The most recent grim US jobs report brought forth calls for more Federal Reserve action on fiscal stimulus. Meanwhile, business leaders call for clarity about long-term policy and the need to return to growth. A recent and intriguing project of the George W Bush Institute weighs in on the emphasis of business leaders with a “4 per cent solution.” While a 4 per cent long-term growth rate for the US is aggressive, this discussion is the right road map for policy.
It is right because the nation faces structural impediments to growth. These are akin to carrying too many extra pounds of weight. They don’t seem to slow us down much walking on a flat surface, but are a burden walking upstairs or up a hill. The injuries to our economy since the onset of the financial crisis were made more painful by our failure to make structural adjustments. No single presidential administration deserves the blame for structural problems, but an important lens through which to judge a policy agenda is whether it recognises and mitigates those problems.
While a growth-focused agenda would have many parts, two fiscal policy issues stand out – getting our fiscal house in order and reforming the tax code. The US is on an unsustainable fiscal trajectory, with a debt-to-gross domestic product ratio projected to rise to second world war levels in the coming years. High and rising debt burdens are a structural impediment to growth. They raise expected future tax burdens, discouraging investment and limiting productivity growth. Some recent estimates of this adverse effect suggest our debt-to-GDP levels would reduce expected growth by half a percentage point per year over the next decade. How debt reduction occurs is also important. Recent research by Alberto Alesina of Harvard, and others, has emphasised that reducing transfer spending is more likely to lead to long-lasting decrease in debt and support for growth than raising taxes.
Gradual fiscal consolidation may also be stimulative in the short run. Research by Hoover Institution economists concludes that reducing federal spending relative to GDP to pre-financial-crisis levels over a decade would increase GDP in the short and long term. This outcome reflects lower future tax rates and the boost from lower interest rates to investment and net exports.
Our tax code discourages work and entrepreneurship, saving and investment, and distorts the allocation of capital. Sweeping tax reform offers one of the best chances to raise growth; by this I mean reform which reduces marginal tax rates on work, investment and saving, and reduces tax preferences for particular industries and assets. With highly mobile capital, high US rates discourage investment in the US (with attendant job creation) by US and foreign firms, suggesting that economic estimates of growth effects of tax reform may be conservative.
Many in Washington argue that an emphasis on the long term is misplaced, that we should focus on near-term “stimulus” and can confront long-term problems later. While there were strong reasons to argue for policy intervention at the onset of the crisis, there are three reasons to be sceptical about the call for “stimulus first”.
First, failure to address structural problems contributed to the crisis (for example, the tax bias against business investment and misallocation of capital to housing). Second, making progress on longer-term debt reduction and tax reform would have given policy makers room to implement bolder short-term fiscal policy to support growth. Third, ad hoc responses to the crisis exacerbated policy uncertainty, weakening the recovery.
We should not underestimate the costs of businesses holding off on investment and job creation because they cannot predict the course of policy, and the cost of consumers deferring large purchases against the backdrop of policy uncertainty. Businesses and households know structural problems must be addressed. But how? When?
One group of economists estimates that policy uncertainty could have contributed to a 1.4 per cent reduction in GDP last year. By their figures, returning to pre-crisis levels of policy uncertainty would add about 2.3m jobs in 18 months.
A growth agenda suggests a policy scorecard for voters: Does a policy platform promote fiscal consolidation and tax reform? Does it promote a clear policy path, minimising uncertainty? For Governor Mitt Romney the answers are yes and yes. For President Obama the answers are no and no.