The Diane Rehm Show

Thanks for joining us. I'm Diane Rehm. Midterm elections are a day away. In many districts, the economy is the number one issue. President Obama has been trying to hammer home the message that Republicans not only got us into this crisis, they've been solidly opposed to passing legislation to help pull us out. But voters have their doubts. Joining me to talk about the U.S. economy, what steps, if any, Washington should be taking, Bruce Bartlett, he is a columnist for The Fiscal Times, Rea Hederman of The Heritage Foundation and from a studio at KUT in Austin, Texas, James Galbraith.

He's an economist and professor of government at the University of Texas. We do invite your calls, questions. Your contributions are always an important part of the program. Call us on 800-433-8850. Send us an e-mail to drshow@wamu.org. Feel free to join us on Facebook or Twitter. Bruce Bartlett, good morning to you.

Good morning.

James Galbraith, good morning to you.

Good morning.

And, Rea Hederman, thanks for being here.

Thank you, Diane.

Rea, if I could start with you. The third-quarter GDP numbers came out last week, positive, but not especially strong. Give us a picture.

Sure. GDP increased in the third quarter over second quarter. The economy expanded about 2 percent, which is well below our historical average of over 3 percentage of GDP growth. And so it sounds like good news that we had stronger growth in the third quarter than in the second quarter, but if you break the numbers down, a few things jump out that concern people. First is that a lot of the GDP growth was from a buildup in business inventories. This means that businesses are stocking their shelves, and they're not going to do this again. It's a one-time boost to the economy unless these goods get sold.

The second thing is that we saw a sharp decline in business investment, which tells us that businesses are still standing on the sidelines, waiting to see what happens. And finally, we know we did see -- kind of see a rise in our trade imbalance again, has import surged, and exports only showed a moderate increase. What this means is that, you know, consumer spending is still going to be a strong factor in our economy, maybe a little bit stronger than people would want right now. It's not the type of GDP -- a growth rate that we'll see that'll boost employment that comes out this Friday. But the good news is it could -- it's another report that puts the failure of a double-dip recession farther in the rear-view mirror.

Bruce Bartlett, how do you see it?

Well, I base -- obviously, those numbers are factually correct. I think the concern people have about consumer spending basically relates to unemployment. If people don't have jobs, then they don't have incomes. And also, the high unemployment rate tends to cause those who do have jobs to be very conservative for fear that they might lose their jobs. And so they hold off making, you know, major purchases and just -- we've seen the savings rate increase as people have -- are more cautious about going forward. So basically, we've just been treading water for quite some time, and there's no -- nothing on this -- that one can see coming down the pike that is going to knock us off dead-center and get us going.

We don't really see much prospect for additional government stimulus, no real prospects for additional business investment, no real prospects for additional consumer spending and no real prospects for increased exports. So everything is just kind of laying dead in the water there. And it's -- a lot of economists now are thinking more and more that we're going to be in this situation for quite some time in a kind of Japanese-type scenario.

James Galbraith, treading water, is that how you see it?

You know, I'm in substantial agreement. What we're seeing here -- normally, at this stage in the business cycle, you would have a -- the beginnings of a credit-based expansion, and that simply isn't going to happen in the present environment. Homeowners are in deep difficulty because of the fallen and still falling value of their houses in relation to their debts. The banks are unwilling, uninterested in expanding commercial and industrial loans. So the kind of inflection point and takeoff point that we saw, for example, in 1994 when we moved into the early phases of a very prolonged credit boom, isn't going to happen. There's no sign of it happening. And so we're not going to get the kind of acceleration that would be required in order to reduce the unemployment rate significantly.

Now...

Can I just add one thing?

Sure. Go ahead, Bruce.

Jamie correctly said that the banks are not lending, but I think a big part of the problem is on the demand side. There simply isn't any demand on the part of businesses to borrow because they're sitting on vast quantities of liquid assets of at least a trillion dollars, maybe $2 trillion of precautionary savings that they could mobilize into investment if they saw any prospects or any need to expand their capacity to meet the demand that they have.

So both businesses and consumers saving as opposed to spending, Rea Hederman?

