President Obama had it exactly right last Monday when he said that “America is in danger of falling behind” in the international economic competition. The most important way to evaluate the deal on taxes that Obama reached this week with congressional Republicans is whether it responds to that threat. And on that measure, the grades are mixed.
Speaking this week in North Carolina, Obama argued that the economic challenge from rising nations such as China and India represented “our generation’s Sputnik moment.” Probably few of the young people in his community-college audience got the reference, but after the Soviet Union beat the U.S. into space in 1957 with the launch of the Sputnik satellite, Washington opened its checkbook to nurture scientific research and education. The fruits of that effort eventually included the moon shot, the semiconductor, and the Internet.
Most Americans appear to understand that the shift in global economic power is presenting the U.S. with a comparable test. That apprehension rings loudly through the latest Allstate/National Journal Heartland Monitor survey, released this week. In the most stunning finding, nearly half of the American adults surveyed said that China possesses the world’s strongest economy; just one-fifth picked the U.S.
In fact, on most relevant measures, the U.S. economy still remains far more productive and prosperous than China’s. The public’s anointment of China is probably best described as an embodiment of unease about our own trajectory. This anxiety hardly seems irrational after a decade that produced the weakest economic performance since the Depression.
Will the tax deal between Obama and Republicans help extricate us from that pit? Maybe. But only if it’s the first act in a two-act play.
The most objectionable part of the deal for Democrats is that it extends the tax cuts passed under President Bush in 2001 and 2003 for all earners, including the rich. However, even some economists who view tax cuts for the wealthy as wasteful worry that withdrawing them now might tip a fragile economy back into recession. As the price for agreeing to the GOP’s top priority of extending those reductions, Obama won inclusion of enough new business and personal tax incentives that the deal amounts to a much larger short-term stimulus plan than once seemed possible.
But more stimulus, while necessary as the economy continues to sputter, isn’t a sufficient strategy for long-term growth. Act 2 must include a serious effort to tame exploding federal deficits and debt, while reorienting both the tax code and Washington’s spending priorities from consumption to investment. This week’s deal ought to be measured not only on its immediate economic impact but on whether it makes such fundamental reform more likely.
Lawrence Summers, the outgoing director of Obama’s National Economic Council, says that the deal could help Washington confront the deficit—both by providing a precedent of bipartisan cooperation and by invigorating the economy. “The first priority for addressing the budget deficit has to be getting the economy growing again at a rapid rate,” he says. “This offers the best prospect that was available for achieving the kind of escape velocity we’ve been seeking for the past two years.”
Those are reasonable arguments. On the other hand, the deal will substantially deepen the near-term debt. It further entrenches the Bush tax cuts, even though the median income and the number of Americans with jobs are lower today than when the tax cuts were signed in 2001 (an almost unprecedented decade-long record of futility). The agreement also places all of its stimulus chips on tax cuts, ignoring the infrastructure investments that Obama has sought. As Joseph J. Minarik, vice president of the nonpartisan Committee for Economic Development, notes, the two sides missed the opportunity to establish a binding process for tackling the deficit when the economy revives.
Obama and Republicans came together partly because each accepted the other’s priorities without much concern for the overall cost. Yet it won’t be possible to build a stable foundation for long-term prosperity without making tougher choices. Eventually, Democrats will need to acknowledge that increasing productive federal investments (in education, infrastructure, or research) will require them to control entitlement spending. And Republicans will need to face the evidence that tax cuts for the wealthy haven’t remotely produced benefits that justify their expense.
Setting priorities isn’t just a euphemism for imposing pain. Gus Faucher, a director at Moody’s Analytics, whose economic analysis has been consulted by both parties, says the firm’s projections show that if the government ended the Bush tax cuts for the wealthy and applied the resulting revenues to deficit reduction instead, not only would the deficit be lower by 2020 but employment and economic output would be higher. “Over the long run, growth would actually be stronger,” Faucher says. If this week’s deal leads both parties to forge more difficult agreements down the road, the U.S. may not need to cede tomorrow to China, or anyone else.
This article appears in the December 12, 2010 edition of National Journal Magazine.