This column by ACRU General Counsel and Senior Fellow for the Carleson Center for Public Policy (CCPP) Peter Ferrara was published November 1, 2012 on Forbes.com.
A central theme of President Obama’s reelection campaign is that we can’t go back to the same economic policies that caused “the mess we are in,” by which he means the 2008 financial crisis. He identifies those policies as the same tax rate cuts and regulatory rollbacks supported by GOP nominee Mitt Romney. This is just about the only Obama theme that has resonated with at least some of the public.
But substantively the theme is foolish. There is no economic theory under which tax rate cuts cause recessions. Even under Keynesian economics, tax rate cuts are expansionary. Even Karl Marx never said that tax rate cuts cause economic downturns.
Tax rate cuts are inherently pro-growth because they increase incentives for productive activities, by enabling producers to keep a higher percentage of what they produce. The result is greater savings, investment, business start ups, business expansion, job creation, higher wages, and more economic growth, depending on exactly which tax rates are cut.
That is why when President Bush cut the capital gains tax rate from 20% to 15% in 2003, capital gains tax revenue doubled from 2003 to 2005. By 2006, capital gains revenues had run ahead of pre-tax cut projections by $133 billion. Similarly, after Bush cut the top tax rate applying to corporate dividend payments from nearly 40% to 15%, corporate dividends paid soared, and so did the tax revenues paid on those dividend payments.
And that is why after the Bush tax cuts of 2001 and 2003, federal revenues soared from 2000 to 2007 by 27%, or over half a trillion. The deficit in the last budget adopted by a Republican majority Congress was $161 billion in 2007, practically balanced compared to Obama’s four years of deficits well over a trillion dollars, or about 8 times as much. The day the Democrat Congressional majorities took office, January 3, 2007, the unemployment rate was 4.6%.
So how did these rate cuts cause the financial crisis? Obviously, they didn’t.
Similarly, after Reagan cut income tax rates across the board by 25% in 1981, and then adopted the 1986 tax reform reducing the top income tax rate from 70% when he entered office all the way down to 28%, the economy boomed throughout the 1980s, and federal revenues doubled, despite the rate cuts.
President Kennedy also proposed income tax rate cuts across the board by roughly 25%, which were enacted in 1964 after his untimely death. The next year, economic growth soared by 50%, and income tax revenues increased by 41%! By 1966, unemployment had fallen to its lowest peacetime level in almost 40 years. U.S. News and World Report exclaimed, “The unusual budget spectacle of sharply rising revenues following the biggest tax cut in history is beginning to astonish even those who pushed hardest for tax cuts in the first place.” Arthur Okun, the administration’s chief economic advisor, estimated that the tax cuts expanded the economy in just two years by 10% above where it would have been.
Moreover, President Bush was not noteworthy as a deregulator. Political propagandists try to argue that the bipartisan repeal of the New Deal era Glass-Steagall Act in 1999 contributed to the financial crisis. But just the opposite was true. The repeal of hopelessly outdated Glass-Steagall eased the financial crisis, by enabling commercial bank holding companies to purchase and rescue failing investment banks. E.g., JPMorgan Chase (or its holding company actually) bought out the failing Bear Stearns.
Glass Steagall was passed to prevent commercial banks taking government insured deposits from failing due to losses incurred through riskier investment banking activities (issuing stock and other securities). But the financial crisis did not involve commercial banks failing due to investment banking activities. It involved investment banks failing due to traditional commercial banking activities, such as issuing and holding mortgage backed securities. But that, of course, was not prohibited by Glass-Steagall.
Glass Steagall was repealed so American financial institutions could better compete with European and Japanese universal banks, which were not troubled by any Glass Steagall separations. By the time the repeal was enacted, modern financial innovations had created so many loopholes in Glass-Steagall regulations that the distinction between commercial and investment banking could no longer be maintained. These are the reasons why Democrat President Bill Clinton joined with overwhelming bipartisan majorities in Congress to repeal Glass-Steagall.
Even with that repeal, commercial and investment banking still could not be formally joined in the same banking corporation. The repeal meant only that a bank holding company, or parent corporation, could own both a commercial bank, and an investment bank. So government insured deposits still could not be used to speculate in riskier investment banking activities. This is why the reform only served to strengthen the financial community, and ease the financial crisis.