Yeah, you know, the only thing I would chime is it's a very different picture if you look at small businesses and kind of entrepreneurs. They are having a great deal of trouble right now getting credit, partially it's because the banks that primarily loan to small businesses -- your local start-up businessmen -- are community banks. And these are banks that been hit some of the hardest by some of the real estate bubbles. And so Dr. Galbraith is correct that a lot of these banks don't want to lose -- don't want to loan to small businessmen, don't want to lose to new business start-ups. And as result, we're seeing very little, you know, product innovation, very little job growth.

Let's talk for a moment about the Fed, James Galbraith. You have the expectation that the Federal Reserve is going to initiate some purchase of treasuries. What's that going to do? What will that mean to the economy?

I think it will mean very little. I really do not understand what the governors of the Federal Reserve Board think they're going to accomplish by this policy. As Bruce already indicated, the economy is awash with cash, so adding additional cash to the economy isn't going to change the fundamental condition faced by business or by households in their decisions to borrow and to spend. So I think, quantitative easing, it's on the table because all other policy avenues are blocked for the moment. But as constructed by the Federal Reserve, it's an illusion. It's an illusion of policy.

But isn't the hope that it will spur more refinancing among homeowners and get those banks to lend more?

Well, the problem there is that the banks just totally screwed up their whole paperwork bureaucracy situation in terms of all these foreclosures and things. And that's going to take a long time to sort itself out. My impression is that it's very hard to get refinancings, even people with good credit. I looked into doing it myself not too long ago. And once I worked through all the numbers, I just decided it wasn't really worth the trouble to save a few hundred dollars a month. So it's -- you know, it's a circular problem.

Okay. So...

You might get some benefit from it, if I might add, but the -- a great difficulty that many homeowners face is that they're upside down in their mortgages...

Yeah...

...and the banks will not refinance under those conditions.

Right. So the three of you are fairly negative about what's happening here. Does anybody have any positive suggestions? James Galbraith.

I think there are basically three lines that policy need to take. First of all, they need to reexamine what I consider to be the original sin of the Obama administration, which was the decision to support the banks and to run an economic recovery policy through the largest banks. This is -- was simply -- it was a grave error, and it left in place banking institutions which were bloated, which had profoundly screwed up their business model and screwed up the economy. And what needs to be done here is to take some of those institutions into hand and to begin to resolve them so that you can begin to have a more competitive banking sector dominated not by the few largest banks, but by more...

What do you mean take them into hand and resolve?

When you have a bank which is in danger of failure, the law requires that the federal government put it into receivership and restructure. And that is what the federal government does on a weekly basis with smaller banks but has been reluctant to do so with some of these largest and most problematic banks.

Okay. All right. So, second, you said three approaches.

Second point is a strategic approach. I think we need to recognize that the era of stimulus of the idea that you're going to get out of this problem with a burst of spending is past. I think the stimulus package did some good, but we're not going to see many more rounds of that. What you need to have is a strategic approach focused on rebuilding the country in important respects, particularly our national infrastructure and particularly the way we handle energy and the environmental consequences of our energy use. And once we start doing that in a consistent way, then over time we will build an avenue for the private sector to begin to invest and to be able to earn profits and to hire people. That's going to take a long time, but we need to recognize that we need a long-term and strategic approach.

And the third thing we have to recognize is that we're 11 millions jobs in the hole already compared to where we ought to be in a full employment economy. We're not going to replace all of those jobs. So we ought to think about how best to make life easier for the many, many people who have lost their jobs, who are spending a great deal of futile effort looking for jobs that they're not going to find for a long time, if at all.

James Galbraith, he's an economist, professor of government at the University of Texas, author of "The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too." Also here in the studio, Bruce Bartlett of The Fiscal Times and Rea Hederman of The Heritage Foundation. Short break, and we'll be right back.

And welcome back. With me here in the studio, Rea Hederman of The Heritage Foundation, Bruce Bartlett is a columnist for The Fiscal Times, his latest book, "The New American Economy: The Failure of Reaganomics and a New Way Forward." On the line with us from the University of Texas at Austin, station KUT, is economist James Galbraith. He's author of "The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too." We are going to open the phone shortly, 800-433-8850. Send us your e-mail to drshow@wamu.org.

