by Henry Oliner

Obama’s response to the recession of 2008 was classic Keynesian; deficit spending to stimulate demand.  Keynes was agnostic on federal spending or tax cuts to stimulate demand. The deficit was secondary.

Spending was facilitated by loose monetary policy, yet the recovery remained weak.  It could have been offset by more regulations and higher taxes, and it could have been countered by the debt reduction in private and business accounts.  I believe it was also influenced by anti-wealth rhetoric from the “you didn’t build that” speeches to the Occupy Wall Street Movement.  The Card Check Bill had a chilling effect even though it did not pass.  It caused many businesses to develop a wait and see attitude to expansion.

The conditions in Keynes’ time were different. He thought government spending would channel money into the economy faster than enacting a tax cut.  But government in his day was not as bureaucratically stifled, and was able to get money into the economy faster. Under the Obama stimulus plan the federal government tried to channel billions through the state governments.  Most of the states were not equipped to spend the money. Some state projects already in progress were delayed in order to use the new federal funds instead of state funds.

Obama was a bit humbled to discover that much of his shovel ready projects were not literally shovel ready.  The reality was that our federal and state spending institutions were unable to authorize and execute the stimulative Keynesian spending as fast as he wanted or expected.

The other option, tax cuts, may have been less effective in Keynes time because income taxes and payroll taxes were less of a factor. The amount of stimulus from taxes would have been limited compared to the funds that could be spread through government spending.  Today it is different;  tax cuts could also spread more money into the economy- perhaps as quickly.

Keynes’ other concern with tax cuts was that the tax payers may save the money in uncertain times and not provide the demand stimulus he wanted.  His savings paradox was misplaced in my opinion since savings provided investment funds for banks and other deployments which are also stimulative, but it may have slowed down the flow into the economy.

The obsessive focus on demand also proved misplaced.   Demand and supply ebb and flow in ways far too organic to be managed by central planning. Periods of innovation create new demands.  New products precede their demand and subsequent manufacturing technology continuously turns luxuries into commodities.

Keynes did not consider a deficit or debt to be a permanent fiscal feature. He assumed periods of prosperity would build a surplus which could be drawn upon in recessions.  As central government’s role has expanded in a century of progressivism, surpluses are quickly drained into the entitlement swamp of expanding eligibility and the value of the benefits they draw.

Obama may have put more money into the economy by suspending all taxes for a year, but a onetime tax holiday may not have caused the spending increase he wanted. Voters tend to save a short-term increase in income.  The permanent income theory of Milton Friedman demonstrated that a tax cut needs to be permanent to have its greatest impact on demand.

The benefit of permanence in tax policy is grossly underrated.  The greater the partisan divide on tax policy the greater the likelihood that the stimulative effect of the tax cut will be muted.