The Romney Program for Economic Recovery, Growth, and Jobs R. Glenn Hubbard (Columbia University), N. Gregory Mankiw (Harvard University), John B. Taylor (Stanford University), and Kevin A. Hassett (AEI) The U.S. economy has the talent, ideas, energy, and capital for the robust economic growth that has characterized much of America’s postwar experience. Our living standards going forward, and the nation’s standing as a world power, depend on restoring that growth and broadly shared prosperity. We are presently in the most anemic economic recovery in the memory of most Americans, with significant joblessness and long-term unemployment, as well as lost income and savings. We are stuck in a low-growth trap following the 2007-2009 recession and financial crisis. The anemic job growth and tragically high unemployment are a consequence of that low-growth trap. The recent second quarter 2012 Gross Domestic Product (GDP) growth estimate of 1.5 percent, following 2 percent growth in the first quarter, makes a stark fact clear: The economy is not getting stronger, it’s getting weaker. The Obama administration says that the economy’s awful performance reflects the reality of the aftermath of a financial crisis and that the administration’s policies generated what little recovery we have seen from the severe 2007-2009 recession – Americans should stay the course. But the historical record is clear: Our economy usually recovers quickly from recessions, and the more severe the recession, the faster the subsequent catch-up growth. For example, recent research by Michael Bordo of Rutgers University and Joseph Haubrich of the Federal Reserve Bank of Cleveland makes clear from historical data that a slow growth recovery is not inevitable. In fact, each year, the administration has forecast just such robust growth for the year ahead, and each time these hopes have been dashed. These repeated forecasts contradict the administration’s excuse that slow growth is the inevitable result of the recession and financial crisis. If a slow recovery were the predictable aftermath of a financial crisis, why has the administration continued to forecast a robust recovery? America took a wrong turn in economic policy in the past three years. The United States underperformed the historical norm shown in the administration’s own forecasts, and its policies are to blame. To see why, we will explore the administration’s economic errors and poor choices. Understanding why the administration’s policies have stuck the economy in a slow-growth trap, we can explain how different economic ideas and choices can move us forward. The Romney economic program will change the direction of policy to focus on economic growth. Its pro- growth effects will work in two basic ways: It will speed up the recovery in the short run, and it will create stronger sustainable growth in the long run. 1 From President Obama: Misdiagnosis and Mistakes in Economic Policy The 2007-2009 financial crisis produced a severe recession. GDP fell 4.6 percent from its peak during the recession to the trough in June 2009. But GDP growth has been anemic since then, averaging just 2.2 percent per year since the trough. This pattern is unusual. The past ten recessions have been followed by faster recoveries, and GDP has fairly swiftly recovered to the previous trendline. Declines in business investment and employment were particularly sharp in this recession. Far from being a lightning bolt hitting a smoothly running economy, the crisis was exacerbated by structural biases against business investment (from the tax code and regulation), financial imbalances (particularly fueled by biases against private saving and by the need to borrow abroad to finance our government deficits), and regulatory choices (excessive promotion of housing investment and inadequate attention to existing financial regulations and the rise of and consequences of shadow banking). No single party or administration is responsible for structural headwinds to growth, but the Obama administration’s errors and choices exacerbated the economy’s structural problems and weakened the recovery. Rather than focusing on the structural problems revealed by the financial crisis and the ensuing recession, the Obama administration focused on short-term fiscal ‘stimulus.’ To put the economy back on track, they borrowed deliberately and spent recklessly, ignoring weaknesses in housing, business investment, and employment. These short-term stimulus packages were ineffective, leaving the nation with higher debt, which acts as a drag on long-term growth because households and businesses understand that the administration must raise taxes significantly to pay off that debt. The negative effect of the administration’s ‘stimulus’ policies has been documented in a number of empirical studies. Research by Atif Mian of the University of California, Berkeley, and Amir Sufi of the University of Chicago showed that the cash-for-clunkers program merely moved new car purchases ahead a few months with no lasting effect. John Cogan and John Taylor of Stanford University examined the 2009 stimulus act and found that the temporary payments and credits sent to people failed to jumpstart consumption, just as predicted by basic economic theory. Moreover, federal grants sent to the states for infrastructure investment were either stashed away in state or local coffers or had the perverse effect of reducing government purchases of goods and services due to various strings attached to the grants. A core error in the administration’s approach was to assume that short-term stimulus, many times if needed, would put the economy back on a sustainable long-term growth path. Rather, attention to long-term structural problems in taxation, spending, and regulation would have offered a better tonic for growth in the short run. Indeed this is the conclusion of a number of economists with policy and empirical experience as documented in a recent book edited by Lee Ohanian, John Taylor, and Ian Wright. In short, the Obama administration chose to emphasize short-term fixes – ineffective stimulus, cash for clunkers, myriad housing programs that went nowhere, and a rush to invest in ‘green’ companies irrespective of cost – rather than restoring long-term growth and productive private- sector job creation. 2 As a consequence of short-termism, uncertainty over policy – particularly over tax and regulatory policy – limited both the recovery and job creation. One recent study by Scott Baker and Nicholas Bloom of Stanford University and Steven Davis of the University of Chicago found that this uncertainty reduced GDP by 1.4 percent in 2011 alone, and that restoring pre-crisis levels of uncertainty would add 2.3 million jobs in 18 months. These attempted short-term fixes, even with unprecedented monetary accommodation, produced average real GDP growth of just 2.2 percent over the past three years, and the consensus outlook looks no better in the year ahead. The accompanying sustained increases in debt raise the specter of large future tax increases, further chilling business investment and job creation today. In addition to these policy errors, the Obama administration has made choices to bypass reforms that would jumpstart long-term growth and job creation. Such reforms would address our anti- competitive tax code and unsustainable trajectory of federal debt – but the president ignored his own deficit commission and submitted no plan for entitlement reform. Treasury Secretary Geithner famously told the Congress that the administration was putting forth no plan, but “what we do know is that we don’t like yours.” Such reforms would also emphasize opening global markets for American goods and services, and improving access to goods and services for American consumers. Yet the president has made no contribution to the global trade agenda, and was only recently dragged into supporting individual trade agreements. The president’s choices cannot be ascribed to a political tug of war with Republicans in Congress. President Obama and Democratic congressional majorities had two years to tackle any priority they chose. Their priority was not growth and jobs but rather a regulatory expansion. The Patient Protection and Affordable Care Act raised taxes, unleashed significant new spending, and raised hiring costs for workers. The Dodd-Frank Act missed the mark on housing and “too-big-to-fail” financial institutions, but raised financing costs for households and small and mid-sized businesses. President Obama’s budget initiatives have stymied growth. The administration has thrown up impediments to domestic energy production and energy security. His plan to raise marginal tax rates on upper-income Americans and on saving and investment (through higher tax rates on dividends and capital gains) fly in the face of tax reform needed to increase American investment and competitiveness. A recent study by Ernst & Young concludes that the president’s policies would reduce GDP by 1.3 percent (or $200 billion per year), destroy 710,000 jobs, depress investment by 2.4 percent, and reduce wages and living standards by 1.8 percent. According to the Congressional Budget Office, the large deficits codified in the president’s budget would reduce GDP during 2018-2022 by between 0.5 and 2.2 percent compared to what would occur under current law. And America’s weakened fiscal position puts our international economic leadership in jeopardy, which in turn negatively affects economic growth. These economic errors and policy choices have consequences: high unemployment, high long- term unemployment, and ranks of discouraged workers. And most startling: At the present rate of job creation, the nation will never return to full employment. 