Here's an e-mail from David, who's in Garland, Texas. He says, "How can the media, any media, report with a straight face and good conscience what the effects or lack of effects of Obama's efforts on the economy have had in relation to jobs -- and even other aspects -- when what has not happened is not talked about or considered? If Obama's and Congress' efforts have prevented a sharp drop in jobs and the economy and created a leveling and slight increase during this crisis, how can't he and they be blamed for minimal or negligent success? What is the baseline?" Rea Hederman.

Well, that's the big debate. I mean, does the Obama administration -- did they prevent a recession? Or did they make things worse? I mean, we know we spent a lot of money on the stimulus bill -- over 800 billions of dollars -- and the unemployment rate is still almost 10 percent and 9.6 percent. And we're seeing very anemic job growth. I mean, given the GDP numbers we have, we should be expecting stronger job growth than we're getting right now.

And so one of the big mysteries we're having is why isn't businesses hiring? Why is the labor market not responding? We're now over a year of businesses increasing temporary workers, which has always been a harbinger of permanent hiring. But we're still not seeing it.

Let me play devil's advocate for just a moment. Didn't the Obama administration say, when they came into office, that the recession, that this situation was far more dire than they had understood it to be when the election took place? And let's not forget that the first stimulus package took place during the Bush administration. Bruce Bartlett.

Well, I don't think there's any question that the downward trend of the economy was much more severe than the Obama administration's economists thought it was when they put forward their stimulus plan and that they -- and furthermore, we know from a great deal of reporting on this subject that Obama's advisor, such as Christy Whitman -- not Whitman, I'm sorry -- Christy...

Romer.

...Romer wanted a much bigger stimulus package in the first place. So if they had known more what the economy was going to do, then they would have wanted an even bigger one.

So do you feel they should have had a bigger one?

Oh, I don't think there's any question about it. But on the other hand, I think Obama's political advisors were quite correct that they got the most that they were going to get out of Congress. There was a great deal of concern about the size of the stimulus, and they -- I think they got as much as they could get, even though it was perhaps half or even less the size of what was actually needed. And I think also the composition of the stimulus package, with the benefit of hindsight, could have been more in different directions.

For example, the money that went to direct purchases of goods and services out of the economy was actually only a very tiny amount of the total package. And that's the stimulus that in the Keynesian model really gets you a lot of bang for the buck.

And, Rea Hederman, you have said that, of course, you've seen the U.K. taking precisely the opposite course with a 20 percent cut in spending.

Right. You have U.S. going in the opposite direction of Europe, and usually the U.S.'s opposite direction is lower taxes, lower government spending. And this time it seems to be reversed 'cause it's not just the U.K. It's some other countries. You're sitting there, seeing Germany. You obviously saw France, the big strikes, as France is trying to reduce some of their government spending. And so you see that the fact that Europe is now wrestling with the problem that the U.S. is going to have to start taking more seriously, and that is, how do we rein in our long-term deficit problems?

How are we going to make serious cuts to problems that we like as a society right now but aren't as necessary? Or maybe there's some beneficial -- it has some other problems. And that's why the U.K. is taking these big cuts. That's why France is wrestling with their pensions. And that's why other countries in Europe are taking even stronger measures to try to rein in their national deficits.

All right. And turning to you, James Galbraith, last night on "60 Minutes," David Stockman, President Reagan's budget director, said we have now got both parties essentially telling a big lie. And that is that we can have all this government, 24 percent of GDP, this huge entitlement program, all the bailouts, and yet we don't have to tax ourselves and pay our bills. That is delusional. He went on to say even Republicans have said there's nothing significant we want to cut. We don't want to cut Social Security entitlements. They don't want to cut Medicare and reimbursements to doctors, farm subsidies, education loans, certainly not defense. What's your view on the current statement regarding taxes from each party?

Well, I must say I find it -- I can't resist the temptation to smile. And Bruce will remember this, too, but David Stockman has been singing this song for 30 years ever since...

You bet.

...Bruce and I were young staff directors of the Joint Economic Committee together in the early 1980s.

And yet he did...

And I don't...

