Avoid the Double Dip
How Obama can save the fragile economy from going back into a tailspin.
BY NOURIEL ROUBINI, MICHAEL MORAN | NOVEMBER 2010
Roughly three years since the onset of the financial crisis, the U.S. economy increasingly looks vulnerable to falling back into recession. The United States is flirting with "stall speed," an anemic rate of growth that, if it persists, can lead to collapses in spending, consumer confidence, credit, and other crucial engines of growth. Call it a "double dip" or the Great Recession, Round II: Whatever the term, we're talking about a negative feedback loop that would be devilishly hard to break.
If Barack Obama wants a realistic shot at a second term, he'll need to act quickly and decisively to prevent this scenario.
Near double-digit unemployment is the root of the problem. Without job creation there's a lack of consumer spending, which represents 40 percent of domestic GDP. To date, the U.S. government has responded creatively and massively to the near collapse of the financial system, using a litany of measures, from the bank bailout to stimulus spending to low interest rates. Together, these policies prevented a reprise of the Great Depression. But they also created fiscal and political dilemmas that limit the usefulness of traditional monetary and fiscal tools that policymakers can turn to in a pinch.
With interest rates near zero percent already, the Federal Reserve has few bullets left in its holster to boost growth or fend off another slump. This lack of available good options was patently on display in August when Fed Chairman Ben Bernanke spoke with a tinge of resignation about new "quantitative easing" interventions in the mortgage and bond markets -- a highly technical suggestion that, until the recent crisis, amounted to heresy among Fed policymakers. It certainly hasn't helped that the U.S. federal deficit has reached heights that make additional stimulus spending, of the kind that helped kindle the mini-recovery of early 2010, politically impossible.
Yet all is not lost. Obama will face an increasingly partisan and divided Washington over the next two years, but he can take steps to reduce the odds that this dark double-dip scenario comes to pass. This will, of course, require deft politics. To that end, the administration should focus on policies that create a revenue-neutral fiscal stimulus -- one that targets both labor demand and consumption.
Start with the one thing that everyone loves to hate: taxes. Forget the political hot potato over the size and shape of the cuts -- there's an easy way to do this. For the next two years, Obama should reduce payroll taxes for both employers and employees. The reduction for employers will lower labor costs and allow the hiring of more workers; for employees, increased take-home pay will get people spending again. It's not just about increasing foot traffic in the mall; households need to pay down the burden of credit cards, second mortgages, and other legacies of the years of easy credit.
But this tax cut can't bust the budget. How can it be funded? By allowing George W. Bush's tax cuts for people making more than $250,000 to expire while keeping in place those for middle- and low-income earners -- the vast majority of Americans. And whatever trickle-down Republicans in Congress say, Obama will have to remain firm on this.
After two years, when U.S. growth is hopefully more robust and the pace of private-sector hiring has picked up steam, Obama can afford to phase out the payroll tax cuts. But the income-tax increases for the rich? They'll need to stick around. To woo key middle-of-the-road Democrats and moderate Republicans and to maximize the incentives for private-sector hiring, the president should make sharper reductions to payroll taxes paid by employers than to those paid by employees. This makes mincemeat of the argument that high-income individuals invariably resort to -- that higher income taxes will hurt small businesses and curtail hiring. By incentivizing both consumer spending and hiring, this plan goes far beyond the modest tax credits for business investment proposed in September.
As for the employee payroll tax cuts, because low-income workers generally consume more of their salaries when given extra money, the payroll tax cut should be designed to provide a larger percentage break to those on the low end of the income scale. This has another ancillary benefit: "Progressive" Democrats will find this tax cut an easier sell.
But the mixture of employer and employee payroll tax cuts, the latter benefiting the majority of Americans, represents only the beginning of what might be done with a more creative approach to tax policy. After all, everyone agrees that something needs to be done: The president's fiercest political rivals go on the record daily declaring an economic state of emergency.
It's high time to hold U.S. financial institutions to account. The very companies that benefited from the billions of dollars of taxpayer stimulus are currently building up huge cash reserves -- in effect, overinvesting in capital at the expense of jobs. Taxing this capital would reduce the relative cost of labor and get companies hiring again.
Both for policy and political reasons, Obama should emphasize that these changes would be temporary. Absent a new stimulus package -- which appears highly unlikely at this point -- these cuts are the best way to avert another economic disaster. They direct billions of dollars back to the American households that are most likely to spend them and those businesses most likely to hire new employees.
Only a tiny percentage of Americans will end up paying more: the highest-income earners, who have already benefited greatly from the service the government (read: taxpayers) rendered to their brokerage firms and investment banks in 2008. Republicans may rail against increasing taxes on any American, but the complaints of the wealthy, in today's economic climate, will have little credibility among middle-class voters. In exchange for this increase, Obama can fashion a large tax break for employers and employees that jump-starts consumption, encourages hiring, and reduces the risk of a double dip -- all without busting the budget.
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