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Larry Lindsey: Bad Government Is a Luxury We Cannot Afford at This Point in Our Country's History

Congress is back in session this week and there are two weighty issues for them to tackle: whether to extend the Bush tax cuts and the deficit reduction from the President's bipartisan National Commission on Fiscal Responsibility and Reform. The political rhetoric has already heated up. Fingers are pointing and heels are being dug into slippery slopes.

If Americans were "sending a message to Washinton" in the midterm elections, the message has been scrambled. The conservative Tea Partying wing of the GOP, believing Americans have voted for change, read it as a message for smaller government, less spending, and smaller deficits. Others say voters were demanding government solutions to unemployment. Still others think Americans were just voting against Wall Street.

One of my close contacts who knows very well the process in which tough economic decisions are made and the ramifications of standing his ground is Larry Lindsey, President and Chief Executive Officer of The Lindsey Group. Lindsey, a former director of the National Economic Council and assistant to the president on economic policy for the U.S. President George W. Bush, was one of the key players in Bush's $1.35 trillion tax cut plan. He called it an "insurance policy" against an economic downturn. Lindsey left the White House in December of 2002 after he estimated the price tag of the Iraq war could reach $200 billion.

Even though Lindsey left "politics" doesn't mean his economic opinons aren't sought out. The Obama White House contacted Lindsey to get his original thoughts on the $800 billion stimulus package. He told them the size of the package was right, but the allocation of where the money would be spent was not. Lindsey called the results of the stimulus an"absolute disaster" because the money appropriated went to areas that had little benefit to the economy or job-creation.

LL: The deficit commission released the proposals they are discussing in terms of cutting the deficit. Are you happy with what's on the table? Should there be more?

LINDSEY: Commission Co-Chairs Erskine Bowles and Alan Simpson deserve the country's gratitude for a very thorough and honest attempt at solving the nation's deficit problem and shoring up Social Security. One doesn't have to agree with every detail in the proposal to appreciate the enormous effort they put forth and their belief in a balanced and bipartisan approach.

Lawrence B. Lindsey
Scott J. Ferrell | CQ-Roll | Getty Images
Lawrence B. Lindsey

LL: Do you think the 2011 Congress will have the political will to tackle the deficit? The choices like raising taxes are not politically friendly.

LINDSEY: Unfortunately, I believe that the vociferous reaction of Speaker Pelosi and similar comments by others on the Left indicate that this proposal has little chance to make any progress.

Pelosi's comments were ill-advised and so wide of the mark on a factual basis that she seems to be on another planet. The Social Security changes (which she is attacking) make the system more progressive. They create a new special minimum benefit that assures that any worker, even one who worked at minimum wage for his or her life, will receive a social security check sufficient to make sure that they are above the poverty line.

The Commission plan makes the system solvent. To do this, 45 percent of the shortfall is made up by higher taxes on upper income workers. Another 35 percent is made up by lower benefits on workers with above average lifetime earnings. Only 20 percent is made up by a very gradual increase in the retirement age, one that means that a current 28 year old will have to work until 68 instead of 67 and a current 6 year old will have to work to 69.

The Speaker's attacks on the proposal thus do not comport with the reality of what the plan is trying to accomplish. They obviously are going to be the centerpiece of her efforts to restore a Democratic majority in 2012 and therefore regain the Speakership. I think it is very regrettable that someone in high office would be so disingenuous, and try to scare seniors and the general public that their benefits are threatened, simply to advance her own political fortunes. I hope that moderate Democrats and the White House do not let the Speaker's statements stand as the official Party position. To do so would really doom any prospect for serious deficit reduction for the rest of the Obama Presidency.

Republicans also have a lot to swallow in this proposal. Essentially the plan closes the gap between spending and taxes at 21 percent of GDP. This is an increase from the historic average level of taxes at 18 percent of GDP and of spending at around 20 percent of GDP. Most of the deficit gap is therefore closed with tax increases rather than spending cuts.

On balance, I think that the proposal does so in a way that also improves the integrity and efficiency of the tax system. This makes the one-sixth boost in the long run share of taxes to GDP and the nearly 50 percent increase in taxes from their current GDP share palatable. But no one should doubt that this is a tax-heavy way of closing the deficit gap.

LL: Do you think there is any threat of a Presidential Veto pen here?

LINDSEY: The President does have a difficult choice politically regarding his re-election strategy. One of the early tests of what he plans on doing politically will be on whether or not he backs up the deficit Commission that he created, or sides with Speaker Pelosi. His endorsement of the co-chairs' proposal would probably provide enough momentum that it would clear the full commission and move on for Congressional consideration.

During the past year he has frequently referred to the Commission as a source of guidance. Pulling the plug on it now, and particularly letting

Speaker Pelosi's comments stand, would indicate that he has decided to run for re-election by shoring up his base on the Left rather than moving to the center.

LL: QE2 has created a firestorm with the rest of the world. You have connections all over the world. What are your contacts telling you?Do you think QE2 is necessary?

LINDSEY: Regarding QE2, I think we will have to watch market developments carefully. There is no question that excess capacity, high unemployment, and a rising dollar (through August) were creating deflationary risks for the American economy.

On the other hand, QE2 has created political stresses both at home and abroad. We will have to see whether the benefits that QE2 is supposed to create become sufficiently manifest that these criticisms become muted, or whether the criticisms will reach such a level that the Fed will have to stop its program before a reflationary success is guaranteed.

LL: One of my contacts, Ian Shepherdson , says he is seeing green shoots in terms of credit and the lending to small business (which he says will translate into a better jobs picture in the middle of next year). Are you seeing any green shoots?

LINDSEY: At the moment the U.S. economy is stalled at a speed that is insufficient to provide a self-sustaining expansion through employment and income growth. This is not an equilibrium that can be sustained over the long run. Either growth will become more robust or the downward pressure on wages and output prices will cause a further contraction. It is vital that we not make a mistake on the fiscal or regulatory side.

Extending the Bush tax cuts in their entirety for anything from two to five years would be highly advisable. The center of the economic crisis is in the balance sheets of households and small businesses. Those can only be repaired by an improving income statement, and left alone, that improvement will not happen. So tax cuts are the most effective way of solving the root cause of the country's economic challenges.

LL: What has you concerned as we go into 2011?

LINDSEY: On the regulatory side we are already seeing the drawbacks of both the Health Care bill and the Financial Regulation bill.

The Health Care bill was badly drafted and so far, the regulations that have seen the light of day have required special waivers to prevent people from being dumped from employer provided health care coverage. This was most clearly seen in the case of McDonalds , although a lot of other large companies also got special waivers. Most employers, particularly small businesses, don't have either the advisers to know what all the regulations mean or the lobbyists to get the waivers.

So, Health Care regulations are gradually killing the ability of small businesses to expand robustly; a moratorium on new health care regulations and a delay in the implementation of the entire bill is in order.

Similarly, in Financial Regulation, the squeeze on bank profitability coupled with higher capital requirements is going to force a continued reduction in bank credit availability. While we often speak of "uncertainty" as the problem, the effects of these two bills on the ability of the country to make economic progress are all too certain.

The bills were enacted without sufficient attention to detail, and we are now paying the price. The most egregious example was in the derivatives part of the Financial Regulations bill. Both Chairman Lincoln in the Senate and Chairman Frank in the House admitted that the bill was badly written. But rather than rewrite it before voting on it, they went ahead and passed a bill they, the authors, knew to be flawed. This is bad government, and bad government is a luxury we cannot afford at this point in our country's history.

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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."

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