...construct Ronald Reagan's huge tax cut program.

And wrote a big book denouncing the...

Exactly.

...failure of moderate Republicans, basically, to vote for spending cuts at that time. But the reality is that this is not the correct way to frame the economic problem that we have. The problem that we have is a failure of the credit system, which occurred over the course of the last decade but came to a head in 2007, 2008, a collapse of a model of growth on which we had been relying ever since the Reagan years, really, a model of -- essentially a bubble and bust in information technology in the 1990s, in housing in the 2000s.

The deficits and the large gap between federal spending and federal revenues that we have now isn't -- is a result. It's an artifact of that disaster, and around the world this is equally true. The IMF has shown that over half of the increase in deficits since the crisis is simply because of the fall-off in revenues that has occurred. A very small part of it is because of an increase in spending, and it's particularly in discretionary spending. There hasn't been all that much.

So what we're faced with here is a need to reconstruct the institutions of our economy, including our financial institutions. And the people who make their living on Wall Street do not wish to face this, and, frankly, the Obama administration didn't wish to face it. So to come back briefly to the conversation you were having a second ago, it seems to me that the Obama administration cut off the discussion of a sufficiently large stimulus internally.

They cut it off by predicting a stronger economy than was reasonable to predict by making a forecast that the unemployment rate would not rise above 8 percent. That was a terrible tactical political mistake, which has come back to haunt them. And they did that in part because they didn't want to face the necessity at that moment of coming to grips with the collapse of the financial system. If they made the problem seem less serious structurally than it actually was, then they could propose and pretend that the measures that they were proposing would be adequate to deal with it. And now we're paying the price.

Bruce Bartlett, after the elections tomorrow, do you expect anything to change in the approach to dealing with the economy?

Not really. The problem is that the two sides are talking past each other. The Republicans are quite insistent that tax cuts and only tax cuts are the -- is the only policy they will consider. And the Democrats don't really have a strategy at all except to sort of muddle through the election. And I think everybody is also looking over their shoulders at the deficit commission that has been meeting and is expected to put forward some recommendations, I think, the first of December.

Yes.

And so you have so many different things going on, and, frankly, the administration has not shown a great deal of leadership in this area. For example, they have never once put forward a basic theory of how -- of what happened. They never -- they've never explained what are the roots of the economic crisis and why the policies they have put forward are particularly adapt or whatever to those particular problems. It's all been very reactive dealing with things, you know, that come up today. And move on, and deal with other things tomorrow. And it's really very confusing, and, you know...

And certainly confusing to voters...

Yes.

...when you have neither Republicans nor Democrats coming -- or Tea Party members -- dealing with these issues. They all seem to be talking around it with the exception of the tax cuts. They talk about the Obama administration as saying, limit them to those making over $250,000. The Republicans are saying, let them all stand. How do you see it, Rea?

Well, that's going to be one of the most important pressing pieces of business that the lame duck Congress is going to have to address. I mean, we're staring down a tax cut in the trillions of dollars, not just the Bush tax cuts. We got to remember they have to fix the AMT. They have expiring tax cuts for small businesses. They have, you know, the ethanol credit. All these pieces of legislation are going to be -- they have to move forward in a very short period of time after a very contiguous election.

But do you believe that they -- that lame duck Congress is going to do that?

I will be shocked and horrified, I think, if the lame duck Congress doesn't pass at least, you know, a two-year extension of all President Bush's -- all the 2001, 2003 tax cuts because, given this magnitude of where we are in the economy, you can't sit there and let a trillion dollars of tax hikes take place the next several weeks.

James Galbraith, do you think that makes sense?

I have no projection on what will happen in the lame duck session, except that it does seem possible that the Bush tax cuts will, in fact, be allowed to expire.

James Galbraith, he is professor of government at the University of Texas. And you're listening to "The Diane Rehm Show." Sorry to interrupt you there, James. Did you want to say something else?

On the question of the Bowles-Simpson deficit commission, I think the latest information that we have, at least as far as the reporting from The New York Times indicated, is that they may fail to come out with a proposal in which case the Congress would not be obliged to vote on their -- the recommendation that might be made by, say, chairman (unintelligible)

How can they fail to come out with a proposal when they've been tasked with this?

