Financial crisis: the latest blow to free-market 'dogma'

Economic woes give plenty of ammunition to economists and lawmakers calling for new regulations and taxes.

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The financial crisis and the trembling United States economy have dealt a hard blow to conservative economic ideology.

It's "quite devastating to the conservative idea that the best policy towards markets is to leave them alone and let them self-correct," says Bernard Wasow, a senior fellow at the Century Foundation, a liberal think tank.

This is not to say every regulation is right, he adds. There is a middle ground in this area. But when government stays out of the financial markets too much, deregulated financial markets can "go over the cliff and take a good deal of the rest of the economy with them," he says.

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It's "almost impossible now" for conservatives to mouth some of their "dogma," says Paul Waldman, a senior fellow at Media Matters for America, a nonprofit advocacy group set up four years ago to guard against what left-of-center analysts regard as conservative (alias Republican) mythology.

For instance, there's the thesis that tax cuts heavily targeted at the rich, such as those passed in the first term of President George W. Bush, will trickle down economic benefits to the middle class and poor. Rather, the rich have been getting richer and little extra income has flowed to those under the top 5 percent.

Or, Mr. Waldman continues, another conservative saying – "Government is dumb; markets are smarter" – sounds almost nonsensical these days.

As a result, progressives today sometimes have an "I told you so" attitude, he says.

Last month, the Economic Policy Institute, a liberal think tank in Washington, published "Tax-Cut Snake Oil," a 21-page paper by Harvard University's Jeffrey Frankel, who considers himself a "middle-of-the-road" economist. In it, Professor Frankel takes shots at the Laffer Hypothesis, which holds that cutting taxes actually increases tax revenues and creates a surplus by accelerating economic growth.

This view, notes Frankel, has been discredited by most professional economists. But it has been endorsed by Sen. John McCain, even though disavowed by his policy director, economist Douglas Holtz-Eakin. Frankel details how the major tax cuts of President Ronald Reagan in 1981-83 and the Bush tax cuts both contributed to record federal budget deficits. He offers quotes indicating that both Reagan and Senator McCain endorsed the Laffer theory at some point in time.

The Bush tax cuts probably helped bring the United States economy out of the 2000 recession, making it one of the shortest and mildest on record, says Frankel in a telephone interview. But by aiming too much of its benefits at the already prosperous, he says, the 2002-2007 recovery was "not spectacular."

Economic growth during the recovery under Bush has been much slower than under President Bill Clinton, who raised taxes decidedly on the well-to-do, notes Frankel. The economic record of the second terms of Bush and Clinton, in terms of employment, growth, and prosperity, has been like "night and day," he adds.

Frankel also attacks the conservatives' "starve the beast" hypothesis. It claims members of Congress are reluctant to increase spending when tax revenues are inadequate (sometimes as a result of tax cuts), resulting in big deficits.

Actually, notes Frankel, during the 1990s, Congress had a "pay as you go" regime requiring any member of Congress wishing to increase spending to show how he or she would raise taxes to pay for it. This "shared sacrifice" approach succeeded in eliminating budget deficits, to a substantial degree by cutting the growth of federal spending. But spending grew faster under the Bush administration. The "pay as you go" system has been blocked in Congress or the White House so far this decade.

Another progressive think tank, the Center for American Progress, also uses statistics to blast conservative economic views. Real investment growth grew at a 10.2 percent annual rate after 1993 and the Clinton tax hike, 2.7 percent after the Bush tax cuts in 2001. Annual real median household income growth was 2 percent after the 1992 tax boost, and 0.3 percent after 2001. Average annual employment growth was 2.5 percent after 1993, 0.6 percent after 2001.

So liberals see the economic perils of today, though unwelcome, as confirmation of the desirability of progressive economic policies and proper regulation.

A majority of Americans "fell for the line" that tax cuts for the already prosperous, including those on Wall Street, would be beneficial, says Frankel. Now there is a huge backlash against the financial community.

To deal with this anger, some liberals are proposing a tiny tax on securities transactions as a way to make Wall Street pay for its costly mistakes. Frankel notes that the American author of this idea, the late James Tobin, a Yale University economist, originally proposed the tax for foreign-exchange transactions. Now it is being suggested as a tax on trade in stocks, bonds, and other financial instruments. Such a tax is imposed in Britain and a few other nations.

Dean Baker, an economist at the Center for Economic and Policy Research, another liberal Washington think tank, estimates it could raise $100 billion a year.

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