Wither the Economy?
MCCAIN AND OBAMA STAKE OUT DIFFERING VISIONS
| KEY ISSUES | ADVISORY TEAMS | EXPERTS |
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mark andresen |
Slapped upside the head by plummeting housing prices, stagnant wages, and rising fuel and food prices, consumers are feeling besieged. Business confidence is faltering as the outlook for the financial markets remains uncertain and inflation looms. No wonder the economy is the front-burner issue in the upcoming presidential election.
But it’s not so easy to know what economic policies either candidate would put into effect if elected. During the rush down the stretch to November 4, John McCain and Barack Obama are focused on one goal: getting elected. While they might not say absolutely anything to achieve that goal, campaign rhetoric can play voters false.
“Ronald Reagan had a great saying: you campaign in poetry, you govern in prose,” says Don Dutkowsky, PhD, professor of economics in the Maxwell School of Citizenship and Public Affairs at Syracuse University. “Clearly, people don’t want to hear that we need to raise taxes. When the candidates voice the painful stuff, they’re treading on a minefield. But in terms of choosing one of these candidates, the best idea is to evaluate how he’s going to govern. How is he going to address the issues when he gets into office in January?”
The best way to imagine what might happen after the elections is to frame the issues in the context of the candidates’ public faces—that is, their campaign economic teams—and their philosophical approaches to economic questions. Those big-picture values filter down into the major issues that are shaping the campaigns and that are likely to shape the new president’s first years in office: taxes, the budget deficit, free trade, and financial-services-industry regulation.
“When looking at the candidates’ positions on these issues, you want to see substance,” says Deborah Hewitt, PhD, a professor of economics at the Mason Business School of the College of William and Mary. “Basically, where’s the beef? You can look at key categories to see how they fit into each candidate’s overall plan, try to glean information about their philosophical leanings, whether they lean toward the market solving its own issues or toward more intervention.”
Labels can only tell you so much and can quickly devolve into name-calling: to the right, Obama may be a socialist; to the left, McCain may be a libertarian. Their beliefs about the function and role of the federal government are the important thing.
It’s apparent that McCain falls on the side of smaller government, free markets, and lessened regulation; while Obama is more of an activist in his belief in the power of government to improve lives, the role of stronger regulatory authorities, and the necessity of the government intervening when markets fail. Taking a look through the lenses of economists across the political spectrum brings Obama and McCain’s key economic leanings sharply into focus.
TAXES
A wide variety of tax issues are front and center, including payroll taxes, corporate tax rates, and renewing the Bush tax cuts—on both the capital-gains and income-tax fronts. If the Bush tax cuts expire, capital-gains tax rates will return to their previous level of 20%, and marginal tax rates will rise for those with the highest incomes. McCain favors enshrining the Bush tax cuts as a permanent feature of the tax system, while Obama would retain them for individuals with incomes below $250,000 and let them expire for wealthier individuals. Obama has said he would raise tax rates on the wealthy to a point slightly higher than when Bill Clinton was in office.
Payroll taxes actually constitute a heavier tax burden for lower-income tax payers than income taxes. Obama would raise payroll taxes on the highest earners by removing the current $102,000 cap on payroll taxes to fund Medicare and Social Security. He also favors a $500 cut in payroll taxes for workers with low earnings. McCain opposes any increase in payroll taxes, but hasn’t said explicitly whether he would cut payroll taxes.
In terms of corporate tax rates, McCain favors a cut from 35% to 25%. He would eliminate the tax credit for employer-provided health insurance with refundable credits for individuals based on income. Obama has no specific proposals, but he does favor extending corporate research and development and renewable energy credits.
Major philosophical differences define their approaches to the tax code. Obama favors using the tax code to redistribute income from the wealthy to the poor and middle classes; McCain is opposed to such policies.
For Kent Gilbreath, PhD, a professor of economics at Baylor University, no issue is more important than the growing gap between the rich and the poor. Because consumer spending is such an important part of our economy, failure to address this gap could be disastrous. “The biggest issue facing the economy is the deteriorating economic status of the vast middle and lower-middle class families,” he says.
This means that consumers are losing confidence in their futures. Gilbreath sees economic assaults coming at consumers from every angle—from dwindling retirement plans to evaporating home equity. “A great many folks are starting to face a life where, soberingly, they see that their future is uncertain,” he says. “Consumers are not replacing the contributions to their retirement funds that were previously made by their employers. Nor do they have the expertise to manage the funds they do save. Previously, people didn’t worry about saving for their retirements or for emergencies. Their homes were their savings plans. All of a sudden, with declining home equity, that house of cards is falling. There’s a great malaise among individuals, a gloominess. It’s a combination of the decline in real income plus the increasing realization of insecurity. The resultant decline in consumer spending will only grow over time.”
