Friction and Fiction

Paul Krugman has an op-ed piece in the New York Times today explaining why President-Elect Obama should do away with the tax cuts in his recovery plan and focus instead on more comprehensive spending programs. While Mr. Krugman’s knowledge of all things economic far outweighs my own, I feel that he overlooked a few essential reasons to keep the tax cuts. The bullet points in their favor are, not surprisingly, more political in nature than they are economic.

First, though, let’s take a look at Krugman’s argument. His main point is that the tax cuts will be ineffective. At a time when American workers have less job security, less money overall, and less access to lines of credit, the most intuitive way to spend the money from a tax rebate is simply not to. Most people will save it. This, in itself, will do little to “jump start” the economy. The $150 billion proposed for the business tax cuts and the additional $150 billion proposed for the payroll tax cuts (although Krugman concedes the latter was indeed a campaign promise), he argues, could be better utilized in a more poignant fashion. In a strictly financial sense, I agree.

However, if we broaden our perspective to include the political implications of the proposed payroll and business tax cuts, we see a drastically different picture. The image of Senate Minority Leader Mitch McConnell smiling and openly supporting Obama’s recovery package tells the entire story. I don’t, however, wish to use facial expressions as my main body of evidence, so let’s look a little deeper.

Through 2010, there will (likely) be 41 Republicans in the U.S. Senate. While they are greatly outnumbered by Democrats, if these Republicans are unified, they present a potential filibuster threat. As we have learned through all of American politics, the quickest way to unite a party, and thus enhance the likelihood of a filibuster, is to polarize the political spectrum. When party loyalty supercedes common sense, both sides can at times transform into a single-minded conglomerate of impatience. And we simply cannot afford such a deadlock in the next two years, not when we are crossing the threshold of what many are calling a “slow-motion depression.”

The advantage to having our financial system crumble slowly is that we may watch and analyze in real time. While we did pass through a few weeks of unfettered chaos in late September and early October, we have to remember that this time around, the markets did not simply crash, the worst case scenario of the credit freeze has thus far been avoided, and there is still some liquidity to our capital. But this does not mean we are safe. It simply buys us time. In order to take advantage of this Matrix like slow down (the bullets are still headed straight for us; they’re just moving very slowly), we have to act quickly. A legislative body in a polarized political deadlock will most certainly move more slowly than we can afford.

Those of you particularly gifted in the detection of nuance have, by this point, inferred that I am calling the Congressional Republicans immature. Partly yes, but more situationally. We have all witnessed blatant and counter-productive stubbornness from both sides. At a time when Democrats hold the majority in both houses and a democratic president is about to be sworn in, the Republicans are the ones who will likely throw a temper tantrum. But in giving to the Republicans reasons to support his plan, Obama is employing a little extra maturity in order to avoid a future partisan death grip. Call it appeasement, call it a pacifier, call it politics as usual– the point is: it works.

Krugman cited an Obama team’s projections of unemployment rates over the next few years both with and without the proposed recovery/stimulus plan, as well as projections by private analysts. Both look grim. If we do nothing, the Obama team predicts an unemployment rate of up to, possibly over, 8% in the next two years, whereas the rate with the proposed plan will be held under 7%. Some of the private analysts are expecting a doomsday 11% in the absence of government intervention, which could be enough to reach the tipping point, where, as Krugman points out, the U.S. might fall into a “Japan-type deflationary trap.” He says that the government must do more in terms of spending to avert these devastating numbers. And he is right.

But at the same time, by putting $300 billion into tax cuts now, steep as it may seem, Obama has thrown the Republicans an ideological bone. He has shown that he understands conservative economic thought, and, even if said ideology is best applied in other situations, he has shown that he is willing to concede substantively in order to achieve a higher end. This gains Mr. Obama an enormous amount of political capital, which in turn could become invaluable when he must push legislation not popular among Republicans. After this point, all he’ll need to do is convince one Republican to side with him in order to defeat a filibuster. Right now, he has the lot of them convinced.