In the November 16th, 2010 Real Clear Politics editorial from Thomas Sowell, he makes the case that Obama's motives are not pure in terms of addressing our outsized budget deficit. Sowell is a respected economist, who holds strong conservative views of government and the economy. He is distrustful of an expanding role of government and an avid advocate of free markets. In this editorial, he believes that Obama formed a bipartisan commission as a ruse to increase tax revenues to cover up for irresponsible spending.
Sowell was highly critical of Obama's emphasis on expanding the role of government in addressing the economic crisis. As noted in August 18th, 2010 CBO Executive Summary of Budget and Economic Outlook, we can see that large federal deficits have occurred over the last two years under Obama's watch. In 2009, our annual budget deficit was over $1.4 trillion and only slightly decreased to over $1.3 trillion this fiscal year. Both figures are the largest in 65 years when looking at them relative to the size of the U.S. economy.
In Obama's defense, one could argue that private sector investment slowed to a crawl due to a financial crisis that almost crippled our financial system. Despite the efforts from the Fed to replenish reserves of failing financial institutions, one could argue that our economy was in a liquidity trap. That occurs when an expansion of money supply does not result in much economic activity. In those instances, Keynesian economists would argue that government needs to play a stronger role to make up for the shortfall of private sector activity. As noted in Howard Penney's Fortune article where he interviews Obama's former budget director, Peter Orszag, we can see that private sector borrowing declined significantly during the period of 2007 and 2009. Whereas private sector borrowing represented 30% of GDP in 2007, it dropped dramatically to -15% of GDP in 2009.
Most of his editorial was aimed at Congress's stimulus legislation which he thought was too expensive. While around a third of the stimulus package consisted of tax cuts for the middle class and small businesses, there were increases in education, infrastructure, and alternative sources of energy. In addition, funds were distributed to the states to help them with mounting deficits that arose from slowing economic activity. In particular, Sowell took aim at various spending items that he felt benefited Obama's constituency such as teachers, unions, and advocates of green economy jobs.
By setting up a bipartisan commission in looking at the deficit as detailed in my November 11th, 2010 blog entry, Sowell believes that Obama is trying to find cover for raising taxes. While the recommendations called for across-the-board cuts in individual income tax rates, the elimination of mortgage interest deductions and child tax credits would actually increase the tax burden on most Americans. Also, there will be limited raise in the gasoline tax between 2013 and 2015. He also does not like the cuts in defense spending, given the current turmoil present throughout the globe. According to Sowell, these proposals would not have been needed if Obama and Congress were not so loose with the taxpayer purse strings.
While Sowell references the benefits of tax cuts, I thought this was somewhat misleading. Even though he correctly interprets past history where revenues increased when tax rates were cut, this can be a deceptive when reading this Heritage paper written by Arthur Laffer on June 1st, 2004. When Sowell mentions the tax cuts in 1920s and the Kennedy tax cuts in the 1960s, the marginal tax rates were much higher than they are now. Laffer is best known for developing the Laffer Curve, which suggests that very high tax rates will cause revenues to decline. However, it should also be noted that very low tax rates will also cause revenues to decline, thus there is an optimal tax rate that can be imposed to maximize revenues. This optimal tax rate was never identified by Laffer because it depends on various circumstances relating to specific characteristics of the present tax system, the level of underground activity, and amount of tax loopholes.
In summary, I thought Sowell's economic facts were accurate and policy analysis was reasonable, but I thought some of his inferences were deceptive and incomplete. I think he makes a valid point that Obama formed the bipartisan commission on the federal deficit to prepare Americans that additional revenue sources need to be found. However, I think the budget outlook was dire even before Obama came to office and requires a solution that involves a shared sacrifice of eventual tax increases and government spending cuts. Otherwise, you have a scenario where some combination of national security, education, and social programming would be unduly compromised. Lastly, I would have liked him to more fully explain the Laffer Curve and the impact that tax rates have on overall revenues. It was unclear how cutting current marginal tax rates, which are much lower than those in the 20s and 60s, would generate similar increases in tax revenue. Of course, I realize this clarification would weaken his overall argument.
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