I watched the debate last night, not so much to pick winners and losers, but to try and get a feel for how Republicans view where we are and what's coming. I'm not talking about specific issues: budget cuts, Medicare, raising the debt ceiling. I'm interested in determining if there is some vision of the future held individually, or collectively. If Republicans had a magic wand, and were able to put their policies and programs into effect, what would it look like?
Here's what I come up with: Taxes on business and individuals would be very significantly reduced. The Healthcare Bill (ACA) would be repealed. Medicaid and Medicare would be changed from a defined benefit to a defined contribution program, with its benefit inflator set at the rate of overall inflation, well below the medical cost inflation rate. Social Security would be trimmed back, most likely raising the retirement age and means testing benefits. Discretionary government spending (Education, Energy, Transportation, Agriculture, etc) would be significantly reduced. Government's regulatory functions would be scaled way back - most of Dodd-Frank would be repealed. Defense funding, on the other hand, would remain strong. Unions, particularly public sector unions, would lose most of their power. Many functions of the government would be moved down to the state level, if they weren't eliminated.
I am convinced Republicans believe that if this program were put into effect, the economy would grow at unprecedented rates (Tim Pawlenty says 5% growth per year for 10 years). Regulatory, tax, deficit and entitlement affordability uncertainties would be eliminated in one fell swoop. It is these uncertainties that have, Republicans believe, stymied our present recovery. Once removed, the economy will explode.
I believe every Republican on the stage last night believes this. I don't. Leaving questions of morality or compassion out of the discussion for the moment, I think it is bad economics. It may also be bad politics, and if the Democrats frame the conversation well, we will find out next November. But I am not talking about politics right now; I'm talking economics and a small bit of history.
After the Big Crash in 1929, Herbert Hoover, supported by his Treasury Secretary, Andrew Mellon, called for significant government spending cuts, tight monetary policy, deregulation and privatization, exactly what Republicans want now. Why would it work now, when it didn't work then?
Tax rates and business confidence are not the problems. It's demand. Economics 101, which I took 51 years ago, gave me this formula, which still applies today:
GDP = C + G + I +(X-M)
GDP = Consumption plus Government Spending plus Business/Private Investment plus Net Exports.
70% of this is C, or consumption. In other words demand. Consumers are buried under a mountain of debt; they are reducing this debt and deleveraging, which pulls money out of the economy. Businesses are not investing, not because they do not have the necessary confidence, but because they don't have the necessary orders. GDP is in the tank because there is so little demand.
Do we think the personal income or business tax cuts will significantly increase Consumption, which business needs to see before they increase Investment? Republicans do. I don't. The evidence from the Bush tax cuts, put in after a much shallower recession, would say the Republicans are wrong. Income tax cuts, particularly investment income tax cuts, simply do not reach 60% , even up to 80% of the US population. So how can the economy explode? If C is stagnant, and G is cut way back, and I won't move far without some energy from C, are we going to pin our hopes on an export boom? Suspect we'll make progress, but a boom sufficient to take us to 5% GDP growth? Don't think so.
The most likely picture for me is a second 10 year run for Wall Street: If we take the regulators off their backs, "clarify" the long term entitlement contingency (capping benefits), and give the investor class a lot more money, the action will be, once again, on the Street: new, complex financial products sold around the world at phenomenal margins, with towers of leverage, and huge profits for investors, but little impact on the real economy.
And if broad-based growth doesn't happen, and we get, instead the anemic growth rates of the Bush years, with huge run ups in asset values, giant profits for Wall Street, and who knows what at the end - what do you think will happen to deficits? Take Pawlenty's tax plan and cut growth rates to what we saw between 2001 and 2007, and you have an amazing mess on your hands.
The Republican vision simply won't work. We need demand through the entire economy, not large tax reductions flowing to a very small percentage of the population. We need strong regulation of Wall Street or we'll be right back to the Fall of 2008. We need broad-based growth in the real economy, and for that to happen, government will need to play a major role.
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