Message to Barack Obama: it is time to panic. Our economy is growing at annual rate of just 1.8 percent. Manufacturing just grew at its slowest pace in 20 months. More than 44 million Americans – one in seven – rely on food stamps. Employers hired only 54,000 new workers in May, the lowest number in eight months. Jobless claims increased to 427,000 in the week ended June 4. The unemployment rate rose to 9.1 percent. Nearly half of all unemployed Americans have been without work for more than 6 months. About 25% of all teenagers who are looking for work are unemployed. Eight-and-a-half million Americans are underemployed – i.e. working part-time because their hours have been cut or because they can’t find full-time work. There are, on average, 4.6 unemployed people for every one job opening. And even if all the open positions were filled, there would still be 10.7 million people looking for work.
To be fair, it’s not as if the President is totally oblivious to this problem. He’s just getting advice from all of the wrong people – the very sorts who got us into our current mess in the first place. Last week, for example, President Obama convened a meeting of several Wall Street executives, consulting them for their thoughts on how to speed up economic recovery. And in his new business-friendly guise, Obama has also been consulting a number of CEOs from leading Fortune 500 firms. The overwhelming consensus to jump-start the economy appears to be an endorsement to cut in corporate tax rates.
This represents a fundamentally flawed approach. Why? Because corporate tax cuts represent a supply side response to a problem that is fundamentally one of poor aggregate demand. Leaving aside the fact that a number of corporations do not pay anywhere near the current prevailing marginal rate (hello, GE), supporters of corporate tax cuts have to explain how further cuts in their marginal rates will help the economy, given that prevailing historically high profit margins and high profit rates already in place have done little to reduce unemployment.
Why are firms ignoring the profit signal to expand production, and hence increase jobs? In fact, you can make the case that with a booming stock market, why should businesses bother with all the uncertainty of reinvesting in tangible productive capital when they can buy back shares, issue a special dividend, or initiate a merger to get their stock price up pronto? How will corporate tax cuts change all of that?
There is little point in offering new investment or R&D tax credits if businesses can’t sell the goods subsequently produced.
Even one of the former architects of our current misfortune, former Treasury Secretary Lawrence Summers, recognizes this basic fact. In a recent Financial Times piece, Summers notes that what we are experiencing today is fundamentally a problem of aggregate demand -- or, to put it more succinctly, a lack of spending power in the economy.
Summers notes, correctly, that introducing supply side reforms – i.e., corporate taxes (a lot of which aren’t paid in any case) -- will not solve the problem of an economy characterized by lack of demand. There is little point, for example, in offering a slew of new investment or R&D tax credits if businesses can’t sell the goods subsequently produced as a consequence of the credits.
Once spending decisions are taken and acted on, the firms then find out whether they have overproduced or under-produced. If they have overproduced – that is overestimated aggregate demand – they observe an unintended build-up of inventories. That signals to firms that they were overly optimistic about the level of demand in that particular period.
Once firms realize they have over-produced, output starts to fall. Firms lay-off workers and the loss of income starts to multiply as those workers reduce their spending elsewhere. At that point, the economy is heading for a recession. Corporate tax cuts won’t alter that reality because the problem is fundamentally one of consumers being unable to buy their products.
The only way to avoid these spiraling employment losses would be for an outside intervention to occur. Yes, this intervention could well come from an expanding public deficit, or it could come from an expansion in net exports. But the latter is dependent on the policy responses of other countries (it takes two to tango), so if Asians or Europeans decide they aren’t interested in purchasing more American goods, then there is little alternative to an expanded government intervention.
Which suggests that income tax cuts, or increased government fiscal expenditure, is the way to engender a recovery in demand. And to anticipate the cries of the fiscal “austerians”, it’s worth noting that those who continue to emphasize the fiscal “costs” of sustaining of aggregate demand via higher government spending or income tax cuts ignore the fact that today there are huge daily losses in foregone income, corporate tax revenues and output from prevailing high levels of underutilized resources. High unemployment actually adds to the very deficit problem the fiscal hawks decry on a regular basis.
The losses engendered by high unemployment will never be regained and the longer we persist with economic bloodletting, the greater will be the damage to the economy for years ahead. It's all about spending and sales. We lost 8 million jobs almost all at once a few years back because sales collapsed. Businesses hire to service sales. So until we get sales high enough to keep everyone employed who's willing and able to work we will have over capacity, an output gap, and unemployment.
A 'normal' economy is one with sufficient demand for full employment. In this context, there is no particular need to promote even more demand. We have a demand deficient economy today. When demand is constraining an economy, there is little to be gained from increasing potential supply. Our advice to the President: sales create jobs, and income creates sales. Families, not big Fortune 500 companies currently don’t have enough income to dig us out of the ditch we’re still in. Take a page from Ronald Reagan’s playbook and cut all marginal tax rates significantly. Or embrace a suspension a full payroll tax holiday for every employer AND employee in the nation. This will have the dual effect of increasing the take home pay of those working for a living which will help sales and employment, as well as cutting business costs, which, in competitive markets, works to lower prices. A “win win” for businesses and consumers and vastly superior policy to another unnecessary cut in corporate tax.