YOU DECIDE: What are the realities facing our new leaders?

Date posted: November 12, 2010

Dr. Michael Walden is William Neal Reynolds professor of agricultural and resource economics at N.C. State University.Dr. Michael Walden is William Neal Reynolds professor of agricultural and resource economics at N.C. State University.

Media Contact: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

By Dr. Mike Walden
North Carolina Cooperative Extension

The election is over and there have been shake-ups in both Washington and Raleigh. There will be many new faces in the U.S. Congress and the North Carolina General Assembly.

Although I’m an economist and not a political analyst, I think it is obvious many voters were unhappy this year, and this unhappiness had a big impact on their votes. Polls showed voters’ displeasure focused around three areas: the economy and jobs, government spending and debt, and taxes.

So what can our new leaders do about this discontent, especially in these three areas? Unfortunately, there are some economic realities — or constraints — that may either limit what may be done or present unpleasant alternatives for change.

The Economy. While “officially” the recession is over — because we have seen an increase in the productive output of the economy since June 2009 — the pace of economic growth has been anemic. Job improvements have been agonizingly slow. A significant part of the decrease we’ve seen in the unemployment rate is simply a result of jobless workers dropping out of the labor force and, therefore, not being counted as unemployed.

So the refrain heard in political campaigns was “jobs, jobs, jobs.” But what’s holding back job creation? Is it the fear of public debt and taxes? Is it lack of confidence by consumers? Or is it something to do with what the recession did to household finances?

Although a case can be made for each, I and many other economists pick answer number three. The recession devastated household wealth, destroying $15 trillion of net asset value at its peak, and this wealth is just beginning to come back. Households entered the recession with record high levels of debt (supported by the record levels of wealth).

However, with wealth down, households have been forced to pay down on debt and save more. What’s left out is household spending. Households won’t be able to spend like they used to until they get their debt situation back under control. Yet, since our economy is largely driven by household spending, frugal households translate into slow economic growth.

Most economists think this process — called deleveraging — will just have to proceed, perhaps for another two to five years, and there’s very little government can do about it. One view is that the frugality displayed by households today is the counterbalance to the high rates of spending and borrowing done in previous decades.

Government Spending and Debt. It’s been the norm in recent decades for federal spending to exceed revenues and, therefore, for the national debt to increase. In fact, in only eight years since World War II has the federal government not needed to borrow to pay its bills.

But the spending and borrowing accelerated in recent years. Indeed, since 2007, almost $4 trillion has been added to the national debt. However, most of this was due to the recession. Federal government tax revenues always fall and spending always rises during recessions. Tax revenues decline because businesses and households are hurting, and spending rises because programs that help unemployed and poor households always expand during bad times.

Yet once recessions end, the government red ink narrows. Indeed, the Congressional Budget Office projects the annual red ink (the budget deficit) will shrink from $1.4 trillion this fiscal year to $900 billion next year and to $750 billion the year after. This happens because tax revenues improve when the economy grows, and special anti-recessionary spending, like the stimulus plan, ends.

But we’ll still have a government spending and debt problem, just as we’ve had one for most of the last 50 years. However, the cause won’t be the recession; instead, it will come from demographic and other forces causing some government programs to expand — specifically the big three of Social Security, Medicare and Medicaid. The problem this creates for elected officials is that these are popular programs, which help the elderly and the poor. Changing them will be extremely difficult.

Taxes. One recommendation heard during the political campaigns is that reducing tax rates is a way of stimulating the economy. Economists have two qualifiers to offer for this plan. While reducing tax rates may motivate more private spending and job creation, if the reduced taxes mean lower spending on public goods valued by businesses — infrastructure would be a good example — then economic growth may stall.

But some claim reducing tax rates ignites so much growth that tax revenues actually rise. Economists have thoroughly studied this claim and have concluded it only happens if tax rates are at a high level, generally above 60 percent. Otherwise, tax rate cuts reduce public revenue.

The election is over and now governing begins. Will tackling and solving our economic problems be easy? You decide!

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks. Previous columns are available at http://www.cals.ncsu.edu/agcomm/news-center/tag/you-decide

Related audio files are at http://www.ncsu.edu/waldenradio/

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