Because they -- fundamentally, they have not really been capable of doing a coherent job with the assignment that they've been given. They -- and internally, they have to pass a very high bar of consensus -- 14 or 15 votes out of the total membership of the commission in order to have a proposal of the commission as a whole.

So what would...

In my view, that would be fine. That would be fine. I think the whole exercise was misconceived. And leaving it for the next Congress to resolve by ordinary legislative procedures will be far better than rushing a vote through the Congress in the lame duck session...

Bruce.

...and that, on that matter, is important as Social Security and Medicare.

Yeah, let me say something about this looming tax increase. The -- it's not -- the Congress could just as easily wait 'till any time next year to act on taxes and simply make it retroactive to Jan. 1. There isn't any drop-dead date that something terrible is going to happen if they don't do anything. Now, some people are talking about the need to raise the withholding tables to reflect the theoretically higher taxes that will take effect on Jan. 1. But the -- that's a purely administrative decision by the Treasury Department.

They don't have to suddenly start taking more money out of people's pockets if they don't want to. If the -- the Treasury could say, we fully expect the Congress to act sooner or later and make the legislation retroactive, so we're going to just keep the same withholding tables. And if we have to adjust them later next year, then that's what we will do.

Yeah, but that falls on the taxpayer, Rea.

Right. Exactly. And what Bruce is pointing out is the complete level of uncertainty that we have right now...

Exactly.

...in the economy. And people don't know what the deficit commission is going to do. We don't know what's going to happen on taxes, and you don't know what's going to come out with all these new kind of regulation commissions that are being created. And that's one of the reasons businesses is just standing on the sidelines. They're trying to figure out what are their labor costs going to be? What's the tax policies going to be? And so you're seeing businesses sitting there saying, I'm going to wait 'till I understand where the directions are going. We have a new financial regulatory.

We have five different, you know, financial regulatory commissions in Dodd-Frank. We have the new medical commissions coming out. And now we don't know exactly what's going on with tax policy in the next couple of weeks. And, yes, we could change withholding tables. But let's remember, there's a lot of, you know, bureaucracy that it has to go through. You know, a lot of people have automated payroll reports. I mean, we're going to have to say -- the Treasury is going to say, well, we're going to try to read the mind of Congress. I mean, that is the type of uncertainty that explains why so much money is sitting on the sidelines.

Now, do you agree...

Now, with all respect, I think the major reason businesses are not investing is that they're unsure of the future of demand and of the direction of the economy. And these other matters may affect some particular businesses, but it can't be offered as an explanation for the slow rate of growth that we're seeing.

Rea, do you agree with Jamie Galbraith, who says that we may see nothing from this deficit commission by Dec. 1?

I think there's a good chance that the parties are going to be unable to agree what's going to happen. I mean, the problem is, is that in some ways consensus has broken down over the last several years. I mean, in the late 1990s, you got people saying we need to do something about Social Security.

Of course.

And then President Bush came up with a proposal, and that widened the partisan gap. And now people are saying, hey, Social Security isn't a problem.

He didn't really come up with a proposal.

Right.

He came up with three.

But he brought it into politics...

Right.

...and everything, and it became kind of poisoned. You're seeing a lot of the same things right now with healthcare that Republicans are saying, you know, maybe we shouldn't be reducing some of the Medicare costs. And that is unfortunately -- reigning in Social Security, reigning in Medicare is going to be one of the biggest drivers of government spending in the future going forward. And so we know right now that Social Security is paying out more than it's taking in. We're going to have to figure out a way to breach these problems, reduce our outlays on these problems going forward if we want to be able to have a sustainable economy.

Rea Hederman, he is research fellow at The Heritage Foundation. James Galbraith, he is an economist, professor of government at the University of Texas, author of "The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too." And Bruce Bartlett, columnist for The Fiscal Times. Short Break. Right back.

And welcome back. We'll go to the phones now. Your calls, your questions, 800-433-8850. Send us your e-mail to drshow@wamu.org. You can join us on e-mail or send us a tweet. First to Miami, Fla. Good morning, Robert. You're on the air.

