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Growing Pains

by Ramesh Ponnuru

Pawlenty sets a bold but questionable economic target

Tim Pawlenty, the former governor of Minnesota, is determined to be the presidential candidate for those conservatives who believe that Republicans have lately been concentrating too much on cutting the budget and not enough on increasing economic growth. His new economic plan is a very aggressive exercise in supply-side economics. It cuts the corporate tax rate from 35 to 15 percent — lower even than Rep. Paul Ryan’s budget, which takes it to 25 percent. It reduces the top income-tax rate from 35 to 25 percent. It abolishes the estate tax, the capital-gains tax, and the dividend tax outright. With these policies — along with spending cuts, deregulation, and free trade — Pawlenty believes that the country can reach his goal of 5 percent annual economic growth for a decade.

He sketches a beguiling vision of the results. “Growing at 5 percent a year — rather than the current level of 1.8 percent — would net us millions of new jobs. Trillions of dollars in new wealth. Put us on a path to saving our entitlement programs. And balance the federal budget.”

But even those conservatives who are broadly sympathetic with the governor’s policies — even those conservatives who are sympathetic to his candidacy — should question some of the assumptions of this quest for growth.

The first assumption is that setting what Pawlenty calls “a national economic growth target” is helpful. John Taylor, one of the few prominent conservative economists to defend the goal, suggests on his blog that it “would focus policymakers like a laser beam on the great benefits that come from higher growth and on the pro-growth policies needed to achieve it. As with any goal, if you take it seriously, you’ll choose policies that work toward that goal and reject those that don’t.”

This seems like an over-idealized picture of how government policy gets made. Right now we have one party that insists that government subsidies to “green jobs” will nurture new industries and thus raise our long-term economic prospects — that is, our growth rates. The other party sees these subsidies as a boondoggle. Even if everyone were to accept a growth target, it would do nothing to resolve this debate.

Lawrence Kudlow, the economics commentator for CNBC and National Review, is another supporter of the goal. Indeed, he was advocating it before Pawlenty was. His case for it rests on the importance of what Keynes called the “animal spirits.” The target would send a signal to entrepreneurs that they will have supportive policies and a government that is firmly against declinism. But surely the actual policies would themselves be a more useful signal. If cutting the corporate tax rate by more than half does not communicate sufficient enthusiasm for business, a growth target would probably fail to do so as well.

A governmental growth target is bound to be politicized. If a president adopts one, what future president will want to set a lower target, even if the country’s achievable growth rate has fallen in the interim? That president would be accused of lacking confidence in his policies, his country, or both. The Pawlenty campaign has itself used this tactic against his critics. Even if the initial target were realistic, over time the practice of setting targets would become a charade.

If it has not already done so. Even if setting a national growth target made sense, 5 percent a year for ten years is almost certainly too high a number. In his speech, Pawlenty pointed out that the economy had come close to hitting the 5 percent growth rate from 1983 to 1987 and again from 1996 to 1999. Critics instantly pointed out that neither period saw the economy actually hit the target, or lasted a decade.

Taylor argues that if we brought the proportion of the working-age population that is actually working back to its 2000 peak over the next ten years, we would get 2 of our 5 percentage points of economic growth from increased employment alone. He says, further, that we have averaged 2.7 percent productivity growth each year since 1996. Keep that up at the same time as we get more people to work, and we would be close to Pawlenty’s goal.

It would be a very tall order to do either one of these things, let alone both of them together. Nobody has a surefire way to raise the employment ratio to its 2000 level. The middle of the last decade saw both economic growth and tax cuts, but the ratio did not climb back to that peak. And these two steps are to some extent in conflict. There is every reason to think that the people who are currently working are, on average, more productive than the people who are not currently working would be if they got jobs.

Conservatives have repeatedly gone astray by overestimating the impact of taxes on economic growth. The predictions of economic doom when Bill Clinton raised taxes in 1993 are a case in point. So is the assumption that the right tax policies can bring the labor market back to its condition in 2000.

Remember: Reagan cut the top tax rate from 70 to 50 percent. The after-tax value of a dollar earned went from 30 cents to 50 cents: an increase of 67 percent. Clinton raised the top tax rate from 31 to 39.6 percent, which reduced that return by only 12.5 percent. Even if Reagan’s tax cuts had a strongly positive effect on the economy, there was no reason to think that Clinton’s tax increases would have an equal and opposite effect. Taking the top tax rate from 35 to 25, as in the Pawlenty proposal, would be a 15 percent improvement in incentives. Reagan’s success has limited the potential for further gains.

Higher growth is also not quite the panacea Republicans sometimes make it out to be. We learned over the last decade that it was possible for the economy to grow without increasing most people’s wages. Rising health-care costs swallowed the raises workers would otherwise have received. Pro-growth measures are not a substitute for tackling them. And even if growth does yield wage increases, it is not a substitute for entitlement reform. Higher wages mean more revenue coming in to Social Security, for example, but they also mean larger benefits going out from it in the future.

Like many other Republican seekers of growth, Pawlenty is convinced that we need a much tighter monetary policy than we have now. In his go-for-growth speech he lamented “the continued debasement of the dollar as a result of the loose-money policies of the Fed.” He said that “inflation cruelly undermines the life savings and life prospects of every American.” The difference in yields between inflation-indexed bonds and unindexed bonds implies a current market projection of 2.2 percent annual inflation over the next ten years, which is lower than the average inflation the country has experienced in any decade since the 1950s.

During the late 1990s, one of Pawlenty’s two examples of the high growth we should strive for, the dollar’s trade-weighted exchange rate was at around the same level as it is in these days of alleged debasement. The 1983–87 period, his other example, saw a decline of the dollar. It is at the least unclear that the high growth Pawlenty wants and the monetary policy he wants are compatible with each other, let alone that they are in the easy harmony his speech would lead one to expect.

Public policies that increase the country’s long-term growth potential are very important. The difference between 3 percent average growth and 2 percent average growth, compounded over 30 years, is a $9 trillion–larger economy. Several of Pawlenty’s policies would likely increase the growth rate and deserve support on that basis. But there is no reason to expect them to have effects nearly as large as he suggests.

“If prosperity were easy, everybody around the world would be prosperous.” The line has been a standard part of Pawlenty’s stump speech for the last few months. It’s one that policymakers should take to heart.

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