Obama's Dilemma

The economic recovery has been slow. Obama has engaged in unwise policies that do more to hurt recovery than to help it. However, he has faced an uphill battle from the beginning. Obama certainly didn’t cause the recession, but he hasn’t helped it either. George Bush didn’t cause the recession either, but he too made recovery harder.

War spending and the expansion of government under Bush has driven the U.S economy into massive deficits. One of the best tools to fight against recession is deficit spending, either by cutting taxes or by increasing government spending. The assumption here, however, is that the marginal returns of such spending will be increasing.

If we already have extreme deficits, that in itself becomes a problem and any positive returns that might be gained by adding to the deficit will diminish very quickly.

Thus, Obama is at an immediate disadvantage because he lacks an important tool for fighting recession. We started with a moderate deficit and Obama’s fiscal policy quickly turned it into a serious deficit. Now that deficit spending is no longer a viable option and is quickly becoming a political liability, Obama is faced with the unenviable decision of whether to play smart politics or smart economics. The decision he faces is whether or not to let the Bush tax cuts expire.

The easy political decision is to pander to the politically motivated, class-warfare mentality that Obama has perpetuated and end the tax cuts. This appeases those on the left who feel a sense of injustice that the “rich” don’t pay their “fair share” (we won’t tackle the validity of such a mindset here, but rather simply accept that that’s how they feel), and it also reduces the deficit (assuming of course that the added tax revenue won’t be spent – a dubious assumption).

Therefore, it must be awfully tempting for Obama to take the easy road and play politics and validate many people’s baseless outrage at the “rich” while at the same time claiming to be fiscally responsible by reducing the deficit.

The other path that Obama could take would be the politically unpopular but economically sound route of keeping the tax cuts. This would be a very hard political decision because it would mean that Obama would have to acknowledge that the tax cuts by Bush was a good policy (one of his few), something that is anathema to Obama. Also, it would mean Obama might sacrifice some of his political points from the left, even though he would be advancing the correct economic policy. I doubt Obama would think it a fair trade off to lose votes on the left but gain respect from the right.

A tax hike in a recession is unquestionably bad policy, uniformly decried by economists. It creates negative incentive for businesses and investors, precisely the types of people who play a key role in getting us out of recession. There is a time that raising taxes might be the best economic policy, as it might have been in the 1990s. We are certainly in a different place than we were in the ‘90s. Just because it might have been good then, doesn’t mean it’s good now.

Obama is certainly in a no-win situation. Deficit-inducing stimulus spending has been ineffective, in part because we started with already moderate deficits. Therefore, continued spending isn’t a viable solution. It must be very tempting for Obama to raise taxes, but it would be precisely the wrong prescription.

Obama must get us out of this recession now. That will entail keeping the Bush tax cuts and stopping runaway spending. There is no overnight solution so Obama must stop looking for one. If the government will rein itself in and keep taxes low and stop interfering in the market, businesses and banks just might venture out onto the playing field again. That is the first step that has to take place. Everything else is moot if investment and lending aren’t nurtured. The best way for government to do that is to reduce uncertainty by staying out of the way.

Once the economy can start growing again, there will be less need for increased government spending and the tax revenue will be up due to increased consumer spending. The deficit problem, ironically, will solve itself if we stop trying to solve it.

Obama could do the self-serving thing and let the Bush tax cuts expire, thus lending weight to irrational and self-defeating attitudes about class-warfare, and causing real harm to the economy and delaying recovery, or he could do the economically smart and necessary thing and reap the political benefits.

Unfortunately, Obama has proven to be short-sighted and more concerned with appeasing his political masters (unions) than he has been about stabilizing the economy, healing partisan rifts and moving the country forward. Therefore, unfortunately it seems that Obama’s Dilemma won’t be a dilemma to him at all.