How you doing, Ms. Rehm?

Good, thanks.

I just want -- I'm really, really frustrated. You know, I listened to that same conversation last night on "60 Minutes" with Mr. Stockman, and he continue -- continues to believe in magic economics. We cannot have these so-called tax cuts and then don't pay for them. It is amazing to me because we're talking about this Republican wave that -- and these people are continuing to say the same thing. And then when you ask them, well, how do you pay for them? Then they start talking about Obama’s a socialist, Obama this, Obama that. But they never say with -- say, well, how they want to -- how they're going to pay for this. This is amazing to me. And (unintelligible) and no one is paying attention to it.

All right. Jamie Galbraith.

Well, the federal government is going to run a budget deficit most of the time. That is to say, it's going to spend more than it takes in in taxes. That has been true since the 1790s. The effort -- occasionally, people like to promote the idea that the federal government should balance its budget or should run a surplus, take in more in taxes than it spends. But every time it's done that -- and it's only done it on maybe seven or eight occasions in history -- the effect of that is to drain money from the private sector and to cause an economic recession.

So the reality is that it's normal for the federal government to spend more than it takes in in taxes. It's -- we're running exceptionally large deficits right now, but the reason for that is that the private economy is in such terrible shape. And the reason for that, once again, is the failure of the credit system.

Well...

And Bruce said earlier that we didn't have a theory of the cause of the crisis, and I think that's right. A theory has not been articulated. But it's clear to everybody that the cause of this crisis lies in the irresponsible emission of subprime mortgages, fraudulent mortgages fraudulently sold to the investment community whose value collapsed in 2007, 2008. And we're seeing the second wave of fraud now as banks try to make up for the deficiencies in their paperwork as they push for foreclosures on many of these bad mortgages.

Here's an...

That is the essential problem.

Here's an e-mail from Gilbert who says, "I believe the banks are sitting on money to delay the economic recovery in an effort to discredit the president's regulatory policies. Big business and banks had the money given to them by the president to stimulate the economy. And now they have the ability to sit out the first term and elect business-friendly congressional leaders." Bruce.

Well, that's complete nonsense. The banks...

Why is it complete nonsense?

Well, because banks are in the business of lending to make money. But they don't feel that there are enough opportunities out there that are worth the risk of what they can get in the market, given the current level of interest rates which has been driven down very low by the Federal Reserve. The idea that banks would forego vast profit-making opportunities just to, you know, stick it to the administration is simply conspiratorial. But let me get back to something the previous caller got into, which is about why nobody pays for the tax cuts.

Well, one reason is because the Republican Party's official position is tax cuts never ever need to be paid for. This has been articulated by the Republican leaders in Congress on many occasions. And if you really push them, they will sometimes rely upon a theory which is called starve the beast, which somehow or other says, if you just take away the government's allowance, that somehow or other, the spending will come down all by itself. Now, this is a nonsensical theory, but it's the one that is deeply ingrained in the Republican psyche and has been for more than 30 years.

Rea.

I think one of the big...

Let me come...

One of the bid determinants is going to be, you know, are we going to see a new type of conservative in Congress? And you do see people like Paul Ryan sitting there, saying, hey, I have a plan, laid it out very clearly on how I'm specifically going to reduce the size of the federal government. And whether or not you agree with it, it's important in paying attention to because they're spelling out the size of cuts that will be necessary to make us sustainable going forward. I mean, you can't sit there, and the Republicans cannot repeat the errors that they made in the previous decade, where you had tax and cuts on one side, Republicans increasing spending on the other side.

All right.

And so hopefully, this election, everything you'll see. People sitting there and saying, hey, conservatives do stand for smaller taxes, and that means smaller government.

Let's go to...

Let me tell...

Oh...

If I could come back on the question (unintelligible) quickly.

Sure. Go ahead, Jamie.

It does seem to me that policy has made it very easy for the banks to sit on the sidelines and still report that they're making money. It has given them essentially zero cost of funds, and it has enabled them to mask the losses that they have incurred in their portfolios by not marking their asset values to market in particular. And so the banks are, in fact, making or reporting very big earnings on the basis of, essentially, negative lending. In 1994, the fed actually kick the banks back into commercial and industrial lending by raising their short-term interest rate and squeezing their margins. We don't see that kind of aggressive attitude toward bank balance sheets in the current (word?) ...

