News & Events

Fixing the Economy

What one thing could President Barack Obama or Gov. Mitt Romney do in the next four years to get the economy going again? Economic and business experts from the University of Iowa offer these ideas…

Stimulate spending through targeted tax cuts

Jon Garfinkel, professor of finance

Jon GarfinkelConsumer spending constitutes 70 percent of U.S. Gross Domestic Product (GDP). To grow the economy we should grow consumption, and that means putting money in the pockets of spenders. The difficulty with this is that one of the government’s simplest approaches to doing so is to cut taxes, which reduces revenues and widens the deficit. So the battle over lower taxes versus reduced deficits arrives. The best outcome is to limit the cost of tax cuts while maximizing the amount of spending/consumption these cuts generate. The key to doing so is to put money in the pockets (cut taxes) of those households that spend the greatest fraction of their after-tax income.

Using data from the Bureau of Labor Statistics’ Consumer Expenditure Survey, it is clear that higher after-tax income families spend smaller percentages of their after-tax income, while lower after-tax income households spend larger percentages of their after-tax income. To accomplish a tax cut for lower income households, one needs to focus on payroll taxes if federal income taxes are minimal or zero on such households. The payroll tax “holiday” could be extended, or even made permanent, with means-testing to limit the cost of doing so and to emphasize the effect on those that spend the greatest portion of their after-tax income.

My other “tax-related” suggestion would be to advocate for a vastly simplified tax code, though not necessarily a flat one. One example of the potential benefits to this: many small companies find it too expensive to take advantage of targeted tax breaks. I would prefer to eliminate the complexity of the tax code, removing targeted tax breaks and consequently raising tax revenues, and then spend the proceeds by simply reducing corporate taxes across the board, not entirely unlike the 1986 Tax Act did.

Raise and enforce the minimum wage

Colin Gordon, professor of history

The lingering recession and the longer-term problem of inequality in America share a common source: a fundamental shift in public policy that has eroded the bargaining power of American workers and the security of American families. The political dimensions—and economic consequences—of this shift are well-documented. They include macroeconomic policies which prefer fighting inflation to full employment, regulatory indifference to everything from financial markets to workplace safety, labor-management policies which tilt dramatically in the employer’s favor, a steady erosion in the incidence and quality of job-based benefits, an increasingly tattered social safety net, and remarkably meager (by international standards) commitments to the work-life balance.

This is a daunting list. If I had the ear of the next president long enough to propose one fundamental policy change, it would be this: raise, index, and enforce the minimum wage. The current federal minimum of $7.25 an hour is—in real, inflation-adjusted dollars—nearly two dollars below its peak in the late 1960s. Evasions of even this meager standard, wage theft by employers, is now distressingly common. Raising the minimum wage has broad (and bipartisan) political support. It would have a substantial impact, especially in an economy in which both recent and projected job growth is heavily weighted toward low-wage service employment. So what should it be? Full-time work at $7.25 an hour is not enough to lift a family of two above the federal poverty level. For this reason, most economists (see recent work by the Center for Economic and Policy Research or the Economic Policy Institute) place the “poverty” or “low wage” threshold closer to $11 an hour. If the minimum wage had kept pace with inflation and productivity growth, it would be closer to $20 an hour today. So let’s split the difference: a staged increase to $14 or $15 an hour over three years, indexed to rise with inflation after that.

Get serious about cutting the debt

Robert Miller, professor of law

The United States faces many grave economic issues, but the most serious one over which the next president will have significant control concerns our unsustainable federal budget deficits. Annual deficits have run to $1.4 trillion in 2009, $1.3 trillion in 2010, and $1.3 trillion in 2011, and 2012 will probably see a deficit of another $1.2 trillion. The national debt thus totals about $11.3 trillion, or more than 70 percent of GDP. This, of course, does not count tens of trillions of dollars in unfunded Social Security and Medicare liabilities over coming decades. World capital markets have not yet demanded higher interest rates for U.S. bonds the way they have for those of Greece, Spain, and Italy (though this happy circumstance could be partly due to the fact that the Federal Reserve now holds about one-sixth of outstanding U.S. debt—the largest percentage in history). Eventually, however, the markets will start demanding higher interest rates from the United States, and the consequences of this will be extremely deleterious.

