Good economic policy takes back seat to elections

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Article Highlights

  • Failure of #supercommittee means major economic decisions will wait for 2013

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  • Important policymaking takes back seat for election time

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  • The key is for near-term government policies to be a bridge to better growth driven by the private sector

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The failure of the Congressional Super Committee means that major economic policy decisions are likely to wait for 2013. The government will be funded and not bump up against the debt ceiling, and perhaps some modest initiatives might go forward such as renewing payroll tax cuts or extended unemployment insurance benefits. Beyond that, however, it is election time, with policymaking taking a back seat.

This is a shame. With the unemployment rate at 9 percent, there is still a pressing need for constructive policies to boost near-term growth. Two years after the economy hit bottom, however, it is time to think beyond the short term. Tax cuts or spending programs to bolster the economy today would be most effective if they are connected to measures to improve the long-term U.S. growth trajectory (think tax and regulatory reform) and address fiscal sustainability (entitlements reform). The key is for near-term government policies to be a bridge to better growth driven by the private sector.

"Two years after the economy hit bottom, however, it is time to think beyond the short term."—Philip Swagel

Unfortunately, we can expect to see the opposite over the next year. President Obama has accurately identified entitlement spending as a key U.S. economic challenge, but the needs of his re-election mean that he is likely to demagogue against reforms. The administration has taken Social Security off the table and proposed only modest changes to a Medicare system facing serious financial challenges. This makes President Obama's Jobs Act stimulus proposal a bridge to nothing.

Still, one can think about what economic policymaking would look like if President Obama could think about the long-term economy. To be sure, the President would not embrace Republican-style tax cuts or Paul Ryan's proposal for Medicare reform. But freed of the electoral constraint, he could put forward policies that make tough decisions over entitlements and thereby help improve growth today and over a longer horizon while addressing dangers to U.S. economy from looming fiscal imbalances.

The near-term part of the policy mix would involve some useful demand-side elements from the Jobs Act proposal, including spending on infrastructure and training. The 2009 stimulus showed that the government cannot quickly spend a huge amount of money to good effect. But spending can proceed more thoughtfully over time to address areas in which there is a role for the government such as infrastructure and training. Roads, bridges, schools, airports, and other infrastructure projects are quintessential public goods, and the weak housing market means that there is likely to remain considerable slack in the construction sector, making it less likely that the government would crowd out private activity.

New training programs would be a useful approach to both help people today and strengthen the economy over time. Millions of Americans suffering long-term unemployment face the prospect that their skills will no longer be appropriate for future jobs. Most training is done on the job, but there is still an important role for well-targeted government-supported training programs. The key is to recognize that the population needing training today is motivated and responsible - these are people with considerable employment histories. Ken Troske and I put forward a training proposal earlier this year focused on this population; other approaches would be welcome.

Policies to address longer term issues would include overhaul of the housing finance system, along with reforms of Social Security and Medicare to address the fiscal challenge. The common thread is that these are areas in which uncertainty about the size and role of the government create uncertainty about future taxes. Moving forward on these areas could reduce this uncertainty and help boost the economy today.

A stable long-term system for housing finance would bring back private capital to fund mortgages. Rather than trying to expand government-run mortgage programs, private investors would put their money on the line to make loans to riskier borrowers. Without reform, private capital will naturally hesitate to get involved in thirty-year assets when the government could change the rules in midstream. There are tough decisions to be made about the future role of the government in housing finance, but all reform plans involve bringing back private capital. Starting this process now would boost the housing market today - and yet the administration has been essentially silent.

On entitlements, a truly depressing aspect of a re-election campaign that could be centered on demagoguery of reform is that there are approaches the President could take that would move toward a bipartisan compromise on both Social Security and Medicare.

Social security reform is fundamentally an issue of generational fairness because delay means that some generations will not share in the burden of the required adjustments. Eventually there will be progressive changes to Social Security taxes or benefits so that people with high lifetime earnings pay more or receive less than currently promised. These changes will shelter people close to retirement or with low lifetime earnings - indeed, reform is likely to boost benefits for those at the bottom. The decision is whether to make the adjustment through higher taxes while maintaining benefits, or through lower benefits without higher taxes. In a sense, then, the fundamental choice is whether to run money into the government from higher earners in order to pay it out as higher benefits to the same group, or instead to have the same people pay lower taxes and receive lower benefits. This is an area ready-made for compromise: the President can propose a progressive solution but with the adjustments through spending on people with high lifetime earnings rather than raising taxes.

Medicare reform is more difficult, but again, there are areas for potential agreement absent the needs of the campaign. Not one should expect the administration to embrace the idea of premium support now that Republicans such as Paul Ryan are in favor of it, but there are ways to reach similar results. Premium support essentially sets a budget constraint for the government's contribution to individual benefits. This would likely lead Medicare recipients over time to choose coverage plans with larger co-pays and deductibles. The President could cut straight to this outcome with a Medicare reform proposal that improves incentives through meaningful adjustments to co-pays and deductibles. At the same time, reforms could involve more assistance for people with low lifetime earnings to offset the impact of the higher out-of-pocket costs to be borne progressively by the rest of the population.

The Administration's reluctance to pursue entitlement reforms is understandable given that the positive economic impacts between now and election might well be outweighed by the political costs of taking on these challenges. Still, we can all look forward to the day when either President Obama no longer faces reelection and is ready to lead from the front on the economy, or there is a new administration with a longer horizon.

Philip Swagel is a visiting scholar at AEI

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