"The Economy Finally Takes Center Stage as Election Nears"

Sydney M. Williams

Thought of the Day

“The Economy Finally Takes Center Stage as Election Nears”

September 2, 2010

Tuesday night, speaking from the Oval Office, President Obama marked the end of “Operation Iraqi Freedom” and said, as reported in the New York Times, that “he sees his primary job as addressing the weak economy…” A focus on the economy will, of necessity, include a debate over taxes, a subject of increasing tensions with adamancy on both sides subsuming reasonable debate. It will also bring the plight of small business, the employer of most U.S. workers, to the forefront. The way out of recession and toward long term prosperity depends on private employers.

The Obama-Biden plan for small businesses incorporates some sensible recommendations, including eliminating all capital gains on small and start-up businesses, doubling federal funding for basic research, making the research and development tax credit permanent, and promoting broadband to every community in America.

But the plan also displays the administration’s predilection for extending their tentacles into the reaches of business and promotes the concept of a wise, paternal and bigger government. For example, the administration, with shades of the 1996 Affordable Housing Act hovering overhead, would expand the Small Business Administration’s loan and micro-loan programs which provide start-up and long-term financing for small firms that are unable to receive through normal channels. They would implement the Women Owned Business program, a plan that helps women set up enterprises that would like to do business with the federal government; additionally, they want to increase the access to venture capital by minority owned firms.

The goals may be noble, but should the purpose of government, in times of economic distress, be to stimulate growth or to promote equality of outcomes? Keep in mind that about 50% of the approximately 600,000 new businesses that start each year fail after five years and about 70% fail after ten years. It is nature’s equivalence of the survival of the fittest. An overreliance on Uncle Sam may breed bad habits and risks a descent down a slippery slope toward an agency modeled on other GSEs, like Fannie Mae, Freddie Mac or Sallie Mae. More than anything else entrepreneurs must be self-starters. The most important thing government can provide entrepreneurs are clearly defined rules, a sense of stability and a tax base that allows them to compete in a global environment. Nevertheless, access to credit has been a problem. While according to the New York Times, the Federal Deposit Insurance Corporation’s quarterly report showed that the banking sector is beginning to recover, the number of “problem banks” reached 829 in the second quarter, an increase of 54 from the first quarter. Tighter lending standards, coupled with their experiences during the 2008-2009 recession, have naturally made banks more cautious.

More than anything else, as we and others have repeatedly argued, the administration needs to restore confidence. An article in Monday’s Washington Times reported that “a recent Labor Department survey found that businesses with fewer than 50 employees – which normally create as much as 75% of all jobs – accounted for 62% of all job cuts and only 54% of new jobs at the end of last year.” A complex healthcare bill, a fragile recovery and uncertainty about taxes have made business people nervous and wary.

The question of extending the Bush Tax cuts of 2001 for those earning more than $250,000 will be first on the agenda. There appears to be a general agreement about extending the cuts for those earning less. What complicates the issue is that about 30 million tax returns report small business income: sole proprietorships, and pass-through entities in the form of partnerships and S-corporations. Many of those would be negatively affected by an increase in taxes.

The question as to the impact of tax increases has been debated endlessly. David Leonhardt, in the New York Times, quotes Moody’s Analytics as estimating that “a new rebate would have about three times as large an effect on growth next year as would making all the 2001 tax cuts permanent.” He also praises last year’s cash-for-clunkers program, though he acknowledges that “of course, no temporary tax cut will solve the economy’s long-run problems.” I am left perplexed.

On the other hand, the Joint Economic Committee of the Congress of the United States in an April 1996 white paper, “The Reagan Tax Cuts: Lessons for Tax Reform”, notes: “the reduction of high marginal tax rates actually increased payments by the rich”. That has always been the case. The Committee’s report goes on to state: “High marginal tax rates discourage work effort, saving and investment, and promote tax avoidance and tax evasion.” The economic benefits of the Economic Recovery Tax Act (ERTA) of 1981 were summarized by President Clinton’s Council of Economic Advisers in 1994: “It is undeniable that the sharp reduction in taxes in the early 1980s was a strong impetus to economic growth.”

The economy needs focus and the President’s words were welcome. Confidence remains low. Corporations, alone, remain in good shape. Their cash levels remain high; M&A has been active, yet investment in green-field expansion, which would encourage hiring, is low. The costs of the enormous federal deficits are being masked by very low interest rates and relatively short maturities. A back up in rates will raise the costs of borrowing and aggravate the deficits. (In fact any business depending upon short term financing is at risk to the potential to rising rates, which will happen.)

It is the economy, and specifically jobs, that has been the principal concern for the majority of people for the past year and a half – not healthcare, not the bankers, and not Iraq or Afghanistan. Remarkably, there has been no bill proposed by the president or Congress as to what to do when the Bush tax cuts expire in four months. Equally disturbing, the administration has chosen to wait until after the mid-term elections to hear the recommendations of the deficit commission. Common sense suggests the focus must be on growing the economy and addressing the deficit. We are pleased that this has become the President’s focus; however, the risk is that ideology interferes with needed changes.

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I will be out the next few days, back in the office on Friday, September 10. My best wishes for a labor-free Labor Day.