post-World War II high of 10.8 percent. Good news all. But the employment declines do continue nonetheless, with more than 7 million jobs lost since the recession began in December 2007

Also continuing to decline is President Obama’s approval rating, which has plunged to 53 percent from 61 percent during the past three months, according to an average of polls calculated by RealClearPolitics. Almost nothing poisons a president’s popularity like high unemployment.

And why think that the job market or the president’s approval rating will improve dramatically during the next year or so? Let’s assume a snappy recovery in 2010 with GDP growth of 3.5 to 4 percent. That’s the JPMorgan forecast. But despite a mild V-shaped recovery, the firm’s economists still see an average unemployment rate of 9.4 percent in the fourth quarter of that year.

Even the superbulls at First Trust Advisors, looking for 4.5 percent GDP growth in 2010, don’t see unemployment breaking much below 8.5 percent. Keep in mind that those rates are almost double what Americans have come to expect the past two decades. It’s going to seem like a jobless recovery to many voters.

The labor market isn’t going to let Team Obama out. Its troubles will continue to drain the president’s popularity and perhaps result in large losses for congressional Democrats in the 2010 midterms. If Obama still wants to pass big change from a position of moderate bargaining strength — and while he still has maximum muscle on Capitol Hill — it needs to be now. This would mean centrist proposals like healthcare reform that would expand coverage while also making it easier for individuals to purchase their own private insurance, or a climate change bill where revenue from carbon emission allowance auctions would offset payroll taxes rather than given away to companies or spent by government.

Rahm Emanuel, White House chief staff, famously said that you “never want a serious crisis to go to waste.” With the moment of acute economic crisis past and a long “muddling through” begun, the president’s time of opportunity is nearing an end.

This from the WaPo:

IHS Global Insight, an economic consulting firm, estimates that the stimulus has increased the 2009 gross domestic product by about 1 percent over what it otherwise would have been, with the benefit almost entirely in the second half of the year.

The firm also forecasts that the package will, in total, result in about 2 million more jobs than otherwise would have existed at the end of 2010. Moody’s Economy.com estimates that the initiative will increase employment by 2.5 million jobs. Both estimates are below the 3 million to 3.5 million jobs the Obama administration estimated the package would create or save …

Me: Again, arguing that the economy would have been worse without the stimulus plan is not as helpful as arguing the plan has restored prosperity.

I listened to VP Joe Biden today talking abut the Obama stimulus package, aka, the American Recovery and Reinvestment Act. A few thoughts:

– Biden credited the stimulus plan for preventing the recession from turning into a depression. I would certainly place the $140 billion or so in stimulus spending behind the Fed’s action and the natural rebound in the economy after a period of intense fear and retrenchment.

– Even though “reinvestment” is part of the name of the plan, at least two-thirds of the plan has nothing to do with long-term growth.

– If the economy was much worse than the White House expected, why wasn’t a) the stimulus bigger, and b) more front loaded toward 2009?  That was a huge misjudgment.

– Clearing some fiscal space with entitlement reform would allow the WH the ability to do a second stimulus for infrastructure or reducing taxes on company and capital.

– Perhaps the smartest thing the WH has done so far is resist calls for raising taxes (like from Pelosi) or to focus on near-term deficit reduction. Those are exactly the sorts of policies that helped retard America’s recovery during the Great Depression and Japan’s during the Lose Dedade.

What is POTUS going to say that is any different, really. The risk of the Tune Out factor is growing. This, from a pro-ObamaCare blogger:

The problem is – Obama has already been specific about nearly all of this — frequently! The 8 insurance regulations he favors are not only in both bills, they’ve been the centerpiece of the “Health Insurance Reform” attempt at rebranding in August. Obama has already specified his preferred way of paying for reform — a cap on charitable deductions for those making over $250,000. And he spent an entire presidential campaign saying that he didn’t want to raise taxes on those making less than $250,000. None of these items are particularly suspenseful, and it would indeed be a surprise if he deviated from what’s been his normal script.

Granted, he hasn’t before specified the level of subsidies he wants to give to the uninsured. But if it’s 400% of the federal poverty line ($88,000 for a family of 4), it’s no surprise as both the House and the Senate Health, Education, Labor and Pensions Committee provide subsidies to that level. If it’s less than that – say the 300% that the Senate Finance Committee is rumored to be toying with – then it would be a surprise. It would also be a bad policy concession.

An interesting bit from the WSJ:

Dave Anderson, chief financial officer of Honeywell International Inc., said the stimulus package actually froze business activity at first as firms tried to figure out how they could benefit from the government spending. The $787 billion package “created actually a slowdown in order activity in terms of the flow that we would normally have anticipated,” Mr. Anderson said at a conference sponsored by Morgan Stanley. “We anticipate that that’s going to actually pick up in the second half of the year. I think it’s not unreasonable to see several hundred million dollars of orders.

