Automatic Economic Stabilizers or Stable Economic Rules?

Former Obama OMB Director Peter Orszag (who joined Citigroup earlier this year as vice chairman for global banking) over at The New Republic thinks we’ve got too much democracy. To fix it, he says, “We need ways around our politicians. The first would be to expand automatic stabilizers—those tax and spending provisions that automatically expand when the economy weakens, thereby cushioning the blow, and automatically contract as the economy recovers, thereby helping to reduce the deficit.”

Orszag has it backwards. Recessions are the worst time to raise government expenditures. Decreasing the resources in the market during an economic downturn only delays the recovery and increases debt, which in the long-term can be even worse for the economy (see Greece for more details). This Keynesian concept is straight from the Hoover-FDR playbook that sank our economy into the dismal 1930s and ’40s. (Contra Krugman myth, Hoover increased spending from 1929-1932 by 50 percent from $3.1 billion to $4.7 billion.)

Orszag should take his cues from the post-war depression of 1920-21, the one with worse unemployment in the first year than the Great Depression. President Harding ignored calls for increased government, slashed spending from $6.4 billion to $3.3 billion reducing the size of government by almost 50 percent. The economy recovered in less than a year and led to rapid growth for the rest of the decade.

Orszag continues, “A progressive tax code is one such automatic stabilizer. The tax code takes less of your income as that income declines, so after-tax income tends to decline less in response to an economic shock than pre-tax income. Since spending is based on after-tax income, the impact on the economy is cushioned…. For the same reason, making the tax code more progressive would strengthen its role as an automatic stabilizer.”

He’s right that when people keep larger amounts of their income, it’s good for the economy. But that’s good anytime, not just during a recession and has nothing to do with a progressive tax code. People are just better at allocating resources than governments. Allowing top wage earners to keep larger portions of their income will increase investment, which will ultimately pull our economy out of this recession.

Orszag is under the false Keynesian view that increased consumer spending ends recessions. He’s wrong. As the Independent Institute’s Robert Higgs has already pointed out, consumer spending has already recovered to pre-recession levels. It’s investment that’s continued to tank. Why? Maybe because investors have no idea what hiring and business conditions will look like in the future due to President Obama’s regulatory onslaught — 75 new major rules since 2009 including Dodd-Frank and Obamacare.

“Unemployment insurance is another automatic stabilizer,” Orszag writes, “as the economy weakens, unemployment insurance expands, providing a boost to demand right when the economy needs it.” Again, increased consumer demand without increased economic output will not fix the economy. The government is just redistributing resources. Unemployment insurance lengthens unemployment, which results in less production and less economic growth. We need to let people get back to work, not pay them not to.

“Automatic economic stabilizers” would be good if the government chose the right ones: less taxes, spending and regulation. Unfortunately, as the last few years have shown, they do not. Instead, what America needs is consistent rules that provide certainty for investors and allow businesses to plan for the future.