The Conversation

Barack Obama has laid out a US$447 billion (A$421 billion) plan to cut payroll taxes and boost government spending to create jobs, in a bid to “jolt” the stalled US economy back to life.

Obama told a joint session of Congress to “stop the bickering” and pass the American Jobs Act, which includes payroll tax cuts to encourage small business to hire more workers and put more money into the pockets of consumers, as well as spending on infrastructure.

But Professor Geoffrey Garrett, CEO of the United States Studies Centre explains how today’s announcement is likely to prompt further political manouevring and financial market instability.

Will this plan work?

Well, there are two definitions of “will it work”. The first one is, will it be passed by Congress? The second one is, if it were passed by Congress would it turn around the American unemployment situation?

I don’t think we’ll get to the second question because I don’t think the bill that the President wants enacted can be enacted by Congress.

So you think it won’t be passed?

They can’t pass it in the current form because there is too much new spending for Tea Party Republicans to endorse.

There are really three major elements to the bill: the first one is tax cuts extending the payroll tax cuts and new tax cuts for small businesses.

Republicans would be pretty hard-pressed to oppose those, I think. But the two spending measures, one, a big shovel-ready stimulus designed for projects like bridges and roads, and second, giving a lot of money to state governments to hire teachers and health care workers and the like – I think Republicans will say, “we’ve been down that road before with the first Obama stimulus. It didn’t work then, it’s not going to work now, we’re not going to pass it.”

US Republican Speaker John Boehner has indicated his support, but was previously rolled by Tea Party members AAP

Republicans in general, or specifically the Tea Party? US Speaker John Boehner has indicated his support.

All the action is in the House of Representatives, because the Democrats have a majority in the Senate. In the House, the Tea Party Republicans undermined their leader John Boehner, the Republican speaker, in the US debt ceiling end game.

So what we know is when it comes to passing new legislation it requires Tea Party support in the House. I don’t think this bill can get this support.

The Tea Party says no new spending: remember in the debt ceiling deal, they got (agreement for) a vote on a balanced budget amendment to the Constitution; that says that under no circumstances could the US ever run a deficit.

They see the budget deficit today – somewhere between $1.5 trillion and $2 trillion – and they say we cannot add another cent to that. And that’s the problem.

Of course this plan increases the deficit. Obama said the US needs fiscal stimulus because it has an economic crisis in the country and that they’ll pay for it down the road.

He was a bit ambivalent on (how they will pay for it), but he certainly mentioned two forms of tax increases that Republicans will oppose that Obama hopes will be popular with the American people.

The first one is letting the Bush tax cuts on the wealthiest Americans – people earning more than $250,000 – expire at the end of next year, and the second one is some strategy for taxing multi-national firms that earn a lot of money offshore and tend to park the money offshore so that they don’t pay taxes in the US.

Obama, I am sure, believes those two provisions would be very popular in middle America.

So what he’s really saying, I think, is the first salvo of framing the 2012 election. Which is to say: “the proposals I am making are not radical left-wing proposals, they are sensible centrist proposals”. It’s the Tea Party that is out of the mainstream.

It’s unclear whether they will work to move the Tea Party back into the mainstream – it didn’t in the debt ceiling debate.

Obamas's economic plan is the first in a series of political set-pieces. AAP

The 2012 election isn’t until next November. What does this mean for the world economy?

In the short term, let’s try to anticipate what will happen in the next couple of days and then the next couple of weeks and months.

In the next couple of days, a lot of Republicans – and I see Michele Bachmann has already done this – will come out and denounce Obama’s speech as more of the same. How will the market react to that?

Well, the financial markets don’t like this partisan warfare in Washington, so this will look like more partisan warfare, and you can’t expect the markets to react well to that.

But we have to remember that this is actually the first of several set pieces in the next few months. The US is supposed to pass its next budget by the end of September; it’s implausible that budget will be passed and what we’d expect is that both sides, Obama versus the Tea Party is what it comes down, will be on different places on the budget.

Then, by the end of November, the super-committee has got to come in and make its proposals to cut another US$1.5 trillion.

There is going to be partisan disagreement over that. At the same time – and as I said, this is a concession the Tea Party won – there will be debate and a vote on a balanced budget amendment to the US Constitution which you’d expect all the Republicans to vote for, at least all the Tea Party – I think for some centrists it will tough – and certainly no Democrats can vote for that.

If one of the major problems at the moment is political gridlock and warfare in Washington, I don’t think we can expect that to go away.

But it’s important remembering there is a difference between the world of international financial markets and the real economy. Corporate America is sitting on a lot of cash because profits are very high, but they are unwilling to invest in the US economy because American consumers aren’t consuming.

The reasons are their houses are worth less than they used to be and they are worried about their job security.

Typically, this sort of stand-off or downward spiral is where there is a role for government – normally that’s where stimulus of some sort would come in.

The problem is, for the past two years, all the US economy has seen is stimulus, first in Obama’s US$800 billion stimulus in January 2009, then with the quantitative easing from the Federal Reserve.

So they have fired a lot of stimulus bullets. What Obama has said today is just because we’ve fired a lot of bullets, doesn’t mean we shouldn’t fire some more, and the Republicans say, “that’s crazy, why would you throw good money after bad?”.

Prime Minister Julia Gillard with Chinese President Hu Jintao AAP

So what do you think China’s response will be to all this? And the impact on Australia?

The short term question is, will China continue to buy US government debt, everything we know, not only for the past few months, but the past few years, says they will.

That’s why American long-term interest rates on American government debt are so low – under 2%.

What Australians should be worried about is, let’s say the US and Europe go into at minimum a slowdown, and at maximum a recession – will the Chinese government be willing to do what it did in 2009 in response to that recession, which was a massive infrastructure and banking lending boom that created all that demand for Australian iron ore?

Could they do it again? Yes. Will they do it again? People say the Chinese government is now more worried about inflation and bubbles than anything else, so they wouldn’t do it.

But my feeling is that if push comes to shove the Chinese government would do another domestic stimulus because they know their legitimacy depends on maintaining full employment and high growth in China.

There is a limit to the number of high speed rail lines you can build in eastern China, but there is still all of western China that needs infrastructure and I imagine that’s where the Chinese would decide to direct their investment and their spending.