It is imperative, therefore, that the United States substantially reduce its budget deficits and deal credibly with its future Social Security and Medicare obligations. This cannot be done solely, or even primarily, by increasing taxes. Even if the federal government confiscated the entire income of every American earning more than $500,000 per year (about $1 trillion total), this would still leave an annual budget deficit of about $200 billion. Leaving aside the effects such a policy would have on economic growth, we cannot tax the rich to close the budget deficit because the rich simply do not have enough money to fund current levels of government spending. The only viable solution entails substantial, permanent reductions in government expenditures, especially entitlements. Achieving such reductions will involve many complex issues, including important ones of social justice. Anyone aspiring to be the next president should now be presenting to the American people a credible program for substantially reducing government spending.

Stop arguing to build consumer and investor confidence

Tom Rietz, professor of finance

Tom RietzWhat can the government do to help improve the economy? Two words: Stop bickering. Uncertainty kills investment and spending. The current partisan political environment creates incredible uncertainty. Politicians swear that this policy or that will surely destroy the economy and that this other one will save it. As soon as a policy as important as health care is passed, opposing politicians threaten it immediately. As businesses and consumers, how can we decide what to invest in or whether to spend money on a new house or car when it seems as though the next election may reverse policies on everything from health care to energy policy and job creation to taxes. My advice is to have a healthy debate and, through the debate, choose economic policies with everyone’s input and representation. Then, and this is the important thing, stick with policies chosen. Give them a chance to work and don’t create uncertainty by threatening them at every juncture. Health care reform passed. Don’t demonize it. Don’t threaten it. Get over it and move on. Maybe revisit it after a pre-specified time lag of 10 or 12 years. Don’t threaten the entire economy over a debt ceiling debate. Deal with it and move on to more fundamental issues. The instability and uncertainty of the current partisanship creates more harm than any particular economic policy could.

On the flip side, if the uncertainty is resolved, people and businesses will adapt to whatever policies are in place. Then, we will spend and invest with the confidence that the policies won’t change fundamentally tomorrow. That spending and investment is what will drive an economic recovery.

Invest in infrastructure

Alice Schoonbroodt, assistant professor of economics, and Martin Gervais, associate professor of economics

Whichever party ends up in power may want to think about investing in infrastructure improvement. This kind of fiscal policy should be fairly uncontroversial and attract support from both sides of the aisle, as well as from most economists.

The last "stimulus package,'' the American Recovery and Reinvestment Act of 2009, had provisions to increase government spending by about $500 billion, which represented around two-thirds of the entire package, and around 3.5 percent of GDP at the time. Only about 25 percent of this was targeted to infrastructure. In retrospect, despite a $56 billion increase in aid to states, the increase in federal stimulus spending in infrastructure was more than offset by the decrease in such spending by states and local governments (see www.bea.gov and the Cooley-Rupert Economic Snapshot; econsnapshot.wordpress.com). While the jury is still out on the impact of extra non-infrastructure spending, investing more in productive infrastructures should be much less controversial. Here is why.

Martin GervaisTaken together, the argument is that borrowing today at very low rates in order to bring forward projects that are already known to be productive at a time when factors of production are relatively cheap and abundant should be a no-brainer. First, recessions tend to be particularly harsh on the construction sector, generating underemployment, job loss, and/or bankruptcies. This certainly has been the case for the recent recession. Figures for 2011 from the U.S. Bureau of Economic Analysis show that the number of full-time equivalent employees in the industry is still down 17 percent relative to the year 2000 and 28 percent relative to its peak in 2006, while real value added is not only down in levels (30 percent below its 2000 level) but also as a percent of GDP (4.7 percent in 2000, 4.9 percent in 2006, and only 3.4 percent in 2011). Second, not only does the federal government have the ability to borrow a large amount of funds but it can do so at relatively low interest rates right now. Third, there are always infrastructure projects that governments know will have to be completed at some point.


Return to top of page