JULY 19, 2010
Obama's Fiscal Priorities Are Right
Redirecting money from the expiring Bush tax cuts to unemployment benefits would be a net job creator and give the economy a much-needed boost.
By ALAN S. BLINDER
A serious debate over fiscal policy is now raging. It probably has Ralph Waldo Emerson, who famously declared "a foolish consistency" to be "the hobgoblin of little minds," smiling from his grave while John Maynard Keynes, the intellectual father of fiscal policy, is rolling in his.
On one side, you find the deficit hawks, Democrats and Republicans, who have steadfastly opposed any "second stimulus"—partly on the grounds that the federal budget deficit is already too large, and partly on the grounds that the first stimulus failed. I argued on this page last month that the latter is not remotely close to true, but never mind. The hawks have even dug in their heels against extending unemployment insurance benefits at a time when the unemployment rate is 9.5%, or helping states and localities avoid laying off teachers in September. That's pretty anti-Keynesian thinking.
Apparently unbothered by the consistency hobgoblin, some of the Republican deficit hawks also want to make the 2001-2003 Bush tax cuts permanent, rather than letting them expire on schedule at the end of this year. Yet their major argument is classic Keynesian thinking: Letting tax cuts expire is tantamount to raising taxes—which is the opposite of what you want to do when the economy is weak. A few days ago, Sen. Jon Kyl (R., Ariz.) even went so far as to declare it OK to raise the deficit to finance tax cuts, but not to pay unemployment benefits. Obviously this is more Emerson than Keynes.
Martin Kozlowski
The Obama administration takes the opposite positions on both of these issues. While it now eschews the phrase "fiscal stimulus," it wants to extend unemployment benefits and initiate or strengthen several other programs to create spending and jobs. But it also wants to let the Bush tax cuts end on schedule for those earning over (roughly) $250,000 a year.
Since high-income households spend money, too, raising their taxes would reduce consumer spending somewhat—as a number of the administration's critics have argued. So is the president's team also guilty of inconsistency?
Well, maybe not.
I argued on this page in May that the right mix of fiscal policies would combine more stimulus in the short run with more budgetary restraint for the long run. And I believe most economists, whether of the left or the right, agree with this prescription, reserving their disagreements for details such as whether to use spending or taxes, and what specific types of each. For example, it seems to me that the case for ending the Bush tax cuts is simple: We couldn't afford them when they were enacted, and we surely can't afford them now. But many conservatives don't see it that way. So be it. That's why we have policy debates—and elections.
The more immediate reason the administration's positions are not inconsistent is because not all dollars are created equal. To take a very relevant example, consider three different ways to add a dollar to the budget deficit: increase unemployment benefits by $1, give a $1 tax cut to someone earning $50,000 a year, or give a $1 tax cut to someone earning $5 million a year.
While the immediate impacts on the budget are identical, the near-term spending impacts are not. The unemployed worker struggling to make ends meet will likely spend the entire dollar right away. The $50,000 earner probably will spend the lion's share of it, saving just a bit—that's what most Americans do. But the $5,000,000 earner probably will save most of the new-found dollar.
The impacts on economy-wide demand will therefore be quite different. Paying more in unemployment benefits offers the most spending "bang" for the budgetary "buck." Extending the Bush tax cuts for the wealthy offers the least.
Hence the following suggested deal: Let the upper-income tax cuts expire on schedule at year end. That would save the government an estimated $75 billion over the next two years. However, it would also diminish aggregate demand a bit. So, instead of using the $75 billion to reduce the deficit, spend it on unemployment benefits, food stamps and the like for two years. That would surely put more spending into the economy than the tax hike takes out, thus creating jobs.
How much more? Getting a numerical estimate requires the use of a quantitative model of the U.S. economy. In recent testimony before the House Budget Committee, Mark Zandi of Moody's Analytics used his model to estimate that extending unemployment insurance benefits has almost five times as much "bang for the buck" as making the Bush tax cuts permanent.
Based on his estimates, the budgetary trade I just recommended would add almost $100 billion to aggregate demand over the next two years—without adding a dime to the deficit. That translates to about 500,000 more jobs each year. Maybe Mr. Zandi's numbers are high. But the direction is clear: Redirecting money from the Bush tax cuts to unemployment benefits would be a net job creator.
Opponents of more generous unemployment insurance often raise another objection: that longer-lasting benefits dull the incentive to seek work, which in turn drives up unemployment. Economic research suggests they are right, though one shouldn't exaggerate the magnitudes. Furthermore, the work disincentives are only part of the story. Remember, we provide unemployment insurance for humanitarian reasons (to aid the afflicted) and to support the economy (by maintaining spending).
Finding the right level of unemployment insurance means balancing these costs and benefits—a tricky calculation. But we know one thing for sure: As the unemployment rate rises, the disincentives that worry conservatives become less important because there are fewer jobs to find, and the income support that motivates liberals becomes more critical. That's why Congress always lengthens unemployment insurance during a recession.
In the 1930s, FDR taught us that heedless self-interest is both bad morals and bad economics. Letting the upper-bracket Bush tax cuts expire and using the revenue to finance more unemployment benefits would be just the reverse.
Mr. Blinder, a professor of economics and public affairs at Princeton University and vice chairman of the Promontory Interfinancial Network, is a former vice chairman of the Federal Reserve Board.
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