Mark Zandi, PhD, chief economist at Economy.com and an advisor to the McCain campaign, argues that tax increases on the wealthy don’t raise as much money as projected because the wealthy take steps to avoid paying taxes. Higher taxes dampen the incentive to invest in the economy, stunting the creation of new jobs. “In my view, you shouldn’t use the tax code to address issues of income and equality or wealth distribution,” he says. “If you are concerned about the distribution of income and wealth, and I do think that’s a reasonable thing to be worried about, it should be addressed on the spending side.”
As for extending the Bush tax cuts, Jim Horney, PhD, the director of federal fiscal policy at the CBPP (Center on Budget and Policy Priorities), believes that such an action would only aggravate the difficulties posed by the federal budget deficit. “The extension of the tax cuts will have a very big impact on the size of the problem and on how quickly the problem could potentially become very serious,” he says.
A CBPP analysis of the candidates’ tax policies reveals that for households making less than $118,000 a year, McCain’s proposals would translate to about $200 in savings per year, while Obama’s would translate to about a $900 tax cut per year. By contrast, people in the wealthiest 0.01% of American wage earners—those who make more than $9 million per year—would save an average of $190,000 in taxes under McCain’s proposals to make the Bush tax cuts permanent. Obama’s proposals would increase taxes on individuals within this group by an average of $800,000 per year, which basically reverses the effect of the Bush tax cuts.
FEDERAL BUDGET DEFICIT
For many economists the largest long-term problem is the federal budget deficit. Hewitt maintains that “because our federal gov-ernment is broke, we don’t have the fiscal weapons to address other issues.”
The issue for Hewitt is fiscal discipline. She’s as disappointed by recent Republican administrations that haven’t espoused the traditional Republican policy of restraining spending and taxes as she is by Obama’s proposals to increase spending and raise taxes. While McCain’s goal is to eliminate the deficit by 2013, she fears that may be too late. “By my estimates, which I have based on the capacity of the global markets to absorb US federal debt, we’ve got five years before those markets have had enough.” She continues, “Just as the typical American family needs a budget, the federal government also needs to have a budget and stick to it without running these enormous deficits.”
Horney blames the escalation of the deficit on the tax cuts enacted in 2001 and 2003, claiming that military spending hasn’t had as much of an impact on the deficit as the tax cuts. “At some point there is going to have to be a serious discussion between policy makers, the president, leaders in Congress, and the American public about the realities of the budget situation,” he says. “The basic fact is that we must decide what needs in this country should be addressed, and we need to raise revenues sufficient to pay for that.”
While McCain has targeted 2013 as his goal for erasing the deficit, Obama hasn’t made any specific promises. But Horney doesn’t think McCain’s plan to reduce the deficit solely by cutting spending is realistic. “I think it is actually harmful for him to make this promise because he is telling the American people they can continue to have all the Bush tax cuts, they can have even bigger tax cuts, they can continue the defense buildup, and they can have a balanced budget,” he says. “That is just not true.”
While Zandi is a proponent of McCain’s proposals for cutting spending and taxes, he believes the budget deficit requires more serious action. “We have to have a collective discussion in much the same format as when we decided to close Army bases,” he says. “We put Democrats and Republicans and some experts in a room, and they come out with a plan, and the entire plan has to be voted up or down.” Without that kind of collaborative effort, it may take a crisis to force action, he argues. “Something will have to happen because the alternative will be politically unpalatable. Interest rates will spike, the economy will tank: there will be no choice. It may be that we don’t have the political will to sit down in that room together until some kind of crisis does hit.”
Other economists are concerned about the deficit but believe there is still time to cope, inasmuch as it is currently a smaller percentage of GDP than at the beginning of the Clinton administration. “We are in a different economy than we were under Clinton, we have all these infrastructure needs, and we must create tax breaks for the middle class and the working class,” says Lori Kletzer, PhD, a professor of economics at the University of California, Santa Cruz.
She adds, “If Obama is elected and gets us out of Iraq, spending will go down there and he will be able to say that he can put us on a path of at least significantly reducing the deficit.” Kletzer labels McCain’s proposal of tax cuts and spending cuts “very weak on deficit reduction” and Bush’s record “incredibly undisciplined.”
