FINANCIAL TIMES – Avoiding Economic Policy’s Bermuda Triangle

The season of policy ideas is upon us in the US, with significant consequences for the nation’s economic future. President Barack Obama offered his economic suggestions in his recent budget. And presidential aspirants from both parties will soon be offering their own thoughts on how to advance gross domestic product, household incomes, and other objectives.

While this policy debate is and will be important, it is unlikely to yield breakthrough ideas to advance growth, work, and economic opportunity. In order to do this, we must go beyond the current triangle of trade-offs among jobs, income security, and near-term budget outcomes.

This triangle is really a tri-lemma — in trying to achieve two elements, we miss the third. This leads to overly constrained policy choices that try to address major challenges with minor tweaks.

For example, a focus on employment and short-term cash savings led to temporary “stimulus” following the 2008 financial crisis – instead of the larger jolt to expectations that the troubled economy needed (and needs) for a real recovery. This caused millions of Americans to lose the long-term security of rising incomes.

Another example is the Affordable Care Act, which emphasised income security and near-term budget outcomes. This came at the expense of employment by taxing work and imposing job creation penalties on businesses.

Similarly, the federal push for a higher minimum wage aims at income security with no near-term budget impact. The costs are hidden in higher prices and diminished employment opportunities.

This tri-lemma is not limited to the president’s policies. While the president’s suggested tax rates on multinationals’ incomes are still too high, other proposals also limit the gains to be had from tax reform. For example, offering greater family support through tax credits, while simultaneously reining in the budget cost by focusing assistance over narrow income ranges, risks high marginal tax rates on work which will inhibit growth.

This problem is not inevitable, but sidestepping it requires more than just additional policy ideas. What we need is a different triangle emphasising growth and opportunity, making work pay, and long-term budget goals.

An emphasis on making work pay can be advanced by wage subsidies or expanding the Earned Income Tax Credit, especially for single workers, given declines in employment and labour force participation for younger adults. Such a subsidy is positive for growth and brings more people into the workforce. A long-term budget orientation allows this pro-work investment to be financed over time by reductions in spending on programmes for low-income households that are less effective, or spending on tax benefits for the affluent. That is, the three elements of the triangle become mutually reinforcing. Likewise, a combination of business tax reform and a thoughtful federal infrastructure programme can increase growth and offer increased opportunity for work. The expenses, examined over the long-term, are defrayed by economic growth and accompanying government revenue.

In particular, an emphasis on long-term budget goals helps balance a future-oriented policy of investing in people and capital for growth with a present desire for social insurance. An example is “premium support” in Medicare — wherein beneficiaries purchase health insurance from among competing plans, with the government paying a portion of the cost of coverage depending on income. Similarly, federal aid to education could take a premium support approach, with the most extensive support for low-income students. Again, the three elements can be mutually reinforcing.

The first policy triangle of jobs, security, and the near-term budget emphasis brings out “vertical” policy thinking, with analysis in individual silos. For example, a claim that tax reform will increase investment by X per cent or GDP by Y present is used as policy analysis. What is required is more “horizontal” policy thinking: How do we combine reforms in taxation, trade, education, and research to enhance overall growth and opportunity? How can we work with colleges to make a college education more affordable?How can we help employers to provide more good jobs and on-the-job training, thereby broadening opportunity and expanding the tax base? This wider view of policy implications also avoids the unfortunate politics of division engendered by phrases like “middle class economics”, tying, say, tax cuts for middle-income families to tax increases on saving and investment by higher-income families.

The next year and a half will bring voters different policy ideas for advancing America’s economic potential. Those views will be more instructive if accompanied by a different way of thinking — problem-solving for mutually reinforcing themes of growth, work, and opportunity, with a eye on the long-term.

This op-ed by Glenn Hubbard appeared in on February 25, 2015