There has been a general societal movement towards greater savings in the post-financial crisis period. Households and firms are saving more than they used to due to the weakened economy. Government has been faced with the choice of stimulating economic growth or confronting the budget deficit. To date, it has tried to spur the economy through low interest rates and increased spending. However, now, the big issue has become the budget deficit. Legislation to cut spending on both the local and national stage has been met with scrutiny and protests. The alternative to cutting spending would be to increase revenues through revised taxation. Republicans and Democrats disagree on this issue fundamentally, which has spurred the debate. Both sides have preached rhetoric attacking the American people’s fears about the job market. The problem with these two issues, cutting the budget deficit and creating jobs, is that may conflict with one another. Cutting spending directly addresses budgetary issues, but may hinder a recovering economy. Attempting to stimulate the economy and increase tax revenue through tax code revision might not address either issue. Cutting spending seems like the best way to tackle the budget deficit, but it is important to keep in mind what is being cut such that economic recovery is not negatively affected.
To understand why the GOP is so concerned with the budget deficit, it is important to understand the underlying economics. While it may seem counterintuitive to say it could have a negative impact on output, government spending can be bad when the government is increasing the national debt. First, increased government spending through increases in output and money demand increases the overall domestic interest rate, which can have a negative impact on consumption, investment, and net exports. Secondly, increasing the national debt through the deficit increases the size of interest payments on that debt. Recently, we have seen countries like Greece and Ireland seek bailouts because of the amount of debt they faced due to mounting debts. The GOP seeks to avoid that sort of situation by reducing government spending. It might be more important to decide what to cut rather than to unleash an all out assault on spending.
Wisconsin has come under the public eye both because of their attempts to pass legislation to cut spending as well as the heated reaction the legislation has received from unions. The key part of the legislation, which Republicans are having trouble passing because the Democrats have boycotted the vote, seeks to increase cost sharing of healthcare and pensions between government and government employees. These savings to government from increasing cost sharing would potentially save 5,500 state jobs and 5,000 local jobs. Private companies have already employed this type of cost sharing plan, so it makes sense for government to do this as well, particularly in Wisconsin where public employees enjoy higher salaries than their private counterparts. Why should government both provide better salaries and full benefits when private employers are not facing the same costs? It is not an efficient use of government funds to provide more than what the market dictates. While the pending issue is the limitation of collective bargaining, the spending cuts in this bill are in line with how government should target spending cuts. Government should try to make its spending more efficient while not hurting jobs.
The Wisconsin legislation gives us insight on the debate between Republicans and Democrats on the national level. After the House passed a $61 billion cut in government spending, Republican House Speaker, John Boehner, said, “we will not stop here in our efforts to cut spending, not when we’re broke and Washington’s spending binge is making it harder to create jobs.” In response, House democratic leader, Nancy Pelosi, disagrees “the Republican spending bill destroys jobs and their reaction is, ‘so be it.’” The key here is to understand what spending is being cut. In Wisconsin, they want to make spending cuts through cost sharing, taking measures similar to private enterprise and saving government jobs. The concern from Democrats is that spending cuts will slash program funding instituted to create jobs. Whoever is right in this regard is dependent on what the spending cuts actually intend to cut. The Democrats seem more intent on tackling the jobs issue than the budget problem.
The Democrats do not seem to have a definitive response to the budget issue, but certain actions that the Democrats are preaching could both help stimulate the economy and indirectly address the budget issue. In his State of the Union speech, Obama preached the need to revise corporate tax code, particularly in closing loopholes. The US corporate tax rate of 35 percent is amongst the highest in the world, but some companies pay much less than that. Obama hopes to simplify the code to lowering the rate, but making sure all companies pay the same rate. He believes this can be done without increasing the deficit. While it might not stimulate investment from these companies, it would resolve a key issue concerning these companies.
Many companies are currently cash rich, but are choosing to issue debt. Much of this money is overseas, so to bring this cash over, these corporations would be subject to the corporate tax. Since interest rates are low, companies are issuing cheap debt rather than bringing over foreign earnings. Companies would rather use foreign earnings to invest in lower yielding foreign assets, borrow money, or even not invest in a potentially profitable project in the US with foreign earnings all because of the tax rate. This is hurting investment in the US and taking away jobs. Whether a lower corporate tax rate would stimulate corporations to bring their foreign earnings into the US remains to be seen, but it is clear that the current corporate rate is discouraging companies from bringing over foreign earnings. This could have significant implications on tax revenues.
The financial crisis and the recession have caused a notable decline in tax revenues. Tax revenues are down nearly $400 billion since 2007, and corporate tax income is down $175 billion over the same period. This is not due a change in the tax code because President Obama has maintained the tax status quo, recently extending the Bush tax cuts. The big difference, however, is that the unemployment rate has risen significantly, meaning less people have jobs, and therefore, there is less income to be taxed. They also had less money to consume, hurting companies’ revenues and their incomes that they could be taxed upon. If simplifying the corporate tax code can spur investment in the US and create jobs, it would help reverse this trend. Unfortunately, there is no definitive effect from taking such measures. Changing the tax code does not mean that companies will invest, thus creating jobs and increasing tax revenues. It does not tackle the deficit problem head on like cutting spending.
Both Republicans and Democrats will debate this issue because they think they know what is best for the country. While the budget deficit is of significant concern, it is further complicated by the recession and the need to create new jobs. Cutting spending is complicated because it can save jobs by making government spending more efficient, but it can also cut programs that would create new jobs. However, it guarantees to tackle the issue head on. Hoping that spending and changing the corporate tax rate will stimulate job growth and tax revenues is not a certainty. In deciding a compromise, Democrats and Republicans must decide what measures will have the most positive impact on the economy.