Richard Ebeling, PhD, senior fellow at the American Institute for Economic Progress, believes neither candidate is facing reality in terms of curtailing entitlement programs, which will be the major engine fueling the budget deficit and spending, in his opinion. “The deficit means that the government has to borrow money to make up the difference between what it takes in as taxes and what it spends as expenditures for these programs.
“Where does the borrowed money come from?” he asks. “It either comes from the savings of private individuals in the United States or it entails our increased reliance on private individuals, companies, and countries abroad. Eventually we’ll either have to pay that back or bilk those who have lent the government money.”
The size of the budget deficit doesn’t leave either candidate much room to enact new programs, says Ronald Rizzuto, PhD, a professor of finance at the Daniels College of Business, University of Denver. And he sees a number of tax-code issues that require attention. For example, Rizzuto insists that the alternative minimum tax must be adjusted to avoid entrapping increased numbers of middle-class taxpayers in a Byzantine shadow tax system that eliminates deductions and increases tax liabilities. “It will take a huge amount of tax revenue to fix the AMT, and the budget deficit demands that that revenue be replaced or made up somewhere else,” he says. “Unless the candidates’ stated desire to do something about the AMT is just rhetoric, they will have to find some middle ground on issues like making the 2001 tax cuts permanent. We’ve got spending commitments on Iraq and entitlements that don’t leave a lot of room on the spending side.”
For Sherry Jarrell, PhD, lecturer in economics at Wake Forest University’s Calloway School of Business, the deficit is a nonissue. “They’ve been saying that the budget deficit is going to ruin the economy for every political cycle, when it’s convenient, during the last 40 or 50 years,” she says. “And we have had every conceivable level of growth, with every conceivable size of deficit—we’ve experienced them all—and there’s no significant relationship between the two. It’s a good thing for the US government and the US economy that foreigners are investing in our economy. They’re getting a healthy rate of return. We’re going to pay them back and go on our merry way. We should be worried if they didn’t want to invest in our economy.”
FREE TRADE
Free trade wins unwavering support from McCain, while Obama wants to see provisions inserted into future agreements (and past agreements, when possible) to upgrade environmental and worker protections. Several free-trade pacts are on the table awaiting approval, while major Doha talks on international trade agreements recently collapsed. Trade is a hot-button issue for consumers and business executives.
For free-trade proponents, the issue is clear, as Ebeling sees it. “Which candidate understands that we are in a global economy? Which sees that borders, while they still remain as lines on a map, are increasingly unimportant?” he asks. “The market boundary is now the world. Do we want to participate in and benefit from this global territory that leaps over and goes under and ignores these artificial political boundary lines? If so, then we need the candidate who is most willing to follow open and competitive trade policies. That candidate will benefit the financial markets and the citizenry as a whole.”
But free trade isn’t so cut-and-dried for displaced workers who have lost their jobs and have had difficulty finding new ones at wages that can support a family. Kletzer, who studies trade issues, believes a more nuanced approach can successfully combine free-trade policies with a strengthened safety net that will protect workers’ earning power. “I believe in the enormous diffuse benefits that we see as consumers and producers from free trade,” she says. “But as a labor economist, I understand the individualized and community costs of free trade. We need to take some of what the gainers gain and redistribute it to where the losers lose.”
She continues, “There is no reason that government programs cannot redistribute some of the estimated hundreds of millions of dollars of consumer benefits in order to help people. These are the kinds of arguments that I think can be made and it seems to me that Obama has the kind of personal courage to do it. McCain comes off as pro-free trade and to hell with any government programs, which is standard for Republicans.”
Zandi disagrees with Kletzer’s assessment of McCain’s policies. “Now we see clearly that globalization hurts low-income, unskilled workers, so it is vital to concentrate our efforts on spending policy, not tax policy, in order to help workers with less education and fewer skills and other advantages. McCain has put forth different proposals with respect to job training, education, and unemployment insurance benefits for people whose jobs are displaced.”
He argues that “globalization makes our economy the best in the world. That’s where we’re the most open, not only with respect to trade but with respect to immigration and investment. You can see that in today’s economy the only real source of growth is trade, our export growth. And I think it’s good foreign policy in that the more closely we’re all tethered together, the more our interests are aligned, and the less likely we are to do damage to each other.”
Robert Kyle, JD, a partner in Hogan & Hartson’s international trade practice, believes the makeup of the next Congress will have a major effect on what trade policies the next president can pursue. “Whoever is president is likely to face a Democratic Congress with strengthened majorities. That will affect what either candidate would be able to achieve,” he says, adding that the next president’s ability to restart international trade talks may be hampered by the protectionist tendencies of increasingly sluggish international economies.
