Congress is the key to a revived economy

By Aparna Mathur

After months of listening to campaign speeches, TV ads and debates, Americans headed to the polls on Tuesday and chose another four years of Barack Obama. But a successful second term will not come easily. The partisan divide has yielded nothing but gridlock in Congress. And the electorate has grown tired of both the Obama New Economic Patriotism and Mitt Romney’s Five Point Plan.

As America faces its biggest economic crisis since the Great Depression, what we really need instead is a Plan For America, with both parties working together rather than against each other.

One advantage of all the political back and forth is that we have seen two competing visions for America. One involves a larger role for government — more spending, higher taxes to raise revenues and more regulation of the private sector. A second vision, truer to the principles of free markets and economic opportunity, involves less government spending and regulations and lower taxes. While both sides believe strongly in their ideals and want the best for the country and the American people, the electorate has not given a strong mandate for either. Going forward, the right policy prescription is likely to be a mixed bag of both sides.

The task ahead for Obama is daunting. In August, the Congressional Budget Office reported that we have now had deficits of more than $1 trillion for four straight years. Net federal debt is set to reach an unprecedented high of 73 per cent of GDP at the end of this year. The economy is headed toward another recession in 2013 if Congress does nothing to stop the implementation of the toxic combination of spending cuts and tax hikes that are set to kick in at the end of this year.

The key is Congress — the president alone can do nothing to stop this fiscal crisis from happening. There has to be a joint effort by the executive and the legislative bodies if we want the economy to recover.

One of the major differences between the two parties regards whether the Bush tax cuts should be extended for all income classes, or just the middle- and low-income classes. The Democrats, under President Obama, have been unwilling to move forward with tax reform unless Republicans consent to tax increases for the wealthy. President Obama believes that raising rates at the top is important because “the rich should pay their fair share.” While both sides agree that small businesses are important for the vitality of the nation, President Obama argues that only 3 percent of all small businesses would be affected by the tax hike.

Romney has similarly argued that he would be unwilling to compromise on a plan that would raise more revenue. He believes that raising taxes in a weak economy is a strategy that will harm hiring, investment and growth. While it is true that less than 5 percent of small businesses would face the hike, their income comprises more than 30 percent of all income, and the small businesses that are the job creators would be the worst hit.

This intractable ideological divide is all the more curious since in August 2009, Obama himself warned against raising taxes in an economic downturn because it “would just suck up … more demand out of the economy and put business further in a hole.” Likewise, Romney has repeatedly argued that he would not lower the levels of taxes paid by individuals at the top. Any marginal tax cut would be offset by cuts in tax expenditures for the wealthy.

Since both sides are in favour of large-scale tax reform to make the tax code simple, fairer and more efficient, there is a lot that could be achieved in a bipartisan manner.

The U.S. corporate tax rate — one of the highest in the developed world — is similarly dysfunctional. The high rate serves as a disincentive to capital investment and employment growth for many firms that can invest overseas in countries with lower tax rates. Indeed, despite having the highest rate, the U.S. collects among the lowest corporate tax revenues in the OECD. Recognizing this, both candidates have proposed plans to lower the rate — from 35 per cent to 28 per cent for Obama and 25 per cent under Romney. Romney has also proposed a territorial system of taxation whereby firms would only be taxed in their country of operation. Perhaps some compromise on tax reform can begin with the corporate rate.

The candidates also offered differing visions when it comes to the role and size of government. Romney favours less government and more targeted regulations, while Obama’s record has favoured sweeping regulations in health care and the financial industries. Such differences are reflected in government spending and outlays. Over the past four years, government spending has grown tremendously, driven in large part by specific government actions to stimulate the economy out of the recession. These spending increases are likely to continue for several years as the economy slowly recovers.

But high spending does little to help the economy since it signals to people that their tax rates are likely to go up in the future as the government attempts to raise more revenues to finance prior spending. Much research in economics has shown that high tax rates slow investment and hiring, leading to lower rates of economic growth. Combined with the economic uncertainty that businesses and consumers already face, this is clearly not the correct path forward if we want higher rates of GDP growth, investment and employment.

Obama now faces a choice: to compromise and engage, or to take the win as a mandate for running on a narrow agenda of high taxes and high spending. For the sake of the country, let’s hope it’s the former.

Aparna Mathur is a resident scholar in economic policy at the American Enterprise Institute. She has been a consultant to the World Bank and has taught economics at Georgetown University and University of Maryland.

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