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November 19, 2009

BY GARY LIVACARI The Tribune-Democrat Thu Nov 19, 2009, 09:03 AM EST

In early 2009, the American economy needed a jolt, and it needed it fast.

Policymakers faced two options in counteracting the recession: Increase government spending to replace sagging private investment and consumption or increase supply by stimulating production and work.

The Obama administration opted for the former strategy, relying on massive government spending to – somehow – rekindle prosperity. Despite worsening job losses, officials now argue that the spending program prevented even higher unemployment. This is hard to believe when we consider that actual unemployment has surged steadily higher than what the administration expected to happen without the stimulus.

Certainly $800 billion in government spending has helped offset falling demand.

Even if we concede that the stimulus has made a bad situation less worse, we can still recognize that demand-side fiscal policies cannot engender the growth necessary to restore full employment. Only private firms, responding to market incentives, can produce sufficient new jobs to enable the economy to escape recessionary pains.

This is no surprise to any small-business owner who, in a competitive marketplace, seeks to maximize profits when making production, hiring and investment decisions.

Given prevailing wage rates, tax rates and market prices, employers and employees alike produce and work until the marginal benefits of their activities equal the marginal costs. The profit-maximization decision is the real force that drives growth.

This decision is distorted by taxes that raise the cost of labor and decrease the return from production and work, lowering the level of employment demanded, and output supplied, by profit-maximizing firms.

A lower payroll tax will lower the cost associated with hiring an individual worker, and increase the amount of employment demanded by businesses.

Similarly, lower marginal tax rates increase after-tax net income, incentivizing firms to expand hiring and employees to work longer hours (leisure becomes more expensive).

This leads to more growth and more jobs.

The resulting spike in income and employment will also spur increased demand, restoring businesses with a robust customer base.

Obama’s stimulus plan includes numerous tax credits for favored industries and groups, namely low-income individuals and “green” businesses. These breaks amount to disguised fiscal policies, boosting demand without changing fundamental supply decisions.

Stimulating demand through government spending only changes the composition of national income, shifting more of our expenditures to the government and away from the market. It does not change the profit-maximization forces that underlie employment and production decisions – decisions that determine whether or not our economy grows again.

Unless the president finally promotes a growth agenda that targets the proven engines of job creation, America’s economic recovery will continue to languish, and unemployment will continue to rise.

We can thank the president, and his predecessor, for stabilizing financial institutions and offsetting an even greater decline in demand. But now it is time to grow. It is time for a real supply-side jolt that will return America to its brightest economic days.

Gary Livacari of Coraopolis has a master’s degree in public policy from the University of Chicago Harris School of Public Policy.

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