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Jeff Madrick

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The 10 Worst Economic Ideas of 2011

Posted: 12/22/11 09:27 AM ET

Cross-posted from New Deal 2.0.

I was at an Occupy Wall Street demonstration this weekend and many clergy addressed the group. One nun told the crowd it was Christmas season and that it was time for something new to be born in America.

It was a nice thought, and I hope that the "something new" is good sense, because it has been a year in which some of the worst economic ideas ever have gained support and are being applied around the world. So here's my list of the 10 worst economic ideas of 2011:

1. Taxes should be more regressive.

At the top of the list for sheer scandalous insensitivity are Herman Cain's and New Gingrich's tax plans for America. Cain and Gingrich are both flat tax advocates. Cain proposes "9-9-9" -- a 9 percent sales tax, 9 percent income tax, and 9 percent corporate tax. He would also eliminate most deductions. Would this raise more or less money? The romantic conservatives claim the lower income tax rate would mean more growth. Never mind that the evidence to support that claim has been found profoundly lacking time and again.

What is eyebrow-raising is how regressive the Cain tax would be. According to the Tax Policy Center, those who make more than $1 million would get a tax cut of about $455,000 on average. Those who make between $40,000 and $50,000 would get a tax increase of about $4,400. The tax rate would be 23.8 percent for this group, compared to 17.9 percent for those who make $1 million or more.

Cain's plan might take in as much money as is now taken in by the federal government. But Gingrich's plan wins the gold medal: his plan is both regressive and a gigantic revenue loser. His flat tax is 15 percent on incomes, with plenty of deductions like the one for mortgage interest still intact. He would eliminate taxes on capital gains and dividends. Those who earn more than $1 million would make out like bandits, saving an average of more than $600,000 a year, while those earning $50,000 a year would save about $1,000. Meanwhile, the government would forego about $1 trillion in annual revenues by 2015.

2. Austerity works.

Is it conceivable that we have learned nothing from history -- or from economic theory, for that matter? It is hard to believe that after a year or so of the momentary return of Keynesianism in the wake of the deep recession of 2007-2009, it has been utterly renounced in practice in most rich nations around the world. The U.S. refuses to adopt a new fiscal stimulus as fears of a long-term deficit now determine short-term policy. The eurozone's decision makers are even more obtuse and dangerous. Germany is leading the pack by imposing harsh limits on deficits as a percent of GDP on member states, which is sure to lead to slow growth and probably growing deficits. In the near term, the refusal to restructure the debt of the southern periphery along with demands for harsh austerity there could lead to a break-up of the eurozone and general catastrophe.

The conventional wisdom, however wrong-headed, is widely accepted in the media. Britain is imposing austerity and its economy only gets weaker, yet a recent Financial Times article gives the country points for economic enlightenment compared to France because it is more willing to punish itself. John Banville, the estimable Irish novelist, writes in The New York Times that Ireland is now considered the "good boy" of Europe because of its intense austerity program. I am not sure he was being ironic. In fact, despite a couple of spikes in GDP, austerity is failing there as well. GDP and GNP (which is relevant because so much of their income is export-dependent) are way below their highs of a couple of years ago in Ireland.

IMF economists have recently produced solid research putting the lie to claims that austerity has led to rapid growth in some countries in the past. It almost never has, and in the couple of cases it has, it was because the countries devalued their currencies sharply to promote exports. Of course, there will be no devaluations in the eurozone.

3. Export growth models are sustainable.

Germany is especially proud that it has exported its way to becoming the strong man of Europe. It has suppressed wage growth, used subsidies to make its products more competitive, and taken advantage of the fixed euro, set at too low a rate to maintain trade balances. It is determined to remain oblivious to the fact that such a model requires countries that buy its products to run deficits and therefore borrow lots of money. This is why export models are known as beggar-thy-neighbor models, and it is why Germany has a moral obligation to help bail out nations like Greece, Italy, and Spain. Export models are really debt models on a global scale.

China also runs on an export model, and the U.S. borrows relentlessly from it. But China occasionally seems to recognize that this model may not be sustainable and is trying to raise wages and reduce imbalances some. More to the point, unlike Germany, it is now prepared to increase fiscal stimulus. This doesn't mean China gets an A for policy -- more like a C. But Germany gets an F, and its low-wage export model cannot be adopted by all of Europe. Someone has to be able to afford to buy something.

4. Fannie and Freddie did it.

A lawsuit by the Securities and Exchange Commission has revived the argument that Fannie Mae and Freddie Mac were the causes of the housing collapse and the financial crisis. The SEC is suing high-level executives for failing to disclose that they had more sub-prime loans than they admitted. In fact, by the actual definition for subprimes that was commonly used, they probably did make these disclosures. But they also piled on risky mortgages in 2006 and 2007, not to meet affordable lending goals as some claim, but to make a profit.