3 From Governor Romney: A Better Way It doesn’t have to be this way: this tough spot reflects economic errors and policy choices. Economic policy must change course. And the American people have a choice. A policy agenda focused on job creation, rising incomes, and broadly shared prosperity is a choice we can make. That choice is Governor Romney’s economic plan for America. Governor Romney’s economic plan will completely change the direction of economic policy. It will emphasize the long-term changes that will increase GDP and job creation, both going forward and now. It will put growth and recovery first. The Romney plan has three overarching objectives: to restore confidence in America’s economic future, to make America once again a place to invest and grow, and to provide opportunities for Americans to compete and succeed. These objectives are all about unlocking the potential for innovation, investment, and initiative in America’s dynamic economy. The Romney plan will achieve these objectives with four main economic pillars: Stop Runaway Federal Spending And Debt. o Reduce federal spending as a share of GDP to 20 percent – its pre-crisis average – by 2016. o In so doing, reduce policy uncertainty over the need for future tax increases. Reform The Nation’s Tax Code To Increase Growth And Job Creation. o Reduce individual marginal income tax rates across-the-board by 20 percent, while keeping current low tax rates on dividends and capital gains. Reduce the corporate income tax rate – the highest in the world – to 25 percent. o Broaden the tax base to ensure that tax reform is revenue-neutral. Reform Entitlement Programs To Ensure Their Viability. o Gradually reduce growth in Social Security and Medicare benefits for more affluent seniors. Give more choice in Medicare to improve value in health care spending. o Block grant the Medicaid program to states, enabling experimentation to better fit local situations. Make Growth And Cost-Benefit Analysis Important Features Of Regulation. o Remove regulatory impediments to energy production and innovation that raise costs to consumers and limit job creation. o Repeal and replace the Dodd-Frank Act and the Patient Protection and Affordable Care Act. The Romney alternatives will emphasize better financial regulation and market- oriented, patient-centered health care reform. History and economic theory suggest the benefits that can be achieved with the Romney economic plan. Better policy raises long-run growth, returning to a trendline of more promising potential GDP growth, as opposed to the prospect of continuing sluggish growth forever. Good 4 policy also fosters recovery, a period of faster growth as the level of economic activity returns to normal. Without a change of course from the current administration’s policy choices, nearly non-existent economic growth is likely to continue at its current pace of approximately 2 percent per year. This pace of economic growth has left us with high unemployment and unused resources. If the current pace of economic growth were in line with the average of past recoveries from deep recessions, the economy would be creating more jobs. If we had a recovery that was just the average of past recoveries from deep recessions, like those of 1974-1975 or 1981-1982, the economy would be creating about 200,000 to 300,000 jobs per month. By changing course away from the policies of the current administration and ending economic uncertainty, as proposed by the Romney plan, we expect that the current recovery will align with the average gains of similar past recoveries. History shows that a recovery rooted in policies contained in the Romney plan will create about 12 million jobs in the first term of a Romney presidency. The Romney plan will also create stronger sustainable growth in the long run. The Romney tax reform plan will increase GDP growth by between 0.5 percent and 1 percent per year over the next decade. These long-run gains from tax and budget reform have been the subject of significant study by economists, as documented in the Appendix. We view these estimates as conservative as they fail to capture important, but hard-to-model, output gains from improved regulation, more certainty about the path of policy, and the aggressive agenda that Governor Romney has put forward with respect to energy, trade, education, human capital, and labor policy. Combined, and bolstered by sound monetary policy, we estimate that the Romney economic program will enable the private sector to create an additional 7 million net new jobs over the next decade beyond the improvement in employment from a more robust cyclical recovery in the short-term as a consequence of the Romney economic program. How large is the growth rate increase including both the short-term recovery and the long-term growth effects? Focus on the next decade. From 2013 to 2022, under CBO’s current projection, potential GDP will grow about 2.5 percent per year on average. Thus, under the Romney program, long run growth over this period would rise to between 3 and 3.5 percent per year. But because of faster growth during the recovery period, actual real GDP growth will be stronger over the decade. Measuring from the first quarter of 2013 through the fourth quarter of 2022, the average growth rate is expected to be approximately 4 percent per year with the upper long-term growth range, and about 3.5 percent with the lower long-term growth range. This compares favorably with the approximately 2 percent pace of the current recovery. Real GDP under the Romney plan will be between $5.5 and $6.5 trillion higher than today, and between $2.1 and $3.1 trillion higher in 2022 than it would be under a continuation of current slow growth. The difference between these expected outcomes and the record and plans of the Obama administration is stark. That difference reflects both new economic ideas and policy choices. 