[Editor's note: This piece was first published at Forbes.com.]
President Obama’s June 14 address in Cleveland presented his foundational economic policy arguments for this fall’s campaign. We will hear those same rhetorical points over and over this year, at least until his pollsters realize they are doing more harm than good.
The marker Obama himself laid down for judging his economic policies is whether they would serve “to create strong, sustained growth…pay down our long-term debt…[and] generate good, middle class jobs….”
Last week, we discussed how his economic policies would consistently produce the opposite of those results, just as they have in his Presidency so far. But his speech contained many more fallacies that further illuminate his perverse economic thinking.
Lowering marginal tax rates, not just cutting taxes, expands the incentives for increased production, and consequently increases productive activities, such as saving, investment, expanding businesses, starting businesses, job creation, entrepreneurship, and work. That expands production and increases GDP, which means economic recovery, growth and prosperity. Even under Keynesian economic thinking, tax rate cuts promote economic recovery and growth by increasing demand for goods and services, which would in theory increase supply, GDP and growth.
But in his Cleveland speech, Obama argued that it was the Bush tax rate cuts that caused the recession somehow. He said, “We were told that huge tax cuts – especially for the wealthiest Americans – would lead to faster job growth….So how did this economic theory work out?”
So let’s review how it did work out. Bush cut the top income tax rate by 11.6%, from 39.6% to 35%, and the second highest rate by about 8%, from 36% to 33%. But he cut the lower rates by higher percentages, including slashing the bottom rate by 33%, from 15% to 10%. Then in 2003, he cut the tax rates on capital, reducing the capital gains tax rate by 25% from 20% to 15%, and the tax rate on corporate dividends to 15% as well.
These tax rate cuts first quickly ended the 2001 recession, despite the contractionary economic impacts of 9/11, and the economy continued to grow for another 73 months. After the rate cuts were all fully implemented in 2003, the economy created 7.8 million new jobs over the next 4 years and the unemployment rate fell from over 6% to 4.4%. Real economic growth over the next 3 years doubled from the average for the prior 3 years, to 3.5%.
In response to the rate cuts, business investment spending, which had declined for 9 straight quarters, reversed and increased 6.7% per quarter. That is where the jobs came from. Manufacturing output soared to its highest level in 20 years. The stock market revived, creating almost $7 trillion in new shareholder wealth. From 2003 to 2007, the S&P 500 almost doubled. Capital gains tax revenues had doubled by 2005, despite the 25% rate cut!
The Bush economy nevertheless did perform subpar because Bush also supported a loose, cheap dollar monetary policy, following Keynesian doctrine that a cheap dollar boosts the economy by promoting exports. Weak dollar monetary policy discourages critical job creating investment that bids up higher wages, because investors fear the depreciation of their investment returns by a declining dollar or inflation, and the rise of artificial boom bust cycles that might crash their investment in a recession. That contrasted with the earlier Reagan boom built on anti-inflation, strong dollar policies that promote job creating, wage increasing investment, without fear of a declining dollar, inflation, or boom bust cycles. As discussed below, the Bush cheap dollar monetary policy did play perhaps the central role in the financial crisis of 2008, as free market critics of Bush’s monetary policy had forewarned.
But there is no economic theory under which tax rate cuts could cause recession. America cannot afford a President who is this confused and deluded.
Obama said in Cleveland, “Over the last three years, I’ve cut taxes for the typical working family by $3,600. I’ve cut taxes for small businesses 18 times.” But Obama’s “tax cuts” have almost all involved tax credits and other loopholes, not reductions in rates, which he is increasing at an historic pace, as discussed last week. It is reductions in rates that promote economic growth and prosperity, because it is the marginal tax rate, or the rate on the next dollar of income, that determines whether the producer is going to undertake the activity to produce that income. Tax credits are really no different than welfare checks, particularly the refundable tax credits Obama has favored, which pay the beneficiary the full amount of the credit regardless of tax liability. But welfare does not promote economic growth and prosperity, Nancy Pelosi to the contrary notwithstanding.
Moreover, in deriding regulatory relief from the exploding regulatory costs he is imposing on the economy, Obama also again identified such regulatory relief, or deregulation, as a chief cause of the financial crisis. He said, “During the last decade, there was a specific theory in Washington about how to meet this challenge….We were told that fewer regulations – especially for big financial institutions and corporations – would bring about widespread prosperity. [But] how did this economic theory work out?”
Obama added, “Without strong enough regulations, families were enticed, and sometimes tricked, into buying homes they couldn’t afford. Banks and investors were allowed to package and sell risky mortgages. Huge reckless bets were made with other peoples’ money.”
Notice that after almost 4 years of Obama’s Presidency, no regulations have been adopted to counter any of these supposed problems. Banks and investors are still allowed to package and sell mortgages, which still bear risk. Financial institutions still make bets with other peoples money, because that is the business they are in. And nobody has ever explained how the financial industry can make good money by tricking people into buying homes that they can’t afford.
