We have all heard the rhetoric coming from each political party: the name-calling, the innuendo, the blame game. What we have not heard, at least not yet, is a cogent debate on the size and proper role of the federal government. After all, this most basic issue is the linchpin to each party's economic approach to future policies.
Interestingly, this topic is not new. The founding fathers heartily disagreed on the issue. Jefferson felt that the national debt was harmful to society and that all debts should be paid off quickly. Hamilton believed in a strong central government with public debt being an important tool for economic growth. Hamilton's beliefs are reflected in John Maynard Keynes' (noted 20th Century economist) theory that says government should spend when the private and business sectors are not. Ronald Reagan built on Jefferson's philosophy in saying that government is not the solution to the problem; government is the problem. Clearly, we have two distinct and contrasting economic views with each forming the base of their respective party's platform.
President Obama's Policies
President Obama clearly believes that government has a big role to play especially when demand collapses, as it did during the Financial Crisis of 2008. Consumer spending dried up and business investment came to a screeching halt, the combination of which ushered in the possibility of a major global depression. Seeing the risk, the Obama Administration increased government spending from 37% of Gross Domestic Product in 2008 to over 40% today; spending that increased the federal deficit from $459 billion in fiscal year 2008 to $1.327 trillion in fiscal year 2012. Mr. Obama has repeatedly stated that he wants to reduce the deficit by raising revenues via higher taxes on the wealthy.
Republicans Respond to Mr. Obama's Policies
Republicans strongly believe that the government should step aside to allow the private sector to carry the responsibility for growing the economy and reducing unemployment. The Republican economic platform is based on supply-side economics that claims growth is achieved from a combination of lowering taxes and reducing spending. According to Mr. Ryan's budget plan, "Roadmap for America's Future", the government would run a surplus beginning 2040. Supply-side policies were championed by Ronald Reagan in the 1980s. In addition to lowering taxes, Reagan believed that deregulation opens the path for private sector innovation and creativity.
Policies on Entitlement Programs
Both parties believe that entitlement programs such as Social Security, Medicare, and Medicaid need reform, although details of how that should occur are not yet well defined. The 2011 downgrade of US debt to AA+ from AAA by Standard & Poor's stressed soaring entitlement costs as a major reason for its action. Medicare and Social Security combined have promised American citizens future benefits totaling $46 trillion more than the government has a plan to pay. Mr. Obama says that cutting payments to hospitals is the way to control Medicare. Still, he gets in trouble with his own party when he even mentions reforming Medicare. Mr. Ryan proposes to repeal President Obama's health care law and transform Medicare into a block grant to states. Medicare would be changed to a voucher system that offers a menu of subsidized private insurance plans.
Taxes, Taxes, and Taxes
The current maximum rate on personal income is 35 percent. Mr. Obama wants to raise that to 39.5 percent. Mr. Romney wants to cut the rate to 28 percent and Mr. Ryan wants 25 percent. The current capital gains rate is 15 percent. Mr. Obama wants to raise it to 20 percent. Mr. Romney wants to eliminate the capital gains tax for all taxpayers making less than $200,000. Mr. Ryan wants to eliminate it all together. The current maximum estate tax is 35 percent. Mr. Obama wants to raise it to 45 percent. Mr. Romney and Mr. Ryan want to eliminate it.
Tax policies represent an especially sharp divide between the two parties. The Obama team says that raising taxes is only fair; that wealthy Americans should shoulder a heavier burden on taxes because they can afford it. The Obama team further says that lowering the tax rates as proposed by the Republicans would only make the deficit worse. The Romney team says the opposite. Raising taxes on anyone at a time when the economy has not fully recovered would be a serious mistake. While both parties see problems from a "fiscal cliff" that must be addressed over time, Democrats see increasing revenue from higher taxes as their priority; Republicans place their priority on reducing expenditures. Each side points to economic theory for support.
Democrats say that spending patterns of wealthy individuals do not help the economy as much as spending patterns of lower income individuals. Democrats believe that wealthy people have already met their basic needs for food, clothing, and shelter, so they save more of an extra dollar of income as opposed to spending it. On the other hand, because lower income people have not satisfied their most basic needs, they spend more of an extra dollar as opposed to saving it. According to this logic, Democrats want to put more money in the hands of lower income people, which would provide a direct stimulus to the economy that is especially important when the economy is struggling to regain its footing.
Keynes was a strong advocate of consumer spending and the redistribution of wealth from upper income people to lower income people. The mechanism Keynes favored for stimulating the economy is tax policy and welfare programs. Being that consumer spending accounts for almost 2/3rds of the entire US Gross Domestic Product, Democrats claim that their stimulative policies are superior to the Republicans' approach of cutting taxes and reducing spending.
Republicans counter by pointing to a well-developed body of economic literature dealing with how incentives drive behavior. According to this logic, one of the major motivators for people to work is the pay they receive as a result of that work. In a capitalistic economy, wealthy people are high achievers who should not be required to give an extraordinary amount of their wealth to the government. Likewise, lower income people who receive welfare checks from the government have an incentive to not work.
Republicans also claim that The Law of Unintended Consequences often interferes with the Democrats' desire to help lower income people. This law says that the intention of providing temporary help to a person who needs it can result in hurting the very person intended to be helped by creating a co-dependency between that person and the government. Milton Friedman, a Nobel prize-winning economist who advised President Reagan, believed that market forces of supply and demand provide a much stronger incentive for people to work than the best designed government program.
Whose Policies are Correct?
Each party cites historical experiences that support their respective view. For example, Democrats claim that their policies under President Clinton benefited lower income people while propelling the economy to grow at a high rate. Republicans, likewise, refer to the Republican Congress in 1996 that made history by passing welfare reform whereby federal authorities began treating welfare as a step up rather than a way of life. If each party is correct in their view, we should be able to see discernible results in either how the economy or the stock market performed when their party was in control of the Presidency.
While any review of history depends on both the time frame selected (i.e., 1980s, 1990s, 2000s, or all) as well as the specific statistic under review (i.e., GDP, S&P 500, unemployment, US dollar), both parties can claim success. This reminds me of the best-selling statistics book of all time, "How to Lie with Statistics" (1954) by Darrell Huff. In Chapter 5, Huff states, "Nothing has been falsified-except the impression that it gives". The reality is that even a sophisticated researcher cannot find clear evidence supporting a conclusion one way or the other. The truth of the matter is that neither party can rightfully claim its policies are superior to the other. The economy is not a laboratory where a researcher can design experiments to test an hypothesis.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.