5 APPENDIX – GROWTH ESTIMATES FOR THE ROMNEY ECONOMIC PLAN Assessing growth effects from the change in economic policy under the Romney plan can be done by analyzing likely growth effects of individual elements of the plan (recognizing that some are more easily quantified than others) or by historical comparisons with earlier periods in which similar policies were enacted (recognizing the inherent difficulty in such benchmarking). Tax Reform. A significant body of economic research concludes that fundamental tax reform could increase real GDP growth over the next decade by 0.5 to 1 percentage point per year. Kevin Hassett and Alan Auerbach surveyed the literature and found that tax reform could increase output by between 5 and 10 percent. (Auerbach, J., Alan, Kevin A. Hassett, Toward Fundamental Tax Reform, Washington, D.C.: The AEI Press, 2005). David Altig, Alan Auerbach, Laurence Kotlikoff, Kent Smetters and Jan Wallsier found that reform proposals would increase GDP by between 5 and 9 percent over the long run, using a dynamic economic simulation model. (Altig, David, Alan J. Auerbach, Laurence J. Kotlikoff, Kent A. Smetters, Jan Wallsier, “Simulating Fundamental Tax Reform in the U.S.,” University of California, Berkeley, September 29, 1999). Young Lee and Roger Gordon found that a cut in the corporate tax rate by 10 percentage points would increase economic growth by 1.1 to 1.8 percent annually. (Lee, Young, Roger H. Gordon, “Tax Structure and Economic Growth,” University of California, San Diego, July 15, 2004) More recently a study by John Diamond of Rice University estimated that the Romney tax reforms will raise real GDP by about 0.6 percent per year over a decade and increase employment in the long run (above the level possible in a more robust cyclical recovery) by 7 million jobs. A long-term reform would also create a more stable tax code, which adds further gains in output by increasing policy predictability. The number of provisions of the tax code expiring each year has skyrocketed from 11 in 2000-2002 to 133 in 2010-2012. The epitome of the deviations from basic principles is the self-inflicted fiscal cliff where many important provisions of the tax code change at the end of 2012. Scott Baker, Nicholas Bloom, and Stephen Davis report the quantitative impact of this uncertainty (in their paper in Government Policies and the Delayed Economic Recovery edited by Lee Ohanian, John Taylor, and Jan Wright). One important feature of business taxation is the link between the taxation of unincorporated business income and the investment and employment decisions of unincorporated businesses. Using estimated effects of taxation from previous research, one can calculate the change in unincorporated business investment and employment as a result of the Romney program’s proposed lower marginal tax rates, as opposed to Obama’s proposed higher marginal tax rates. (See the research in Robert Carroll, Douglas Holtz-Eakin, Mark Rider, and Harvey S. Rosen, “Entrepreneurs, Income Taxes, and Investment,” in Joel Slemrod, ed., Does Atlas Shrug?: The Economic Consequences of Taxing the Rich. Cambridge: Harvard University Press, 2000; and Robert Carroll, Douglas Holtz-Eakin, Mark Rider, and Harvey S. Rosen, “Income Taxes and Entrepreneurs’ Use of Labor,” Journal of Labor Economics, April 2000.) Using similar research methods, the decline in the top effective rate in the Romney program raises the probability that a small business undertakes additional investment by 40 percent, and augments the capital outlays 6 of those that do expand by 54 percent. As these expansionary incentives are put in place, the demand for capital goods will rise – a fundamental of strong economic growth. The decline in the top effective rate under the Romney program would raise the probability that a small business would add to payrolls by roughly 48 percent – a significant impact. Similarly, for those firms that do additional hiring, the growth in payrolls would be enhanced by over 14 percent. In sum, tax reform that reduces marginal tax rates would benefit workers by increasing hiring and wages. Spending and Entitlement Reform. Recent research by John Cogan and John Taylor of Stanford University and Volker Wieland and Maik Wolters of Goethe University estimates that the output effects of a fiscal consolidation, like the Romney plan, would