Election 2010: Jobs, Taxes and the Economy at Stake

Last Updated Nov 3, 2010 8:04 AM EDT

This article was updated on November 3, 2010.


The people have spoken, and because the people are angry and frustrated, many fresh voices are about to join the jawboning in Washington. Much of the discussion about economic policy will be the same as it was during the last two years, and, frankly, the last 80.

To help make sense of the national conversation, we asked a top economic policy advisor from each side of the aisle to explain his party's positions and speculate about how they may influence decisions on key issues. The new Congress won't be seated until January, but why not give the debate a rousing head start? In an intensely polarized nation, it is especially important — and disturbingly rare — to hear sober, well-reasoned arguments from both sides. So tune out conspiracy theories about creeping socialism or overthrowing government, and read on.

Parker

Stating the Democrats’ case is Richard Parker, a lecturer in public policy at the John F. Kennedy School of Government at Harvard University. Parker has served as a consultant to leading Democratic senators, including Edward Kennedy, John Glenn, Alan Cranston and George McGovern. Not that his liberal credentials need further buffing, but he also co-founded the left-leaning political magazine Mother Jones.


Representing the Republicans is Keith Hennessey, a fellow at the Hoover Institution at Stanford University who teaches at Stanford’s business and law schools.

Hennessey

Hennessey served as a senior economic advisor to President George W. Bush and director of the National Economic Council in the Bush administration.

The two agree on almost nothing, although they are in perfect accord on what they disagree about. Both acknowledge the same central issue that has always divided the two parties: the extent to which government should participate in and steer the economy. They disagree on how great the tax burden should be and who should bear it; the government’s role in making social policy and redressing perceived injustices through income redistribution and other mechanisms; and how much intervention there should be in business and financial activity. When applying their beliefs to the economy today, they start off on the same page, then move on to different stories altogether.

Employment is Key

“What’s wrong is not enough people are working,” Hennessey said. “Employment is often the most important metric, and right now it’s the first, second and third most important metric.” The reason for the sluggishness, as he sees it, is that “businesses are uncertain about the future, not just about the economy but about policy” with respect to regulation and taxation. “I think [that] is more important than people in Washington give it credit for. As long as it’s unresolved, consumers and businesses will be uncertain.”

Looking back over the last two years, Hennessey described the measures to rescue big failing banks as “solutions that were imperfect but generally necessary.” But he dismissed the administration’s efforts to kick-start the economy, particularly the $800 billion spending bill enacted in early 2009, as “far less effective and far more wasteful and inefficient, largely because they’re pushing money out through government spending channels.”

Parker made a similar initial observation that “the economy is functioning well below full employment growth.” He attributed it, by contrast, to insufficient and misdirected intervention by Washington, in particular the bank rescue and tax cuts contained in the stimulus measures. Parker argues that the administration did not go far enough: His solution to the financial crisis would have been to nationalize the failing banks. He said he “would have wiped out the shareholders [and] sent in an army division of CPAs” to sort through and clean up the books, then put the banks back into private hands. Instead of the tax rebates used to stimulate growth, he would have preferred large, New Deal-style public-works projects.

Spend More ...

Befitting the ideological chasm, the economists offer significantly different prescriptions for the economy — ideas that correspond to what the party leaderships would put into practice if they could — for the next two years and beyond. If Parker were running the show, he would introduce a public works program worth perhaps $1 trillion. “There are a number of classic construction projects that could create jobs and improve the infrastructure of America,” he said. “Cities across the country have water systems built in the late 19th century, and we need a new national grid system.” When it comes to paying for them, he advises changing the way money flows between Washington and the public. “There’s too much tax relief and not enough direct tax spending,” he said.

Making his case that higher taxes and government spending enhance prosperity, Parker pointed out that top tax rates were much higher in the decades after World War II and so was economic growth. He’s not against tax incentives altogether, though. He favors using them “to make it easier for people to move more freely to take jobs.” He would offer breaks to homeowners underwater on their mortgages or young people heavily encumbered by student loans.

On another key issue, Parker opposes overhauling Social Security to allow investment choice. “It’s a terrible idea,” he said. “Investors stay in markets too long, they put too much in one company and bet on companies that have lobbied research people to recommend them.”

Parker prefers pragmatism to high-mindedness on trade matters. “It’s not a question of protectionism versus free trade. We have to recognize that the world works on multiple rules. The Chinese are a glaring example of that.” He suggested using “non-tariff barriers,” pressuring rivals via diplomatic channels, for instance, to gain wider access to foreign markets.

... Or Tax Less?