All right.

... (word?).

To Dave in Mishawaka, Ind. Good morning. You're on the air.

Yeah, hello.

Hi.

I'd like to say on the extending the tax cuts for the rich. I -- you know, one guy on there from The Heritage Foundation said that he'd be appalled if they didn't extend it. I'd be appalled if they did. You know, certainly, you know, the Republicans have -- are screaming about the national debt. But they have this amnesia or, I mean, not -- yeah, amnesia about the national debt when it comes to tax cuts for the wealthy. Because when Clinton was president, he passed a federal deficit reduction plan, which raised taxes on the richest 1 percent. And, you know, the Republicans went around screaming like this was going to amount to a deep recession, massive unemployment and huge budget deficits.

Well, the results were we had the greatest economic expansion in our history, 22 million new jobs created and budget surpluses in Clinton's last three years. Then Bush comes in, cuts taxes for the rich again, and we have two recessions, two stock market crashes, a financial collapse, a doubling of our national debt. And if you count the two years into Obama administration, we had -- you know, I don't know how many -- what, 6 million jobs lost. So, I mean, to allow the rich to have a tax cut just -- I mean, that just shoots that idea right in the head.

All right. Thanks for your call. James Galbraith, does our listener have it right?

Well, I would indeed be shocked if in the -- given the Republican approach to governance in the last couple of years, if a Democratic minority in the Congress to come -- or for that matter, in the lame duck session -- suddenly decides to be cooperative with a major element on the Republican Agenda. I mean, it would just be much better from every political point of view to let these guys get their own votes on these issues.

Well, the whole question of having raised taxes on the wealthy as President Clinton did and creating a surplus, creating a very lively economy. Why doesn't that make sense now?

Well, because you had in the 1990s a vast credit boom...

I'm asking...

Yeah, you had a vast...

...Rea.

Oh, sure. Go ahead.

Sure. Well, I think part it is you're at a different place in the economic cycle, you know, when Clinton did it. And then you're taking a look at the fact that you're raising taxes higher now than when President Clinton did it.

Well...

What is so different?

Well, the inflation situation for one thing is quite different. Interest rates are -- the interest rates...

Zero inflation right now.

Oh, that's right. But in the early part of the 1990s, inflation was still a problem. This was important because it has a lot to do with Federal Reserve policy. When you have some inflation in the system, the Fed can create negative real interest rates very easily. They cannot do it when there's zero inflation because you cannot have a negative nominal interest rate. So there was a lot to be gained by reducing deficits in the early 1990s by bringing down inflationary expectations and reducing interest rates that won't do any good now because we have zero inflation and zero interest rates. So bringing the deficit down would have no positive effect on the general economy under current economic conditions.

But the real question is what about raising taxes on the wealthy? James Galbraith.

Well, in the 1990s, you were able to generate a vast investment boom which brought us to full employment, and the wealthy paid those high tax rates very easily. Now, when the government budget went into surplus, eventually that choked off the expansion in 2000, 2001, so it had a -- it was self-limiting. And you basically have not been able to recover from that since. But the -- I mean, would it be a good idea now to raise the tax rates on the wealthy? I think so, but only because it would force the Congress to come up with alternative measures that would help bring about an economic recovery.

And there are basically two ways to do this. One is to expand investment -- public investment in infrastructure, an investment in infrastructure-related physical capital that would -- among other things, as I said before -- deal with our energy problem. And the other is to relieve the burdens on indebted households by basically reducing the tax rates and tax payments paid by lower income people. You could do it by offsetting the payroll tax, and there are a number of ways that you can do it. But what you want to do in this situation is to make the burden on highly indebted lower income people easier, and you want to expand investment. And if you have to do that by creating new institutions for funneling credit to businesses, you should go ahead and do that, too.

And to that point, here's a message from Scott who says, "What about a bottom-up approach? Instead of quantitative easing at the top, take the same amount of money, send it to the lowest income groups. Banks are afraid to pump the cash out into a stagnant economy, but the lower income brackets won't hesitate to stimulate the economy with every dollar they get." Rea.