gradually reduce federal spending relative to GDP. In a long-run model, the fiscal consolidation raises both investment and output (the latter by almost 2 percent). In an alternative model with short-run rigidities, the spending consolidation also raises output by about 2 percent. In both cases, output rises even in the short run, as households and businesses respond to lower expected future tax rates as a result of the fiscal consolidation. Beneficial Effects of Tax Cuts Versus Temporary Stimulus Packages. Recent research by Alberto Alesina and Silvia Ardagna of Harvard University argues that policies to increase economic growth are more effective if done with tax cuts than with spending increases. In their conclusion, they write about the Obama stimulus: “About two-thirds of this fiscal package is constituted by increases in spending, including public investment transfers, and government consumption. According to our results, fiscal stimuli based upon tax cuts are much more likely to be growth-enhancing than those on the spending side.” (See Alberto Alesina and Silvia Ardagna, “Large Changes in Fiscal Policy: Taxes versus Spending,” in Jeffrey Brown, ed., Tax Policy and the Economy, Cambridge: MIT Press, 2009.) Separate research by Andrew Mountford of the University of London and Harald Uhlig of Humboldt University concurs: “Our key finding is that the best fiscal policy to stimulate the economy is a deficit-financed tax cut and that long- term costs of fiscal expansion through government spending are probably greater than the short- term gains.” (See Andrew Mountford and Harald Uhlig, “What Are the Effects of Fiscal Policy Shocks?,” CEPR Discussion Paper, July 2005.) Regulatory Reform. Recent research by Ellen McGratten and Nobel laureate Edward Prescott concludes that higher regulatory costs reduced both R&D and fixed investment during the financial crisis and its aftermath; and regulations continue to increase. Between 2009 and 2010, the number of pages devoted to final rules in the Federal Register rose from 20,782 to a 24,914 – a 20 percent increase. Stopping this growth and applying cost benefit analysis will remove impediments to investment and increase long-term growth. Historical Comparison to the Reagan Recovery. One historical comparison is particularly relevant in this context – the recovery from the 1981-1982 recession. In the 1981-1982 recession, the unemployment rate soared to 10.8 percent. In the 2007-2009 recession, it peaked at 10 percent. “Both downturns were rooted in financial convulsions. The 1981-1982 recession was induced by restrictive monetary policy aimed at breaking the back of double-digit 7 inflation and interest rates, which generated a housing and savings-and-loan crisis. The more recent recession resulted from excessive government intervention to increase homeownership by expanding subprime housing loans, on which substantial leverage was built. The resulting wave of defaults damaged the base of the banking system. Fifty-three months after the start of the 1981-1982 recession, total employment in the U.S. was up 7.5 million, or almost 7.5 percent higher than when the recession began. The labor-force participation rate rose to 65 percent from 63.8 percent, as optimism about the future pulled potential workers into the job market. Real per capita gross domestic product increased by $2,870, and was 11 percent higher than when the recession started. Fifty-three months after the start of the 2007-2009 recession, however, total employment in the United States is still down four million jobs, or 2.7 percent lower than when the recession began. The labor-force participation rate has dropped to 63.8 percent from 66 percent, as discouraged workers have exited the labor market. Real per capita GDP has declined by $964, and is 2.2 percent lower today than when the recession began. If the current economy had matched the job-creation rate of the recovery from the 1981- 1982 recession, there would be 15 million more Americans at work today, 8.3 million more Americans would be in the labor force, and per capita GDP would be $5,792 higher than it is today.” (Phil Gramm and Glenn Hubbard, Op-Ed, “Gramm and Hubbard: What A Romney Recovery Might Look Like,” The Wall Street Journal, 06/06/12) Policy responses in the early 1980s aimed not just at overcoming the 1981-1982 recession, but at overcoming the structural problems of the 1970s. By reducing domestic discretionary spending, setting out a three-year program to reduce tax rates, and alleviating the regulatory burden, policymakers sought to make it profitable to invest in America again. These principles match those in the Romney plan. Governor Romney would reduce the size and cost of the federal government. He champions a reduction in marginal tax rates in the context of a general tax reform. Particularly powerful are his proposals to reduce marginal tax rates on business income earned by corporate and unincorporated businesses alike. 8 Paid for by Romney for President, Inc.