Hennessey’s approach is much simpler: “Resolve policy uncertainty in a way conducive to creating conditions for economic growth,” he said. “You need to keep taxes low so businesses have more money in their pockets ... and stop regulating so darned much.” He would “aggressively push for free trade and open investment” across borders. While he would keep Social Security under government control — “I reject the term ‘privatization’” — he would shift to a 401(k)-style defined-contribution system that links benefits more closely with wages and raise the age at which future retirees could collect benefits. That’s critical, in Hennessey’s view, for achieving his other main long-term goal of controlling spending and shoring up the government’s balance sheet.

Parker and Hennessey are excellent advocates for their sides. Each articulates his party’s principles and positions well. So which of them, if either, is right? Despite what fierce partisans will tell you, the short answer is it’s hard to tell. An economy that seems to have an infinite number of moving parts does not exactly offer controlled laboratory conditions in which to test different theories.

Apart from the everyday complexities, there are big events, good and bad, that are beyond political leaders’ control. Most of the 1990s was a boom time, in part because the Soviet Union had recently come undone and the world was a more peaceful, less edgy place. The Internet and other technological breakthroughs produced an economic transformation. Democrats like President Bill Clinton benefited, but so did Right-leaning leaders across much of Europe. Think of it as the stopped-clock theory of leadership: Eventually something will occur by chance that makes your policies look good.

Skepticism Required

The merits of one philosophy or another can also be clouded by politics. The party in power is often prevented from implementing its programs as it would if it had its unfettered druthers. Clinton, a masterful politician, was an especially effective Democratic president in part because his failed early attempt to transform health care instilled in him an almost Republican inclination from then on to manage the economy by leaving it alone. Ronald Reagan, himself no slouch as a politician and perhaps the most Republican of recent presidents, presided over a massive buildup in the federal deficit in part because a Democrat-controlled Congress did not reduce spending after taxes were slashed in 1986.

Still, enough history has unfolded — maybe too much history lately — to evaluate the two schools of economic thought and the potential effectiveness of Parker’s and Hennessey’s solutions for what ails us. As would be expected in a partisan political debate, some of both economists’ analysis and recommendations can be called into question.

Parker’s linkage of the ultrahigh top tax rates after World War II with the era’s strong economic growth is worthy of a raised eyebrow. After 15 awful years of depression and war, a generation of elevated growth was almost guaranteed, especially in the United States, which had a head start on the rest of the world by being one of the few countries not to have spent half a decade being bombed.

Demand for homes, cars, consumer electronics and much else was huge, and hundreds of thousands of demobilizing troops conveniently showed up to provide cheap labor and keep inflation at bay. Civilian applications for wartime technology stimulated growth too. So did favorable demographic conditions. The population was young, and it stayed young when those returning troops and their wives did what comes naturally, creating the Baby Boom. Today the economy has many more elderly, nonworking people to support.

With so many other explanations for the strong postwar economy, the high tax rates may have nothing to do with it, or even less than nothing. Such high rates can encourage people either to work less or to seek loopholes to cut their tax bills, so it’s unclear how much income was actually taxed at the highest rates.

Low Taxes, Low Returns?

Conservative economists have noted that lower tax rates in mature economies tend to correlate highly with over-all prosperity.Republicans also must face some inconvenient truths (to borrow a phrase). They consider their party the friend of business, and the Democrats sort of view the Republicans that way, too. Certainly, GOP policies of low taxes and light regulation feature prominently on corporate wish lists. Still, citizens who vote Republican because they think that the economy and their stock portfolios will get a better shake must confront this fact: It isn’t true.

A 2003 study by Pedro Santa-Clara and Rossen Valkanov at the UCLA Anderson School of Management found that returns in the stock market between 1927 and 1998 were nine percentage points greater each year — 10.7 percent versus 1.7 percent — during Democratic administrations than Republican ones. The study measured excess returns, meaning returns above the level of Treasury bills, rather than absolute returns; that’s a way of adjusting for inflation.

As for the economy, the study’s authors note that growth tends to be higher when a Democrat is in the White House. Inflation is generally higher too, but interest rates are significantly lower after adjusting for the rate of inflation.

Just why the economy and stocks do better under Democratic administrations is unclear. The authors concede that it could be a coincidence, but the low real interest rates may have something to do with it. They could serve as an artificial stimulant that creates imbalances that must be corrected the hard way when Republicans come to power. The lag between when policies are implemented and when they have an impact on the economy is another potential factor. The strong Clinton-era growth may owe a lot to a spirit of entrepreneurship fostered by the Reagan tax cuts.

With the economic recovery still fragile, there will be a lot at stake as the next two years unfold. One other source of agreement between Parker and Hennessey is that with the same party no longer controlling the White House and Congress, the momentum to introduce major new programs is likely to slow. Depending on which party has won your allegiance, a stalemate in Washington could provoke a sigh of relief or a sigh of frustration.

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