Obama’s bad economic bet may ruin Democrats

The anemic third-quarter U.S. GDP report is another indication that President Barack Obama’s economic
gamble may yet fail to pay off. And that could be terrible news for Democrats heading into the 2010
midterm elections.

While the new report showed the economy shifting into recovery mode, it looks like a pretty anemic
expansion. As the economics team at IHS Global Insight see things, temporary factors such as cash for
clunkers (accounting for nearly half of the past quarter’s growth) and the homebuyers tax credit artificially
inflated growth during the past three months. The firm puts underlying growth in the economy at closer to
2 percent than the 3.5 percent.

See, back at the start of 2009, the new White House team wagered that it could construct a stimulus plan
that would both boost the economy, helping Democrats in the 2010 midterms, and serve as a significant
down-payment on its long-term policy agenda in areas like clean energy and education. That would help
Obama in 2012.

It’s a lot to ask of one plan, even a $787 billion one.

Of course, the task would have been easier had the administration gone with a $1.2 trillion stimulus option
suggested by White House adviser Christina Romer. But worried that the deluxe option would stall in
Congress while also spooking global bond vigilantes, Team Obama went with the mid-sized approach.

The administration didn’t count on the recession being far worse than it anticipated, driving the
unemployment rate toward double digits. So while the stimulus plan was effective enough to help nudge
the economy away from depression in the second quarter — it’s tough to spend a trillion dollars with
absolutely zero short-term impact — and into mild recovery mode during the third, it wasn’t nearly
powerful enough to ignite a V-shaped recovery.

Indeed, during the first quarter of the last 10 economic recoveries, real GDP rose a far more impressive 5.8
percent on average. For instance, the first five quarters of the Reagan Boom coming out of the 1981-82
recession showed GDP growth of 8.1 percent, 9.3 percent, 8.1 percent, 8.5 percent, and 8.0 percent.

There was another, better path Obama could have taken. In a new study, Harvard economists Alberto
Alesina and Silvia Ardagna conclude that fiscal stimuli based upon tax cuts are more likely to increase
growth than those based upon spending increases. The Obama stimulus was two-thirds spending and one-
third tax cuts or credits. And of course tax cuts thought more permanent by Americans could have
produced a large impact on working, savings and investing – and powerful economic growth.

Romer herself has conducted research showing the economic oomph that tax cuts produce. And there’s
research from economist Robert Barro who found that “a one-percentage-point cut in the average marginal
tax rate raises the following year’s GDP growth rate by around 0.6 percent per year.”

As it is, Democrats are saddled with an economy that may not grow fast enough over the next year to
substantially bring down the unemployment rate, if at all. So now there is a new wager in Washington: Just
how bad will Democrat losses be next year?

James Pethokoukis is the Money & Politics columnist and blogger for Reuters where he covers the nexus
of Washington and Wall Street.

Previously he was the economics columnist and business editor at U.S.News & World Report magazine.
Pethokoukis is also an official CNBC contributor and appears frequently on that network's Kudlow Report,
Power Lunch, and The Call shows. In addition, he has appeared numerous times on MSNBC, Fox News
Channel, Fox Business Network, CNN, and Nightly Business Report on PBS.

A 1989 graduate of Northwestern University where he double majored in Soviet politics and American
history and a 1991 graduate of the Medill School of Journalism, Pethokoukis is a 2002 Jeopardy!