The repeal of the long outdated Glass-Steagall Act actually helped to ease rather than cause the financial crisis. Because of that repeal, bank holding companies that owned sturdier commercial banks like JPMorgan Chase could buy investment banks that were failing like Bear Stearns, or the Bank of America conglomerate could buy the failing securities firm Merrill Lynch.
The financial crisis was not caused by deposit holding commercial banks engaging in investment banking practices, which was the original concern giving rise to the Glass-Steagall separation of commercial and investment banking. The crisis reflected investment banks and securities firms getting into trouble doing what these firms are in the business of doing, buying, selling and marketing securities. Some mortgage companies like Countrywide also got into trouble doing what mortgage companies do, investing in mortgages. But Glass Steagall did not prevent investment banks and securities firms from buying, selling and marketing securities, nor mortgage companies or deposit holding banks from investing in mortgages, and neither Dodd-Frank or any other Obama Administration regulation has done so either.
By the time of the 1999 bipartisan repeal of Glass-Steagall, fully supported by the Clinton Administration, the original act had already been so riddled with loopholes that it was already ineffective. Those loopholes had been added by federal regulators over decades to enable American banks to compete more effectively with European and Asian banks that did not face any Glass-Steagall restrictions. Even after that final deregulation, commercial banks still could not engage in full investment banking directly. The repeal only allowed bank holding companies to own both an investment bank and a commercial bank, and no commercial bank was brought down because its holding company owned an investment bank or a securities firm.
Rather than tax cuts and deregulation causing the financial crisis, it was more nearly the opposite, as I have explained in another column. It was Bill Clinton’s overregulation that forced financial institutions to abandon traditional mortgage lending standards, in the name of homeownership for minorities and the poor. Once those standards were demolished for lower incomes, they could not be maintained for higher income speculators. The government’s sponsored enterprises Fannie Mae and Freddie Mac, with effective government guarantees, were able to pump trillions into the subprime housing bubble, and spread trillions in toxic mortgage securities based on non-traditional subprime mortgages throughout the global financial community. See, Paul Sperry, The Great American Bank Robbery: The Unauthorized Report About What Really Caused the Financial Crisis; Gretchen Morgenson, Reckless Endangerment ; Peter Ferrara, America’s Ticking Bankruptcy Bomb.
President Bush’s cheap dollar monetary policy pumped up the housing bubble even further, bringing down the economy when the bubble inevitably burst. As Stanford Economics Professor and monetary policy guru John Taylor explains in his timely book, Getting Off Track:
“The classic explanation of financial crises, going back hundreds of years, is that they are caused by excesses – frequently monetary excesses – that lead to a boom and an inevitable bust. In the recent crisis we had a housing boom and bust, which in turn led to financial turmoil in the United States and other countries. I begin by showing that monetary excesses were the main cause of the boom and the resulting bust.”
But in his Cleveland speech, Obama used the financial crisis as an excuse for his own failure to achieve a traditional recovery from the recession. He said, “Throughout history, it has typically taken countries up to 10 years to recover from financial crises of this magnitude.” Obama is telling us the standard of recovery he wants to be judged by, 10 years to get back on our feet, like during the Great Depression.
Of course that is not based on the history of American recessions and recoveries. That history is fully recounted at the website of the National Bureau of Economic Research (NBER). That history shows that since the Great Depression, and before this last recession, recessions in America have lasted an average of 10 months, with the longest previously being 16 months. But here we are 54 months after the last recession started in December, 2007, and there has been no real recovery
Moreover, the American historical record is the deeper the recession the stronger the recovery. Based on that historical precedent, we should be in the third year of a booming economic recovery by now. Instead what Obama has produced is the worst economic recovery since the Great Depression, as I have recounted previously.
Obama always wants to measure his performance from the trough, or worst point of the recession. But every recovery is always better than the worst point of the recession. Obama’s recovery is to be measured as compared to previous recoveries from prior recessions in the American economy. By that standard, Obama’s recovery has been pitiful, again the worst economic recovery since the Great Depression, especially as compared to the all-time record Reagan recovery.
Indeed, if Obama’s perverse policies are not reversed, his soaring tax rate increases next year on top of his skyrocketing regulatory burdens and runaway federal spending, deficits and debt, will just throw America back into recession, before there was even any real recovery from the last recession. Then unemployment will soar back into double digits, the deficit will soar to new records over $2 trillion, and President Obama will have added more to the national debt than all prior U.S. Presidents combined, from George Washington to George Bush. The entire period will then look just like an historical reenactment of the 1930s. That should be no surprise that Obama in modeling his Administration after FDR is getting the same results as FDR. That is not fighting for the middle class, that is trashing the middle class.