Frank Partnoy and I have written about this in the New York Review of Books. The problem was not Fannie and Freddie. The crisis was created by the highly risky mortgages bought and sold by the private sector between 2003 and 2006, when Fannie and Freddie were cutting back their activities. They became big buyers when the damage was already done. And even now, their mortgage defaults as a percentage of their portfolios, despite the devastation in the housing market, are much lower than defaults in the private sector. Those who want to blame the government for the crisis keep coming back to this stale and very misleading issue. Get over it. And as for the SEC, can it be that the only case they can drum up against high-level executives is at Fannie and Freddie? You mean there were no bad big-time execs at Citigroup, Merrill Lynch, Morgan Stanley, Lehman, Goldman, and so on?

5. Cutting Social Security benefits is a priority.

We have a very long-term deficit problem, not a short-term one. Social Security did not contribute to the short-term deficit -- the Bush tax cuts, the recession, and the slow recovery are the main culprits over the next 10 years. But even in the longer run, Social Security benefits will rise from a little under 5 percent of GDP to 6 percent of GDP. Cutting these benefits is not a priority and any deficit can be fixed with affordable tax increases. So why is everyone focusing on Social Security? Because it is the low-hanging fruit. The really big problems, like Medicare and Medicaid, are driven by a dysfunctional healthcare system, and that is too hard to fix. It is a little like Reagan invading Grenada and calling it a great American victory.

6. Inflation is just around the corner.

Remember the claims by the right wing that all that Federal Reserve stimulus in 2008 and 2009, not to mention the Obama spending bill, would lead to big-time inflation? Nothing would be better than a little inflation in the U.S. right now, but the economy has been too weak to deliver it. Bring on some inflation, please.

7. The Medicare eligibility age should be raised.

Reports had it that President Obama had momentarily agreed to raise the Medicare eligibility age from 65 to 67. Indeed, a New York Times editorial recently seemed (a little less than wholeheartedly) to endorse the idea. Yes, this might reduce Medicare expenditures, but it would raise the total amount Americans spend on health care. In fact, the Kaiser Family Foundation figures it would increase private health care costs for most of the seniors leaving Medicare by more than $2,000 a year on average. There would be other cost-raising effects, as, for example, healthier seniors left Medicare. Kaiser figures the increase in total health spending by Americans would be twice the amount of savings to Medicare. And of course some seniors would simply give up coverage. Call it triage.

8. Competition between Medicare and private health insurance will reform the health care system and reduce costs.

Say it ain't so, Ron Wyden. The Democratic senator from Oregon has teamed up with Congressman Paul Ryan to propose an option for Medicare recipients to buy private plans. They would be offered a flat payment to buy private plans if they so chose. Competition for these dollars will supposedly make Medicare and the health insurance companies more efficient. More likely, however, it will result in misleading claims by the health insurance companies or reduced coverage plans. It will raise costs for Medicare as healthy seniors are induced to take cheaper private plans with healthier individuals. Allegedly, the Wyden-Ryan plan would control for all this by setting minimal standards. Forget about that. The Obama administration has already given in on federal standards for Obamacare, letting states set their own. Guess who most of the states will favor. Seniors will probably have to move to New York or Massachusetts to get decent plans.

But that's not even the big rub. It is that Medicare payments will be limited to growing just 1 percent faster than GDP. Health care costs have risen considerably faster than that for a long time. Somehow Wyden thinks that such a limit will force reforms. In sum, it will simply lead to less coverage and more expense for beneficiaries.

9. Federal spending should be capped at 21 percent of GDP.

The president's Simpson-Bowles budget balancing commission proposed this cap because it is the average for the last 40 years. How's that for reasoning? With fast-rising health care costs and an aging population, such a limit is patent nonsense. For a nation that needs significant investment in infrastructure, energy savings, and education, it is especially damaging. There is no evidence to support the claim that such a cap would promote economic growth. An alternative plan offered by Rivlin and Domenici at least raises the cap to about 23 percent, according to the Center on Budget and Policy Priorities.

The whopper is the House Republican plan to adopt a budget balancing amendment to the Constitution. It would reduce federal expenditures to 18 percent of the previous year's GDP, meaning more like a 16.5 percent cap. This would change America as we know it, testing the nation's political stability with harsh cuts in social spending and precluding any serious public investment in the nation's economic foundations.

10. Balancing the budget should involve equal parts tax hikes and government spending cuts.

This is not economics; it is politics. But economists argue for it all the time as if it is good economics, not admitting their conservative bias that high taxes are bad for growth and government social and investment spending never helps.

Most of the major budget balancing plans of 2010 and 2011 argued for more spending cuts than revenue increases. The Bowles-Simpson plan is comprised of two-thirds spending cuts, one-third revenue increases. Obama's budget plan last spring also had much more in spending cuts than tax increases. Only the Rivlin-Domenici plan was balanced. The one conspicuous exception was the plan from the Congressional Progressive Caucus, which of course got short shrift in the press. It was about two thirds tax increases to one third program cuts.