The Perfect Fiscal Storm

Wisconsin Governor Walker’s attack on workers has been taken on the pretext that state employee wages and pensions have driven the budget into deficit. We all know that is ridiculous. The reality is simple: Wall Street crashed the economy, crashed state revenues, and crashed workers’ pensions.

Washington responded with a massive bail-out for Wall Street—perhaps $25 trillion worth. It gave a mere pittance to “main street” in its $1 trillion stimulus package. Since the recession manufactured on Wall Street cost the economy a lot more than that, main street is not on the road to recovery. No one is projecting that jobs will return for many more years. It is delusional to believe that economic recovery can really get underway until we have added 8 million jobs. State spending cuts (or tax increases) will not restore their budgets. Just take a look at the results of austerity in Greece or the UK. Budget-cutting in a downturn does not reduce deficits significantly.

The reason is obvious: austerity slows the economy and reduces tax revenue. Art Laffer’s supply siders were onto something, although they mostly got it the wrong way around. Yes, a booming economy will generate a movement toward balanced government budgets. They thought that tax cuts are always the answer to everything—cut tax rates and you get more tax revenue. I would not say that that never works, but it didn’t when Presidents Reagan and Bush tried it. However, if we get the Laffer Curve the right way around, we can use it to explain why austerity in a downturn just makes budget deficits worse.

In truth, state budgets will not recover before the economy recovers. And state austerity will just make the economy worse. So, as a Thatcher might say: TINA: there is no alternative–to federal government stimulus, that is. I realise that goes against the deficit hysteria in Washington. But it is the truth. What kind of stimulus makes the most sense? I think we need another trillion dollars, minimum. This can be split equally between aid to the states and extension of the payroll tax holiday. The federal government should provide $500 billion in block grants to the states, on a per capita basis. On the condition that they stop attacking state workers. The funds would be used to replace lost tax revenue—to cover operating expenses (and where possible, to actually increase spending on priority projects). This program would continue until economic growth and job creation reaches established thresholds. Let us say 10 million more jobs or measured unemployment rate of 4%.

The payroll tax holiday would also be expanded, by half a trillion dollars until those thresholds are reached. Tax relief for both workers and their employers. Why penalise job creation with an employment-killing payroll tax? Reward firms for providing jobs by giving them tax relief. Let workers keep more of their hard-earned pay.

These measures are only a first step. We still have a lot of damage to repair—damage caused by Wall Street’s excesses. And we will need to rein-in and prosecute the fraudsters, otherwise they will blow up the economy again. Actually, they are already trying to do that—creating yet another commodities market speculative bubble. It is looking an awful lot like 2006 all over again. However this time, we are down by 8 million jobs and trillions of dollars of household wealth. Wall Street is bubbling up even as the economy as a whole is in the trenches. This bubble will not last long. It is going to crash. That will expose the huge accounting holes in the bank balance sheets. Wall Street will want another 25 trillion dollar bail out. This time, we’ve got to follow Nancy’s dictum: just say no.

L. Randall Wray is a Professor of Economics, University of Missouri—Kansas City. A student of Hyman Minsky, his research focuses on monetary and fiscal policy as well as unemployment and job creation. He writes a weekly column for Benzinga every Thursday.

He also blogs at New Economic Perspectives, and is a BrainTruster at New Deal 2.0. He is a senior scholar at the Levy Economics Institute, and has been a visiting professor at the University of Rome (La Sapienza), UNAM (Mexico City), University of Paris (South), and the University of Bologna (Italy).

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