Reasons for the failure of big spending liberalism

Allan Meltzer:

Those who heaped high praise on Keynesian policies have grown silent as government spending has failed to bring an economic recovery. Except for a few diehards who want still more government spending, and those who make the unverifiable claim that the economy would have collapsed without it, most now recognize that more than a trillion dollars of spending by the Bush and Obama administrations has left the economy in a slump and unemployment hovering above 9%.

Why is the economic response to increased government spending so different from the response predicted by Keynesian models? What is missing from the models that makes their forecasts so inaccurate? Those should be the questions asked by both proponents and opponents of more government spending. Allow me to suggest four major omissions from Keynesian models:

First, big increases in spending and government deficits raise the prospect of future tax increases. Many people understand that increased spending must be paid for sooner or later. Meanwhile, President Obama makes certain that many more will reach that conclusion by continuing to demand permanent tax increases. His demands are a deterrent for those who do most of the saving and investing. Concern over future tax rates is one of the main reasons for heightened uncertainty and reduced confidence. Potential investors hold cash and wait.

Second, most of the government spending programs redistribute income from workers to the unemployed. This, Keynesians argue, increases the welfare of many hurt by the recession. What their models ignore, however, is the reduced productivity that follows a shift of resources toward redistribution and away from productive investment. Keynesian theory argues that each dollar of government spending has a larger effect on output than a dollar of tax reduction. But in reality the reverse has proven true. Permanent tax reduction generates more expansion than increased government spending of the same dollars. I believe that the resulting difference in productivity is a main reason for the difference in results.

 Third, Keynesian models totally ignore the negative effects of the stream of costly new regulations that pour out of the Obama bureaucracy. Who can guess the size of the cost increases required by these programs? ObamaCare is not the only source of this uncertainty, though it makes a large contribution. We also have an excessively eager group of environmental regulators, protectors of labor unions, and financial regulators. Their decisions raise future costs and increase uncertainty. How can a corporate staff hope to estimate future return on new investment when tax rates and costs are unknowable? Holding cash and waiting for less uncertainty is the principal response. Thus, the recession drags on.

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There is much more.

Taking incentive away from job creators and giving it to those who do not have jobs is not the way to increase employment or the growth of the economy.  Tax cuts have been far more effective job creators when they have been aimed at the top marginal rates rather than at the lower end of the income scale.  The Perry Tax cut plan is already under attack because it cuts the rates more for the rich, but they are most likely to do something with the cuts that will benefit the economy.  Liberals like Obama would rather punish the rich than create jobs.