Five Economic Mistakes Obama is Making
David Barker

To ensure long term prosperity, Obama needs to be smarter about tax cuts, stimulus spending, and his rhetoric towards business

The economy is improving, but problems remain. Should President Obama receive credit for the improvemen or blame for the problems? Obama took office after the worst financial panic since the Great Depression, and the stock market crash following his inauguration suggests that investors expected worse to follow. The economy has partially recovered, meaning at least that Obama hasn't made mistakes big enough to prevent annualized GDP growth improving from negative 6.7 percent in early 2009 to 3 percent in late 2011, and unemployment from 9.9 percent to 8.2 percent, all while core inflation has generally remained below 2 percent. But even though the economy looks promising in the short run, the administration is making mistakes that threaten long run prosperity. Here are a few:

1. Unnecessary Tax Cuts

The federal government needs revenue. Current receipts are well below the post-World War II average as a percentage of GDP. Balancing the budget by cutting spending might be better than raising taxes, but as long as spending remains high, it has to be paid for somehow.

The most prominent tax cut supported by President Obama was the reduction in the employee portion of payroll taxes from 7.65 percent to 5.65 percent for one year. The idea behind the cut was to stimulate spending by putting more money in the hands of workers. But by announcing that the cut was temporary, the administration informed workers that they should save the money, because taxes will go up next year. One of Milton Friedman's greatest insights was that temporary windfalls are saved, while permanent increases in income are more likely to be spent.

Bank reserves are well above regulatory minimums, so additional reserves gained from worker savings will not increase lending, and so will not stimulate the economy. The tax cut will cost the federal government an estimated $93 billion, adding to an already staggering amount of debt.

Obama pushed other, less well known tax cuts. One example is bonus depreciation, enacted first in President Bush's stimulus package, but doubled by the Obama administration. In 2010 and 2011, companies were allowed to deduct in a single year the entire value of new assets that will last up to 20 years. Since many of these assets would have been purchased anyway, tax revenue was lost with no offsetting increase in investment. What's more, when Obama doubled the tax incentive in December of 2010, he made the change retroactive to September, a gift to investors whose deals had already been completed.

2. Inefficient Stimulus Spending

Academic studies suggest that stimulus spending did boost the economy -- but not all spending is created equal. Infrastructure spending and aid to poor families had the biggest effects, while grants to states for education and law enforcement had negligible, or even negative effects. The only stimulus from this kind of spending is political, as the administration rewards powerful allies. The same studies show that states with more senior congressional delegations received the most per capita spending.

Overall, the best estimates suggest each job lasting one year created by stimulus spending cost somewhere between $170,000 and $400,000. According to government surveys, the average job pays approximately $63,000, and an average job in the bottom half of the income distribution pays around $20,000. If the primary goal of stimulus spending was to boost employment, a great deal of money appears to have been wasted, even allowing for the fact that job creation requires capital expenditure in addition to wages. Only 7 percent of stimulus spending was budgeted for infrastructure, and much of that spending has been delayed.

The reason wasteful stimulus spending matters, of course, is that the money borrowed to pay for it must be repaid someday. That money will come from taxes, which will depress the economy. It might be worth it to gain stimulus in bad times at the cost of higher taxes in better times, but waste is still costly, so it is best to spend stimulus dollars with care.

3. Failure to Liberalize Markets

Before the financial panic of 2008-2009, the United States had less unemployment than most of the developed world. Many economists believe that this was because of the flexibility of U.S. labor markets. Flexibility means employers are free to fire workers without penalties, wages are not heavily regulated, tax rates are moderate, unions do not dictate work rules or hiring practices, and unemployment benefits are low.

A consequence of flexibility is that unemployment rises during economic downturns. The U.S. unemployment rate briefly exceeded that of the European Union in 2009, but is now back below the European Union rate. While painful in the short run, labor market flexibility keeps employment high over the long run. Flexibility is also important in financial, product, and housing markets.

European countries are proposing significant deregulation of labor and other markets. Instead of stimulus, they hope that structural reform of their economies will produce growth. The U.S. economy has plenty of structural issues that could be addressed, such as the increasing number of occupations that require licensing, frivolous lawsuits, and red tape discouraging household employment.

Instead of structural reform, the Obama administration has proposed new restrictions on employers and has helped unions to reduce employer flexibility. At a time when many countries are improving their scores on indices of economic freedom, the United States is losing ground.

4. Demonizing Business

Nobel Prize winning economist Robert Lucas recently suggested that Franklin Roosevelt's demonization of business contributed in part to the long duration of the Great Depression. Anti-business rhetoric from the White House causes business to worry about future taxes and regulations, and to cut back on investment plans.

While Obama's rhetoric is less harsh than FDR's, he has given business cause to worry. He has talked of "fat cat bankers," wealthy people and Wall Street executives "makin' out like bandits," the "unchecked power" of insurance companies, suggested that "now's not that time" to make profits and bonuses, and said that his goal after the BP oil spill was learning "whose ass to kick."

Combined with new regulations on the healthcare and financial industries and constant talk of higher taxes on "the wealthiest," this rhetoric convinces businesspeople that if they invest and succeed, their profits might be taxed or regulated away.

5. No Long Term Plan

Probably the most serious shortcoming in Obama's economic strategy is the lack of a long term plan to reduce government debt. In his 2013 budget, the president claims to lay out a strategy to put "the nation on a sustainable fiscal path" but that same budget proposal contains supplemental materials forecasting that federal debt will eventually rise to nearly 200 percent of GDP, not including shortfalls in Social Security and Medicare which are even larger, according to the Treasury Department's own financial statement. Testifying before Congress, the president's Treasury secretary said, "You are right to say we're not coming before you today to say 'we have a definitive solution to that long term problem.' What we do know is, we don't like yours." Not only is there no long term plan, but the Senate, controlled by the president's party, hasn't passed an annual budget since 2009.

Businesses are understandably reluctant to invest at the moment, knowing that if debt isn't reigned in there must eventually be dramatic spending reductions, tax increases, inflation, or a default on federal obligations. If they at least knew which to expect, they would invest more.

David Barker is a former Federal Reserve economist and the author of Welcome To Free America.