The Economy and the Election: 

What if the Democrats Win?

Charles N. Steele
Issue CCLXII - October 28, 2010
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What does the upcoming election imply for the economy?  I’m loath to predict election outcomes: to do so requires one to guess what large numbers of people whom one doesn’t know are thinking.  But given an outcome, predicting is less difficult.  One simply has to understand economics, and the incentives faced by particular political actors.  In this article I’ll tackle what it might mean if the election leaves Democrats in control of Congress.  But first, let’s rehash our debt dilemma a bit.

I’ve previously argued that the greatest threat America faces is its growing level of debt, especially public (government) debt: our existing commitments to spending are simply beyond our ability to pay.   We cannot simply raise taxes to cover everything, because the tax rates required would be destructive.  Unfortunately, draconian spending cuts would also be destructive.  Our spending commitments are for keeping people alive beyond working age (Social Security), health care (Medicare and Medicaid), and repayment for funds we’ve already borrowed.  Cutting any of these means cutting people from what they’d been promised, what they expected to have, and what they arguably are entitled to.  After all, Social Security and Medicare have been deducted from our paychecks for some time, whether we liked it or not.  Our consolation was that eventually we’d at least be paid back.  And of course lenders were explicitly promised their returns.

We cannot cut these payments without inflicting harm on people.  But we cannot possibly pay them, either, without inflicting harm on others – i.e., taxpayers.  Sufficiently high tax increases will begin to shut down our economy.  People work because it benefits them, not because they want to pay taxes.  Businesses operate because they seek a positive return, not because they want to pay taxes.  Entrepreneurs discover new ways to create value because they wish to earn profits, not because they want to pay taxes.  Taxes that are too high eliminate the net benefits of working, absorb positive returns, and steal profits.  Taxes are destructive, and high taxes are highly destructive.  Hence our debt dilemma.

Well, this is a fine mess we’ve gotten ourselves into.  It’s a real mess, and there’s no painless way out.  So the questions we should address are “what is the least painful way out?” and “how we might get onto the 'least painful' track?”  But I’ll skip these for now, and ask a different question – what might the upcoming election imply for our debt dilemma?

Suppose the Democrats win, where “win” is defined as retaining control of both houses of Congress.  What can we expect, regarding fiscal discipline? 

Nothing, if the recent past is any indicator.  Our federal deficits have exploded to record levels under Democrat control.  The only contribution of the current Democrat Congress to fiscal responsibility that I can discern has been to repeatedly remind us that George Bush and his Republican Congresses were fiscally irresponsible.  True enough, but this hardly absolves them of their own irresponsibility for the exploding debt.  Now of course, with the Great Recession of 2007-2008  it was inevitable that deficits would grow, no matter who was in power.  With a recession, business activity falls, and therefore tax revenues necessarily fall as well.  Hence even if had there been no new spending deficits would have increased.  Spending necessarily increased, because automatic stabilizers kicked in, e.g., unemployment insurance payments went up.  But the Democratic Congress went well beyond this in increasing spending.  And even if we were to grant that short-term stimulus spending is warranted in a downturn (something I do not grant – unproductive spending will not stimulate us to back to growth), they were fiscally irresponsible.  Obamacare is a case in point.  This health care reform program – better described as “Rube Goldberg” than Obamacare – is clearly not fiscally neutral, and once the flimflam is stripped away, it is a commitment to increased future debt over the long run.

As an example of flimflam, consider the 1099 provision that imposes enormous new costs on small businesses, costs entirely unrelated to health care but important in the blackboard calculations that pretend Obamacare is fiscally neutral.  This provision is designed to catch businesses that are hypothesized to be failing to pay taxes.  It requires businesses to file 1099 forms and engage in withholding whenever they spend $600 or more, and promises an explosion of paperwork and legal and accounting fees that small businesses can ill afford.  I was chatting with a couple who own a very successful small business, and this topic came up.  They told me that if this provision goes into force, they expect zero change in their tax status, but the compliance costs will be sufficiently high that they might simply close and retire.  The taxes not paid that this provision will collect are purely speculative.  The businesses that will close because of higher costs are not.  But this flimflam, and others, will almost certainly not remain in force.  These are the things CBO terms “difficult to sustain,” i.e., politically unacceptable provisions that will very likely be repealed, once the public is hit by them and the ensuing screams lead Congress to begin “improving” the program.  It takes only one or two such items not being sustained, and the program goes into the red.  It’s flimflam – the mainstream media, and some of the public, might find such provisions convincing evidence of fiscal responsibility.  But it is quite unlikely that our primary creditors, the central banks of East Asia, will fall for this.

If the current crop of Democrats in Congress have shown us anything, it that they are fiscally irresponsible, without vision, and in denial over our debt crisis.  Their continual complaints that the Republican Congresses under Bush were also fiscally irresponsible are correct, but do not mitigate their own fiscal irresponsibility.  The Democrats show no interest in actually tackling the problem of our exploding debt.  Although Republicans describe them as “tax and spend” (and admittedly they probably are less averse to direct tax increases than are Republicans), they do not exhibit sufficient stomach to even try to balance the budget.  Should the Democrats retain control of Congress, I would not expect them to become fiscally responsible.  To the contrary, given the widespread predictions that Democrats are in for a sharp defeat, I would expect a Democrat victory to embolden them, and set them off on programs that would dramatically expand the size and power of government.  Quite apart from negative effects of such expansion, the increased spending would greatly worsen our debt crisis.

Of course, the general opinion is that Republicans will make substantial gains in Congress, probably taking control of the House, and possibly the Senate.  In my next post I’ll discuss the likely consequences of a Republican victory.  Don't expect a substantially rosier message.

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