Well, we tried that. I mean, President Bush tried several different rebates. I mean, you already pointed out his 2008 stimulus was kind of based on that same principle. You know, throw as much money out and hope people run to the Best Buy, run to Target, you know, spend the money as fast as possible. It didn't really result in the economic recovery we wanted to see. The problem with these high-income tax increases is that we want investment. And what you're doing is you're raising taxes on capital, and you're discouraging private investment.

I mean, President Clinton cut the capital gains tax rate in 1997, and that's when we saw, you know, the red, hot job market unemployment well below 5 percent. And so the problem is if you're going to sit there and say, we're going to subject capital gains to a 60 percent tax increase in four years, that's going to really make it very difficult for business investment to increase. And that's one of the things holding back the employment.

Rea Hederman of The Heritage Foundation. And you're listening to "The Diane Rehm Show." Let's go now to St. Louis, Mo. Good morning, Paul.

Good morning. I wanted to ask a question about the American corporations and how many jobs have they started in foreign countries in the last two years.

Bruce.

I don't think we have that data, but -- the idea that you're going to somehow or other gain jobs by punishing multinationals, I think, is just one of these fallacies. It's -- I mean, foreign countries are not exactly gaining jobs either, unless you're talking about places like China. So I think that's just, you know, a red herring.

And I think one of things is to realize that you still have foreign companies coming over here creating jobs. You have a much more global economy. Take a look at, you know, the car dealerships that are being created in the south -- Toyota, Nissan, BMW, for example. And let's remember that a lot of these American companies are creating new domestic positions here to support their international operations. So the idea, I think, that we can throw up a fence around corporations and say, you know, just focus on American-only jobs is not going to work.

One of the interesting things is that the rest of the world is kind of changed their taxation systems. They're going to more of a territorial taxation, but the U.S. remains stuck behind saying, we're going to tax the corporations anywhere they are. And as a result, that's kind of encouraged some corporations to expand their offshore faster than it would, simply because the U.S. has a very uncompetitive corporate tax rate.

All right. To Wolf Creek, Ore. Good morning, Carter.

Yeah, good morning. I heard on Saturday that the -- there's some highly placed financial person in Britain is calling for the breakup of the largest banks there in their country. And I would like to hear a detailed discussion about doing that in this country and what the likelihood of what is happening in Britain.

What do you think, James?

I think it is a very feasible line of policy. I mean, what you have here is a banking sector, which is maybe half again as big as it was 20 years ago in relation to the economy. It's bloated. It's much too large for the purposes that we need served. The way to correctly right size it is to take some of the largest institutions and restructure them. And since these institutions are being propped up by government to begin with, since their misdeeds, their frauds are being -- still being covered up, essentially, by public policy, you change that policy.

You take over some of these institutions. You restructure them, return them to the private sector, smaller, managed by people who don't have the fraudulent track records and who are paid substantially less, who are more amenable to working within a good regulatory framework. You will have a healthier, more competitive, more progressive banking system that will help fund jobs in America. That's what we need to do.

Give me an example of one of the banks you would take and break up.

Well, two professors who know a lot about this subject -- William Black and Randy Ray -- wrote about Bank of America in the Huffington Post a week or so ago, and that article was taken up in The New York Times, The Wall Street Journal and The Washington Post. And I recommend it. It gives you a case to be made for focusing on that particular institution.

Bruce.

Well, perhaps that's something that might have been considered, you know, two years ago in the midst of the financial crisis, but Congress has debated this issue. They had a big debate about too big to fail, and they passed the Dodd-Frank Legislation. And I -- and whatever the virtues are of Jamie's proposal, I think the odds of getting legislative action at this point are zero.

All right. We'll have to leave it at that. Bruce Bartlett, he's a columnist for The Fiscal Times, his latest book, "The New American Economy." James Galbraith, he's an economist, professor of government at the University of Texas. Rea Hederman of The Heritage Foundation. Gentlemen, thank you for joining me. We shall see what happens next. Thanks for listening, all. I'm Diane Rehm.

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