Harvard Economics Guru Breaks Down Obamas' Income Redistribution Plan


Since President Obama took office in January, 2009, his administration has pursued a broad range of economic policies.  The purported goal has been to make the economy work better, such as by ending the recession, stabilizing the housing market, or reforming health care.  Thus, the policies claim to expand the economic pie, not just redistribute ownership.

The reality is different.  The fiscal stimulus aimed to grow the pie, but its design emphasized redistribution rather than efficiency.  Other new policies were almost entirely about redistribution, rather than about making the economy more productive.   It is no surprise, therefore, that the economy is recovering slowly; the economic policies pursued over the past ten months have been inimical to productivity and growth.

Consider first the fiscal stimulus.  The administration’s goal for this policy—ending the recession—made sense, and conventional wisdom suggested that a fiscal stimulus might help. The problem is that the particular stimulus adopted was vastly inferior to alternatives the administration could have chosen.

A fiscal stimulus can take two forms: increases in government spending, or reductions in taxes.  In choosing the mix, policymakers should consider which form is most beneficial on cost-benefit grounds, since this makes the best use of society’s resources.  Policymakers should also consider the evidence on which kind of fiscal stimulus is most effective.

As it turns out, both considerations suggest the stimulus should have consisted of reductions in taxes—especially lower tax rates—not increased expenditure.  The scope for additional, productive government spending is minimal in the U.S., not because all government is unnecessary but because the beneficial activities already exist.

At the same time, existing evidence makes a better case for the efficacy of tax reductions than spending increases.  This makes sense, since tax cuts leave spending decisions to households rather than government bureaucrats, and because reductions in tax rates diminish the distorting impact of taxation.  Two particularly desirable cuts would have been lower employment and corporate income taxes.

Thus while adoption of some stimulus package was defensible, the actual package fell far short of the ideal.   It was a payoff to interest groups (unions, the green lobby), not a package designed to end the recession and promote growth in the most effective manner.

The administration’s second major policy intervention was the Homeowners’ Affordability and Stability Plan, which provided $75 billion to help homeowners avoid foreclosure and $200 billion to Fannie and Freddie to purchase and refinance mortgages.  This was on top of the $8,000 refundable tax credit for first-time home buyers in the fiscal stimulus package.

These interventions were designed to prop up the housing market, thereby improving bank balance sheets and spurring lending.   These interventions were also meant to prevent foreclosures, since these are allegedly costly for both lenders and borrowers.

Yet the interventions in the housing market were problematic.  During the bubble years, housing prices far outreached fundamental values, so they needed to decline substantially.  Relatedly, homeownership boomed among homeowners who could not really afford their mortgages, so foreclosure was inevitable.   Preventing price declines, propping up housing investment, and forestalling foreclosures is exactly the opposite of what economic efficiency dictates.

The true motivation for the administration housing’s policies was therefore transferring wealth, not enhancing efficiency.  And, by adopting these policies, the administration has delayed appropriate adjustments in the housing market, implying failure and reallocation down the line.

The third main administration policy initiative has been its proposed “reform” of the health care system.  The administration initially claimed it could improve efficiency in this sector by reducing fraud and abuse in Medicaid and Medicare, by adopting new information technology for medical records, and by imposing “best practice” medical care widely.  These changes were allegedly going to save enough to insure another 30-40 million people, without reducing care for those already covered.

These claims were never plausible.  The only way to make the health care system more efficient is for consumers to face a higher share of the costs of their health care.  This means less government subsidy of insurance, not more.

The real agenda behind health reform is therefore again redistribution: the proposed bills in Congress provide new health insurance subsidies for moderate income households and pay for these subsidies with taxes on middle and upper income households.  These changes will make the health care system worse, not better.

By tilting its policies so dramatically toward redistribution, the administration has missed a golden opportunity to engineer significant improvements in the U.S. economy.   By cutting or eliminating employment and corporate income taxes, it could have spurred employment and investment in the near and long term.  By allowing the foreclosure process to runs its course, it could have promoted a better match between homeownership and the ability to afford a home.  By phasing in a higher age of eligibility for Medicare – or repealing the tax exemption for employer-paid health insurance premiums – it could have slowed the growth of health spending and given consumers more incentive to consider the costs of their health care choices.

But the administration did none of these things, and the U.S economy is the worse for it.