A Policy Tool Kit to Stop Irresponsible Tax Cuts And Achieve Fast Recovery By John Atlee, 4/30/03

President Bush's unsound and partisan/ideological economic policies are now on the defensive. This offers a window of opportunity for fiscally and economically responsible members of both parties to develop a comprehensive, credible bipartisan economic plan. The coordinated "tool kit" of basic policy reforms summarized below, if put into legislative form now and adequately promoted, could help stop the budget-busting tax cuts and provide the basis for a bipartisan 2004 sea-change in budget and economic policy.

1. Explicit economic policy goals -- a balanced federal budget, sound Social Security and stable full-employment growth. Most basically, we must recover quickly to the 4% unemployment rate mandated by the Humphrey/Hawkins "Full Employment and Balanced Growth Act of 1978" and again reached in 2000 -- without inflation. Credible political proposal of these goals would inspire many people who were too turned off to vote in 2002.

   Basic Principle: It's still a depression until everybody who wants a job can find one.

2. "Dual Deficit" budget format & management -- a 4% unemployment version of the Congressional Budget Office (CBO) "standardized" budget, excluding Social Security, with the Congress-controlled component explicitly labeled "Policy Deficit" (about $164 b. in 2002), and the rest explicitly labeled "High Unemployment Deficit" (about $146 b. in 2002). This highlights the key fact that each 1% unemployment costs the budget over $70 billion.

   This format is much more transparent -- understandable to the public -- than the present Enron-like budget based on unreliable and ever-changing economic forecasts. This makes it far easier to determine responsibility for the two deficits, independently.

   Basic Principle: "No permanent tax cuts until the Policy Budget is balanced and unemployment is below 4%."

The CBO (or some private think tank) should quickly make a draft projection of this twin-deficit budget as a basis for congressional and public debate and lobbying, leading to its legislative adoption in 2005.

3. "Standardized" (4% unemployment) Social Security projection -- This projection is financially sound for the full 75 years. Any shortfall of actual current SS surplus from this projection should be reflected in the High Unemployment Deficit, not the Baby Boomer Trust Fund.

   Basic Principle: Insulate SS from inappropriate economic assumptions, high unemployment, and non-SS deficits.

4. Effective "economic stimulus" recovery policy -- Monetary and fiscal policies are complementary, not alternative, policy tools.

   Basic Principle: Monetary and fiscal policies must be systematically coordinated.

1. Monetary Policy -- Fiscal policy alone can't jump-start the economy. The Federal Reserve must finance a "quick soft landing" recovery track -- ostensibly by aggressive 2001-type Fed Funds interest rate cuts, but actually by indirectly managing the growth rate of bank-created checking-deposit MONEY. Each dollar of new checking-deposit money now finances about $9 of GDP growth.

   (The rate-cut charade could be entirely avoided by increasing the present effective reserve requirement of about 1 1/2% to, optimally, 100% -- to enable the Fed to regain direct control of money and economic growth.)

   Basic Principle for the Fed: Don't just FORECAST the economy and hope for recovery; actively MANAGE it for a "quick-soft-landing" recovery to below 4% unemployment.

2. Overall Fiscal Policy -- Since money growth actually takes place only in the process of bank lending, when total borrowing is so weak that the Fed Funds rate falls below normal and approaches zero, the Fed runs out of its rate-cut "ammunition." Meanwhile, banks face a "pushing on a string" syndrome (as now in the US and a decade ago in Japan) that forces them to use whatever reserves the Fed gives them to buy the Treasury securities that finance the High Unemployment Deficit, rather than the new business and consumer loans that should be financing economic growth.

   Because the recession-induced INCREASE in the High Unemployment Deficit tends to be much less than the recession-induced REDUCTION in consumer and business borrowing, federal ECONOMIC RESPONSIBILITY requires that the economically-reactive High Unemployment deficit be augmented by a special policy-proactive Recovery Deficit.

   Therefore, effective "fiscal stimulus" has two complementary purposes: first, to quickly and directly increase total GDP spending, and, secondly, to replenish the Fed's rate-cut ammunition by increasing total borrowing enough to replenish the Fed's rate-cut ammunition by increasing the Fed Funds rate.

   Basic Principle: In a recession, fiscal policy's ECONOMIC RESPONSIBILITY to systematically coordinate with the Fed to achieve fast recovery takes precedence over its normal FISCAL RESPONSIBILITY to avoid budget-busting long-term deficits and resulting high interest costs.

3. Policy-Budget Deficits -- As a basic rule, fiscal responsibility calls for approximate balance in the standardized Policy Budget. But the need for recovery deficits provides an opportunity for more adequately financing badly-needed long-run social investment spending on education, health, etc.-- spending that increases long-run productivity growth more effectively than income tax cuts that benefit mainly the very rich.

4. Temporary "recovery stimulus" -- This should take the form of a semi-automatic proactive policy-augmentation of the "reactive" High Unemployment Deficit -- entirely separate from the main Policy Budget -- including:
• Unemployment benefits for all officially unemployed and "discouraged workers," and emergency aid to state and local governments -- to avoid their present economically inappropriate tax increases and spending cuts in education, health and other essential services.
• A highly flexible "Recovery Bonus" for every worker who pays FICA contributions. The amount could begin at a round $50 a week, but be continually adjusted so the related short-term Treasury borrowing is just high enough to supply the Fed with adequate rate cut ammunition. Subsequent amounts could be determined by a specific formula worked out jointly by the Fed Chairman and Treasury Secretary.

  The cost of the Recovery Bonus and other "stimulus" spending would be "self-financing" (like a good business investment) by the recovery it produces -- and the public could actually watch this happen as the recession-caused High-Unemployment Deficit itself recedes.

These same policies could work for other countries and facilitate international economic cooperation.

If these policies are backed up by empirical prototypes, graphic illustrations and incisive analysis, to adequately explain them to American voters, they will convey a sense of credible fiscal and economic responsibility.

For a more detailed description of these reforms, and their underlying conceptual framework, see IEA's "policy" and special-notice sections.