Obama's Latest Push - Neither New Nor Helpful
The central issue that faces the American political economy, and which has ramifications for investing in American stocks, is whether it can set itself on a path of long-run sustainable economic growth. The President's latest proposals give no hope in that regard.
Let's see what negatives that Obama and his team propose to inflict upon the American economy as revealed in the 2010 State of the Union address. Most of them are items that they have been pushing since they took office.
First up is a "fee on the biggest banks." That's a tax. The structure of this tax is expected to increase capital costs to all banks. These costs will be passed on to borrowers. This is not a growth-generating proposal.
Next comes a government loan program to banks of less than $10 billion in assets. The loans are to be at rates of 1-5 percent. This program continues Washington's meddling in loan markets. The attempt here is to lower capital costs to these banks. Why will banks borrow from the government at these rates when the system is awash in excess reserves that cost banks nothing? If this loan program works, the banks will be inclined to make more marginal loans - not a basis for sound and stable growth.
If banks are not lending enough to suit Washington, the question is why not? The basic reasons for their inactivity should be addressed. It makes no sense to incentivize them to lend more without fixing the basic problems, which include a multitude of bad loans on their books. This program is a subsidy to these banks, but why push these banks to make more loans when it was that kind of encouragement and pushing that got them into trouble in the first place?
Obama is "also proposing a new small-business tax credit, one that will go to over 1 million small businesses who hire new workers or raise wages." This recycles an Obama-Biden proposal that has previously been rejected by Congress as unworkable. Anyway, padding payrolls is not an avenue to greater economic efficiency. Using taxes to fund higher wages is a wealth transfer that has no redeeming virtues.
The sustainable avenue to higher real wages is through capital accumulation that passes the market test. Indeed, the Obama proposals are none of them geared to passing market tests. They are all more of the same selective government manipulations. These are a staple product of Congress and have been such for a very long time.
Next up is to "eliminate all capital gains taxes on small-business investment and provide a tax incentive for all large businesses and all small businesses to invest in new plants and equipment." The small-business investment may refer to stock issued by certain selected small businesses and not others. Obama proposed something like this last year. It is a timid and very limited step in the right direction. America is uncompetitive in the international arena when it comes to capital gain taxes. They need to be eliminated altogether.
Obama also proposes here to resurrect the investment tax credit. Early in 2009, Congress passed selective investment tax credits for favored energy industries. These subsidies were a very bad idea. In both theory and practice, Congressional attempts to pick industrial winners damage the economy. They are altogether unnecessary.
A broad-based investment tax credit harkens back to Kennedy's 1961 tax credit for machinery and equipment purchases. This too is a proposal flawed in both theory and practice. In an NBER paper, Obama advisor Lawrence Summers writes
"We find little evidence that the investment tax credit is an effective fiscal policy tool. Changes in the credit have tended to destabilize the economy, and have yielded much less stimulus per dollar of revenue loss than has previously been assumed. The crowding out of 'non-favored' investment has been sufficient to offset a large percentage of the increase in the stock of equipment resulting from the use of the credit. We are led to conclude that the reliance on the investment tax credit and other investment tax incentives should be reduced."
This kind of a credit obviously causes business to focus on one kind of fixed investment (in tangible capital goods) to the exclusion of other kinds of investment in training and skills. This distorts the economy, producing malinvestment in some sectors and in some lines of business. This kind of market manipulation, which is a facet of government interventionism and central planning, does nothing to promote healthy long-term growth.
Obama promises infrastructure investments, such as high-speed railroads. After years of Amtrak and postal price increases that outpace inflation without better service, one is entitled to skepticism. There are certainly infrastructure projects that have long-term beneficial payoffs. There are certainly measures that can be taken to improve matters now. Is high-speed rail one of them? Who knows? It is not at all clear that the nation has an effective objective or business-like method of selecting those projects that have promising payoffs. We have a political method.
Obama is pushing his 2009 proposal to raise taxes on American companies with overseas operations. At present companies do not have to remit taxes on overseas funds that they reinvest overseas. That's a nice tax break. Why not extend it to companies that operate domestically? Hey, that means doing away with taxing earnings unless they are paid out as dividends.
Will taxing companies that are making money overseas promote growth in America? Does this overseas tax break actually ship jobs overseas as Obama contends? The evidence suggests the opposite. A paper by Mihir Desai states that foreign activity complements domestic activity. It does not substitute for it. In other words, if foreign economies are doing better because American companies are investing more there due to lower taxes, that redounds to the benefit of the American economy, presumably because those economies then do more business here. Desai writes
"This paper address these questions by analyzing the available evidence on two related claims - i) that the current U.S. policy of deferring taxation of foreign profits represents a subsidy to American firms and ii) that activity abroad by multinational firms represents the displacement of activity that would have otherwise been undertaken at home. These two tempting claims are found to have limited, if any, systematic support. Instead, modern welfare norms that capture the nature of multinational firm activity recommend a move toward not taxing the foreign activities of American firms, rather than taxing them more heavily. Similarly, the weight of the empirical evidence is that foreign activity is a complement, rather than a substitute, for domestic activity. Much as the formulation of trade policy requires resisting the tempting logic of protectionism, the appropriate taxation of multinational firms requires a similar fortitude."
Let's skip ahead to the newest element in Obama's address, which is a freeze on government spending:
"Starting in 2011, we are prepared to freeze government spending for three years. Spending related to our national security, Medicare, Medicaid and Social Security will not be affected, but all other discretionary government programs will."
Actually, 83 percent of the budget will not be touched.
By the time that Congress gets done with the remaining 17 percent, by the time that the White House negotiates with Congress, by the time that new events overtake the political economy, and by the time all the phony accounting is put into place, no recognizable budget cuts of any substance will be visible.
If this is the government's attempt at an exit from endless fiscal deficits of very large size, forget it. Even their own claim that the cuts will be $250 billion over a future 10-year period looks small compared to their own projected deficits.
No one can take this proposal as making serious inroads on a government budget that is out of control. Government promises far exceed its capacity to fund by any means beyond draconian taxation and money-printing. In the end, these promises will not be kept.
Obama gets it right with this statement:
"The only way to move to full employment is to lay a new foundation for long- term economic growth and finally address the problems that America's families have confronted for years."
Judging from this address and past proposals, the problem is clearly that he and his team are clueless when it comes to laying that foundation. We should not permit them and Congress to build our house. Their business as usual, which is a congeries of subsidies, tax increases, warfare, welfare, and inflation, is what has brought us to where we are. Congress cannot come through for us with sustainable long-term growth and good jobs that pervade the economy by reaching into this grab bag of worn-out legislative gimmicks.
The only way to lay a new foundation for long-term economic growth is for Americans at large to understand why they do not have such growth now. The basic reason is that they and the government are following poor policies. These policies have become institutionalized. Americans then have to fashion a new consensus around policies that make sense and that will succeed. Then they have to see to it that their representatives execute on these policies. This will require throughly shaking up existing institutions, including eliminating some.