The New President's Economy Problem

Thursday, May. 15, 2008 By JUSTIN FOX

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Traders on the open outcry Euro/Dollar pit of the Chicago Mercantile Exchange.

Anthony Suau for TIME

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Voter's Guide to the Economy

The U.S. has money troubles that are deeper than just one downturn. Who's got the best big ideas?

TAXES
$500 billion
THE BILL FOR THE DEFICIT IS DUE. YET EVERYONE'S FOR TAX CUTS

In general, we levy taxes not to ease income inequality but to fund government. They haven't quite been doing the job lately: for the 2008 fiscal year, which ends in September, the government will probably spend $500 billion more than it takes in, a deficit of 3.5% of GDP. That should shrink when the economy starts growing again, but it's not going to disappear without either big cuts in spending or substantial tax increases.

And make no mistake, somebody is going to have to pay those bills someday. The message many Republicans took from Reagan's successes of the early 1980s, and still preach today, is that tax cuts pay for themselves. That's nonsense — Reagan's rate cuts for the rich may have paid for themselves, but the 1981 tax package as a whole (which included cuts for the poor, the middle class and corporations) clearly did not. The real lesson of the 1980s was that the U.S. can get away with running far bigger deficits than anyone thought possible while still enjoying strong growth and low inflation.

We've seen a bit more evidence of this in the 2000s, but it can't go on forever. There comes a point at which government debts grow so large that they start to weigh on the economy, through higher interest rates, bigger debt payments, a weaker currency, etc. Reagan and George W. Bush had the advantage of starting out with a relatively small debt as a percentage of GDP. The next President won't be quite so lucky.

The reductions in tax rates on income, capital gains and corporate dividends that President Bush pushed through in 2001 and 2003 are due to expire in 2010. That could prove a tough blow for a still wobbly economy to weather, but it would help shrink the deficit over time.

Both Democratic candidates say they'd let most of the Bush cuts expire. Both also want to end the U.S. occupation of Iraq — the cost of which has ballooned the Bush-era deficits — although extricating ourselves certainly won't be free either. On the other hand, both are itching to spend more on everything from increased college aid to better broadband connections.

McCain wants to stay the course in Iraq. And despite his admirable record of fiscal probity in the Senate, his campaign statements about the deficit have been less than convincing. He wants to extend the Bush tax cuts that he once opposed — and add a few more of his own, saying he'll make up the difference by cutting "wasteful spending." But even eliminating the pork-barrel congressional earmarks that McCain has long criticized would make only a dent in the deficit.

The deficit quandary is one for which none of the candidates have an entirely convincing answer — at least not yet. Unlike the current President, though, the winner in November may be forced to arrive at one once in office.

ENERGY
$4 a gallon
BURNING FOSSIL FUELS AND MONEY ISN'T AN ENERGY POLICY. LET'S GET ONE

One of the biggest factors in making paychecks seem smaller in recent years has been the sharp increase in energy prices. There's very little a President can do to change this in the short term; the summer gas-tax holiday proposed by McCain and Clinton would put just a few dollars in the pockets of all but the biggest gas hogs. Where Presidents (and Congress) can have a big impact is in the long-term trajectory of energy prices and their effect on the economy. Elected officials can do this by steering Americans away from oil and toward other energy sources and conservation measures — or by failing to do so, which has been the laissez-faire policy of the past quarter-century and has helped land us in our current sorry situation.

What makes doing the right thing on energy difficult is that it would almost inevitably involve raising costs now, with higher taxes on oil, increased subsidies for other energy sources or higher energy-efficiency standards for vehicles and homes — or all three. Economists tend to prefer the first of these approaches because taxes on gas, oil or fossil fuels in general tamp demand and allow the market — rather than members of Congress — to sift out the best alternatives.

As a rule, presidential candidates not named Ross Perot don't propose fuel-tax hikes. Interestingly, though, to fight global warming, Clinton, McCain and Obama are all in favor of a carbon-cap-and-trade regimen, which would raise the price of fossil fuels just as surely as a direct tax would. Almost in spite of ourselves, we may end up with a semi-rational long-term energy policy. It won't make gas cheaper anytime soon — or perhaps ever — but in the long run, it could strengthen the country's economic prospects.