March 2011

A Supply-Side Solution Based on Limited Government

By John Hendrickson

“The best way to revive the economy is not to cut the federal deficit right now. It’s to put more money into the pockets of average working families. Not until they start spending again big time will companies begin to hire again big time,” argued former Secretary of Labor Robert Reich, who served in President Bill Clinton’s administration.[1] In other words Secretary Reich is arguing for more Keynesian style — prime the pump — economics that have failed to resolve unemployment and restore the economy. The current policy debate facing policymakers centers on government spending and taxation. President Barack Obama has recently proposed a $3.7 trillion budget for 2012, which if enacted by Congress, would be the largest budget in history. Government spending is already 25 percent of Gross Domestic Product (GDP). The idea and philosophy that more Keynesian stimulus or “investment” spending will create economic stability should be dismissed. Policymakers should pursue a policy solution based on supply-side economics and limited government.

Historically Keynesian economics have not worked well in solving recessions or depressions. During the Great Depression, President Franklin D. Roosevelt utilized many Keynesian style stimulus measures in order to resolve unemployment, create demand in the economy, and create economic growth. Roosevelt’s bold experimentation did not resolve unemployment nor end the Great Depression. In fact, Roosevelt’s Treasury Secretary Henry Morgenthau, in response to the administration’s policies stated: “We have tried spending money. We are spending more than we have ever spent before and it does not work.”[2]

The economy is still struggling to recover and unemployment remains at 9 percent. Businesses are still uncertain over the massive increase in regulations, the new health care law (the Patient Protection and Affordable Care Act), and the escalating debt and deficit. The national debt is over $14 trillion — and rising — and the federal government is running deficits in the trillions. The deficit for 2011 is projected to be $1.5 trillion and this is on top of $1.4 trillion deficit in 2009 and a $1.3 trillion deficit in 2010, and the deficits are projected to continue if spending is not reduced. In addition the entitlements, such as Social Security, Medicare, and Medicaid, are increasing in cost and are threatening to bankrupt the nation. It is estimated that the unfunded liabilities of entitlement programs will be up to $100 trillion. The Patient Protection and Affordable Care Act will be an additional burden on the budget unless it is repealed or declared unconstitutional by the United States Supreme Court.

The massive increased levels of government spending have not been seen since World War II and this is also causing uncertainty in the economy as businesses and individuals are worried about tax increases, higher interest rates, and even possible default if spending is not controlled. Inflation is another factor as demonstrated by higher commodity prices and the possible side-effects of the “Quantitative Easing” policies of the Federal Reserve.

Policymakers need to implement supply-side solutions based in limited government, which means reducing spending, lowering taxes, and eliminating hurtful and unnecessary regulations. The Administration’s budget proposal contains tax increases, including repealing portions of the Bush Tax Cuts. The budget proposal “includes (yet disguises) a massive tax hike on small businesses and investors and is otherwise bereft of ideas for reforming the income tax to strengthen the economy in the future.”[3] Tax increases would be a setback for the economy and certainly would not help the employment situation.

Further tax reform needs to be considered including lowering the corporate tax rate. President Obama has hinted at lowering the corporate tax rate and lowering this tax would allow American businesses to be more competitive in a global economy and also help in job creation. Historically cutting taxes has worked as a stimulus for the private sector of the economy. As economic historian Burton Folsom wrote:

 If spending our way deeper into debt doesn’t work, what does? Answer: Increase incentives to invest. For example, if we lower tax rates, we tell investors they can keep more of what they earn. That gives them incentives to expand, hire new workers, and try to create new products — or better existing products — that consumers will want to buy…The U.S. tried this strategy of across the board tax cuts in the 1920s and 1980s, and those two decades were among the most prosperous decades in U.S. history.[4]

Policymakers must pursue a policy of reducing government spending in order to avoid the looming fiscal crisis. Republicans are currently pushing to cut $100 billion from the budget and Senator Rand Paul (R-KY) has even proposed cutting $500 billion from the budget. Representative Paul Ryan (R-WI) is also pushing for spending reductions and his “Roadmap” proposal addressed reforming entitlement programs. On a bipartisan level the Simpson-Bowles Debt Commission has offered some significant recommendations on entitlement reform and spending reductions which deserve serious consideration.

“The most severe economic emergencies of the past century were suffered before the elections of 1920, 1932, and 1980.”[5]  In these economic emergencies Presidents Warren G. Harding, Franklin D. Roosevelt, and Ronald Reagan all handled economic policy differently. Both Harding and Reagan advocated tax, spending, and regulatory reductions, while Roosevelt followed the opposite course. In the economic and spending crisis of today policymakers must follow a policy rooted in tax, spending, and regulatory reductions. This is the supply-side and limited government solution, which is also rooted more closely with constitutional government.

John Hendrickson is a Research Analyst at Public Interest Institute.

The views expressed herein are those of the author and not necessarily those of Public Interest Institute or Tax Education Foundation. They are brought to you in the interest of a better-informed citizenry.

[1] Robert Reich, “The Obama Budget: And Why the Coming Debate Over Spending Cuts Has Nothing to Do With Reviving the Economy,” February 13, 2011, RobertReich.org, < http://robertreich.org/> accessed on February 15, 2011.

[2] Henry Morgenthau, quoted in, Burton Folsom, Jr., New Deal or Raw Deal: How FDR’s Economic Legacy Has Damaged America, New York, Threshold Editions, 2008, p. 2.

[3] J.D. Foster, “President Obama’s 2012 Budget Builds on Failures of the Past,” WebMemo, No. 3152, February 14, 2011, The Heritage Foundation, <http://www.heritage.org/Research/Reports/2011/02/President-Obamas-2012-Budget-Builds-on-Failures-of-the-Past> accessed on February 14, 2011.

[4] Burt Folsom, “Will our nation come to its senses?” BurtFolsom.com, February 11, 2010, <http://www.Burtfolsom.com> accessed on February 15, 2010.

[5] Garland S. Tucker, III, High Tide of American Conservatism: Davis, Coolidge, and the 1924 Election, Austin, Texas, Emerald Book Company, 2010, p. 306.