FINANCIAL-SYSTEM REGULATION
The subprime mortgage debacle, the failure of Lehman Brothers, and the takeover of Fannie Mae and Freddie Mac leave little doubt that regulation of the financial system and financial institutions will intensify. But how broad will regulation become, and what form will it take?
Obama is explicitly in favor of increased regulation, both inside and outside the financial system and financial-services industry. McCain tends toward an antiregulation stance but recognizes that Fannie and Freddie’s critical importance to the housing market demands government support.
The need for more regulation in the financial system is long overdue, argues Timothy Canova, JD, associate dean for academic affairs at the Chapman University School of Law. Canova criticizes both George W. Bush and Bill Clinton for regulatory laxity. “Deregulation has been going on for a long time and has undermined the safety, soundness, and integrity of the US financial system. The problems are systemic and pervasive. Some kind of sanity must be restored to financial regulation.”
According to Canova, “Economic libertarians are living in a fantasy world, because they think we can have markets without any regulation. It’s funny—if you want an extreme, deregulated, libertarian market, you’re going to end up with socialism because the markets will collapse.”
Free-market economists couldn’t disagree more. “I got my PhD in regulatory economics and the thing that I have verified, at least to my own satisfaction, is that government regulations are part of the problem, not the solution,” says Jarrell. “The vast majority of regulations cause approximately eight times the cost of the benefits the regulations were designed to create. We always underestimate the side effects and the multiplier effect of the cost of regulation. We should be doing the exact opposite and deregulating.”
If brokerage houses such as Bear Sterns or quasi-public entities such as Fannie and Freddie are on the brink of failure, Jarrell is in favor of letting the market take its course. “Let ‘em fail,” she says, comparing them to homeowners facing foreclosure. “This is going to sound heartless to the individuals who are affected by it, but they got in over their heads. They have to pay the consequences, like working two jobs to get out of it. If the government comes in to bail them out, it is essentially like having their neighbors bail them out.”
Hewitt emphasizes that any regulation or government program that attempts to correct perceived market deficiencies is in effect transferring income or resources from one group to another. “Every dollar in the economy comes from somewhere else,” she says. “Even if you use it for a good purpose, to bail out homeowners, you are taking it away from their neighbors. Economically, such actions are only valid for an externality in the economy, for facilitating the creation of clean cars, not for bailing out equity owners who took a risk. Those people need to take the hit. If you try to keep the system afloat by bailing them out, it’s a classic case of taking money from people who were doing the right things and giving it to people who were doing the wrong things.”
Zandi cautions against overreacting to recent events. “I think one lesson we learned coming out of the tech stock bust and the corporate accounting scandals is that we moved too quickly,” he says. “Sarbanes–Oxley has some good elements to it, but the consensus is that it overstepped where we needed to go. The unintended consequences of that legislation were probably the result of moving too quickly.”
He doesn’t dispute the need for a strengthened regulatory framework for the financial system, however. “I think the financial system was part of the reason we got into this mess. The regulatory pendulum swung too far to one side and there really was very little regulatory oversight. That was a mistake.”
Christopher Dolan, PhD, an assistant professor of political science at Lebanon Valley College, distinguishes between necessary and overly burdensome regulation. “Regulation that benefits the private sector is certainly much more positive than regulation that hampers the free market,” he says. “I do think there will be more regulatory powers under an Obama administration. With McCain, I’m not so sure. I don’t see McCain doing anything different than Bush. How has Wall Street perceived the Bush administration? If Wall Street hasn’t been very happy with Bush, I don’t see them being much happier under McCain.”
A FINAL WORD
As the campaigns progress throughout the presidential and vice-presidential debates, more specifics will undoubtedly emerge about the candidates’ economic policies and how they plan to put them into practice. Dutkowsky asserts that these specifics will arise directly out of Obama’s and McCain’s records, their philosophical approaches, and the makeup of their campaign staff and hypothetical administration staff.
“You’ve got to project how they’re going to deal with these things,” he says. “I’m not going to hold them to their promises or anything like that—when someone says, ‘Read my lips, no new taxes,’ I know better. If we want things, we have to pay for them. I understand they want lots of votes. I look at what they are talking about and what they see as the needs of this country to get some indication of how they would address those issues.”
Amy Buttell Crane is a journalist working in Erie, Pennsylvania.
