Mixed stimulus bag Obama's short-run fixes neglect much-needed long-term reform

Should voters blame President Barack Obama for America’s current economic malaise?

The Mitt Romney campaign, hard as it tries, will find it difficult to convince moderates that Obama completely mishandled the short-term stimulus. Their better argument is that the president focused too much on the immediate crisis, and did too little for the future. That future is already upon us.

Obama took office in 2009, in the middle of an economic crisis he didn’t create. At worst, he was only one of many members of Congress who failed to support a 2005 bill to reform those benighted mortgage behemoths: Fannie Mae and Freddie Mac. As president, he has faced constant headwinds, most recently from Europe, but he has chosen to respond to these troubles with short-run fixes that missed opportunities to carry out more lasting reforms.

The automotive-industry crisis illustrates the conflict between short- and long-term objectives. When General Motors and Chrysler were in a freefall, Obama chose a bailout, a solution that probably saved thousands of jobs and stopped a bad situation from getting worse. Bailouts come at a high cost, however, because the promise of federal largess discourages painful restructuring and corporate breakups that can create nimbler, more competitive companies.

The short-run answer isn’t always wrong, and the bailout may have been better than any alternative. But the president should have ensured that industry and labor unions understood this was a one-time, unfortunate event.

Instead, he announced that “I believe the nation that invented the automobile cannot walk away from it,” which sounds like an open-ended commitment (as well as demonstrating ignorance about the German origins of the car powered by the internal-combustion engine).

More generally, it is hard to argue that the stimulus package – $772 billion as of Sept. 12 – was too large given the depths of the recession. But it is fair to claim that the administration failed to couple short-term palliatives with a more sustainable, long-range economic plan.

The American Recovery and Reinvestment Act had four important elements: significant tax cuts, especially in the payroll tax; big increases in entitlements, particularly unemployment-insurance extensions; grants to states, which primarily went for Medicaid and education assistance; and direct government spending, mainly for transportation and infrastructure. Some of these initiatives were sensible, others were less so, but all dealt with near-term exigencies.

The tax cuts were generally sound and supported by Republicans and Democrats. Reducing the payroll tax and expanding the earned-income tax credit put money in people’s pockets, and increased the incentive to work. Even so, Obama missed a chance to show more commitment to fiscal rectitude for the long haul. He could have insisted that the younger workers who benefited from lower payroll taxes cover the cost of those cuts by accepting a slightly higher retirement age for Social Security.

Other tax breaks, such as the first-time-homebuyer tax credit, which was heartily supported by Republicans, created benefits so short-lived as to be positively ephemeral. The credit generated only a temporary increase in housing prices from May 2009 to May 2010; they began declining again when the incentive was phased out in the summer of 2010. Delaying the housing market’s transition to a new, lower plateau by a year seems like a small return for $10.4 billion in lost revenue.

As for entitlements, we spent $61 billion on extra unemployment insurance, expanding the weeks that the jobless could receive benefits from 26 to 99. In addition, spending on food stamps ballooned from $30 billion to $72 billion from 2007 to 2011, as benefits were made more generous and restrictions on receiving aid were lifted.

These entitlement programs enabled people to spend, which may have helped the economy. More important, they assisted needy Americans. But extending the duration of unemployment insurance also created a strong incentive for people to stay out of work.

A famous paper by economist Bruce Meyer demonstrated that people work less when benefits rise and that the unemployed go back to work right before their unemployment-insurance benefits end. Food-stamp payments decrease by 30 cents with every extra dollar earned, which discourages people from trying to make more money.

Unemployment “hysteresis” can set in when people spend serious time out of the workforce – as some Obama administration officials recognize – which makes it dangerous to pay people not to work. The relief could have been combined with incentives to reduce prolonged joblessness.

The administration might have considered one-time lump-sum payments to those affected, instead of limiting the aid to continued unemployment, which provides almost two years of financial incentives not to work.

The third leg of the stimulus act’s four-legged stool was aid to states: $50 billion for education and $89 billion for Medicaid grants. Because states, unlike the federal government, have to balance their budgets during economic declines, the aid from Washington reduced their need to lower spending and raise taxes.

But in a better world, states would have rainy-day funds. This would mean service levels could be maintained during temporary recessions. The Obama administration could have moved states in that direction, by linking assistance to a requirement that they commit to saving more during booms.

The least defensible part of the stimulus package was the direct federal spending, $66 billion of which predominantly went toward transportation and infrastructure. It is impossible to build public works both quickly and wisely, meaning they are terrible candidates for a short-term boost to the economy.

These projects are often high-tech operations, employing a few skilled engineers rather than the masses of high-school dropouts. Moreover, the government has an unfortunate knack for picking politically motivated, foolish projects, from Detroit’s People Mover monorail to high-speed rail outside the Northeast corridor.

You would think Republicans would squawk about infrastructure spending. But the party’s platform bizarrely complains in the “the vaunted stimulus package, less than 6 percent of the funds went to transportation.”

Spending any general tax revenue on projects such as roads is a mistake, as fiscal purists going back to Adam Smith have argued. Highways should be funded by user fees, such as tolls and gas taxes.

By increasing the use of general tax revenue for these purposes, Obama set a bad precedent, which is reflected in the recent highway bill that directs $18.8 billion to subsidize drivers in low-density states. A better path would have been to push for public-private partnerships that would build today, but be financed by future user fees.

To be fair, the president has pushed some far-reaching reforms, notably the Race to the Top program, which sets higher standards for education and invests in human capital, the nation’s most important long-term resource. His mistake was that he let health care, not education, dominate his first term.

The recession did call for a short-term stimulus, perhaps even a larger one than the U.S. received, but long-run growth requires fiscal stability, robust corporate and individual incentives, and limited regulation.

Luckily for Obama, and unfortunately for the country, the Republicans have yet to show that they have the wisdom and character to be better long-term stewards of the economy. They have squandered much time and now have less than two months to make that case.