Me: This sounds similar to what seems to happen when cutting taxes. If the start date is a ways off, economic activity is delayed.

Allan Meltzer (WSJ) pleads for people to stop comparing this downturn to the Great Depression. It is more like the 1973-75 period, he argues. He also opines that it has been in the Obama administration’s self interest to overstate the severity of the recession so it could hype its own achievements in “saving” the US economy.

I would also add that it was in the WH interest to maximize economic concern to maximize the chances of successfully pushing through its economic agenda. But the WH made the mistake of a) thinking that concerns about economic security would dwarf concerns about the sustainability of massive government spending and budget deficits, and b) underestimating how concerns about economic growth would undercut cap-and-trade  and the attempts to pay for healthcare reform by raising taxes.

Howard Gleckman over at TaxVox does a great job on the new government budget forecasts. This is my favorite bit (bold is mine):

Even once the economy gets back on its feet, the White House projects spending will settle in at about 23 percent of Gross Domestic Product. That is a substantial increase from the average of 19 percent or so in recent decades, and significantly more than estimated tax revenues. We can try to run deficits of 4 percent of GDP as far as the eye can see, but only if the Chinese continue to help out.

Finally, take a look at both CBO and OMB forecasts of long-term trend economic growth: OMB figures it will be roughly 2.5 percent once all the effects of the recession and the stimulus package wash out. CBO is even more pessimistic. These forecasts are not new, but they are worth keeping in mind. Over the next decade and beyond, the economy will grow significantly more slowly than in recent years, in large part because many more Americans will be retiring than joining the workforce. And that will put growing pressure on fiscal policy.

When Budget Director Peter Orszag and others talk about medical costs being unsustainable, this mismatch between health spending and economic growth is exactly what they have in mind. In the decade 1998 to 2007, both Medicare and Medicaid grew at more than 7 percent per year. And you don’t need to be an economist to understand what will happen if medical costs keeping rising at 7 percent while the resources to pay for them grow at only 2.5 percent.

Maybe it should be a trillion reasons. But budget guru Stan Collender paints a picture of the future:

But regardless of who is to blame for the deficit, there’s no doubt that it’s Obama’s responsibility to deal with it. That leads to the most important result of the mid-session reviews: it’s now far more likely that the fiscal 2011 budget debate, which will start next year when the president submits his budget to Congress in late January or early February, will be among the most difficult, vicious, and painful of any that has taken place in the past 30 years.

Here’s why:

1. It will be an election year

2. Partisanship in Washington is much stronger now than it was during any of the previously budget figthts. This includes the Gramm-Rudman-Hollings debate in 1985 and the Clinton-Gingrich debate in the mid-1990s that resulted in government shutdowns.

3. The deficit is much larger now both nominally and as a percentage of GDP than it has been since World War II.

4. The national debt is much larger now than it was when GRH was debated and Clinton and Gingrich sparred. The much greater interest being paid on the national debt will put far more pressure on all other spending in the budget and tax increases.

5. More than 50 Blue Dog Democrats will push the White House to deal with the deficit.

6. The deficit will be a big issue for the first-term Democrats who were elected from what had been Republican districts. They will be facing what could be the toughest reelection battles of their careers and will need to show their constituents that, because of them and their party, some progress has been made on the deficit.

7. The bond market will push for deficit reductions.

8. Foreign creditors, especially the Chinese, will push for deficit reductions.

9. Some on Wall Street and elsewhere will express extreme concern about inflation and interest rates stopping the recovery in its tracks unless deficit reductions are put in place.

10. Obama, who promised deficit reductions once the economy started to recover, will be hard-pressed not to live up to that promise. He will be pressured to do so by the Blue Dogs, many of which supported the White House this year because they were told that the deficit would become a front burner.

That is the analysis of my pal Rich Karlgaard over at Forbes. (Insert joke about Obama and fahrvergnügen here.) Some sectors of the economy will boom as others muddle through or stay on the mat. Warren Buffett put it best: “When the tide goes out, you discover who’s been swimming naked.” Here’s a bit from the piece:

But here’s the thing. The American recovery may be U-shaped, on balance, but within that U will pockets of Vs and Ws. That’s why I call it the VW recovery.

The V part of the VW economy includes dynamic growth companies and large exporters. Apple is enjoying a V recovery. Salesforce.com just reported a big, booming V quarter on Friday. Mobile broadband is an entire industry that will enjoy sustained V growth. Low-tax states like Texas, Tennessee and North Dakota are experiencing V recoveries.

America’s W economy includes all those companies, industries, states, cities and personal careers where deteriorating value propositions were masked in good times. It always happens that way. Recessions unmask bad business models. … Today’s W economy: newspapers, McMansion builders, inefficient manufacturers, high-tax state and local governments, and workers unable to adapt, relearn and relocate.