The financial crisis cost the American people trillions in investment losses, home equity declines, and unemployment and lost wages. The crisis and those losses were caused not by deregulation or tax rate cuts, but by the benighted market interventions of the last three Presidents.
The roots of the financial crisis began with the excessive, overregulation involved in President Clinton’s National Home Ownership Strategy, announced on June 5, 1995, though some of the same policies had been building for almost 20 years. That involved more than 100 regulatory initiatives to force banks to abandon their traditional lending standards and create the subprime mortgage market. Included were a vastly beefed up Community Reinvestment Act, actual or threatened discrimination suits by Justice and HUD to enforce regulatory requirements, and regulatory mandates on Fannie Mae and Freddie Mac to finance trillions in mortgage securities backed by subprime mortgages.
The depreciated lending standards spread throughout the mortgage market, including for higher income borrowers speculating in second and third homes, since once the lending standards were trashed for those with the lowest incomes and weakest credit, they couldn’t be denied to those who were more creditworthy. All this extra mortgage money flowing into housing gave birth to the housing bubble.
The government sponsored enterprises Fannie Mae and Freddie Mac were able to attract trillions in additional financing from the market because their securities were recognized as effectively government guaranteed. That pumped up the housing bubble further.
The leading credit rating agencies failed to do their job in rating these Fannie and Freddie subprime mortgage securities AAA, misleading everybody as to the real risks involved. But their ratings enjoyed privileged recognition in regulations governing investments by banks and other financial institutions, protecting them from competition, so they had incentives to avoid rocking the boat. This again was another problem caused by too much regulation.
George Bush contributed to the crisis too. Instead of Reagan’s strong dollar monetary policies that slayed inflation, Bush’s weak minded Treasury Secretaries supported weak dollar monetary policies with even negative real interest rates for years. Bush-appointed Ben Bernanke was already at the Fed in those years promoting that monetary deconstruction. That pumped trillions more into the housing bubble and other overconstruction, as cheap money and record low interest rates promote overinvestment in the longest term
Once the housing bubble inevitably burst in 2007, because it grew beyond what could be further supported, then all these chickens came home to roost in 2008. Mortgage backed securities comprised of toxic subprime loans had been spread throughout the world financial community by Fannie Mae and Freddie Mac. Major investment banks overinvested in those securities, further misled by negative real interest rates into massive overleveraging, went bust.
President Obama’s job was to manage a timely, robust recovery from this bust. But he pursued exactly the opposite of every pro-growth policy pursued by President Reagan. Instead of Reagan’s lower tax rates, Obama has pursued higher tax rates, coming to fruition on January 1 of next year. Instead of cutting spending as Reagan did with his much vilified budget cuts starting in 1981, Obama started off with a trillion dollar stimulus that has stimulated nothing except government spending, deficits and debt. Obama continued from there to become the biggest government spender in world history. Instead of reducing regulatory costs and burdens, Obama has gone wild with new regulatory costs and burdens, from EPA, to Dodd-Frank, to Obamacare, and beyond.
And instead of anti-inflation, strong dollar monetary policies that make every American holding a dollar richer, Obama has led the cheerleading for continued weak dollar, zero interest rate, pro-inflation monetary policies that have made every American holding a dollar poorer.
The result has been the weakest recovery since the Great Depression, with only a third or less of the growth in Reagan’s real recovery. Unemployment remained above 8%, until last month, for the longest period since the Great Depression. Millions more have dropped out of the work force, with the lowest labor participation rate in over 30 years. Real wages and incomes have plummeted, even more since the recession was supposedly over. Poverty and dependency have soared to the highest totals in American history.
Indeed, these and other Obama policies have only perpetuated the exact causes of the financial crisis. Obama’s regulators have continued to pursue many of the same subprime regulatory policies as Bill Clinton, including the Community Reinvestment Act (which should be repealed), and expanded lending discrimination suits for maintaining traditional lending standards in housing and in business lending. Moreover, the Obama Administration has led the cheerleading and maintained political cover for Helicopter Ben’s loose as a bordello monetary policies, with continued negative real interest rates for years. So Obama has already laid the groundwork for renewed recession and financial crisis, which can be expected on or about January 1, 2013, if Obama gets the chance.