The White House last year released a supposedly scientific analysis that claimed to show that adopting the “stimulus” bill would cut unemployment. Indeed, the report specifically estimated that the unemployment rate today would be down to 7.5 percent.

All that matters from a jobs perspective, though, is that government has made it more expensive to hire workers and more expensive to provide the capital needed to make workers productive.

Something obviously went wrong. The actual unemployment rate is 9.5 percent, a statistic that doesn’t include the millions who’ve given up looking for work or can only find part-time jobs. What were President Obama’s biggest mistakes?

Part of the problem was a misplaced faith in Keynesian economics — that is, in the discredited notion that politicians can borrow money from the economy’s right pocket and increase prosperity by dumping money in the economy’s left pocket.

But the bigger stumbling block is the folks in the White House seem to have no clue how the real-world economy works. Critics have noted that the Obama Cabinet sets the record for the lowest-ever level of private-sector experience. That doesn’t necessarily mean people who don’t understand how and why jobs are created — but that seems to be the case with this administration.

Profit and Investment Are Necessary For Job Creation

LET’S start with two common- sense observations. First, businesses are not charities. They only create jobs when they think that the total revenue generated by new workers will exceed the total cost of employing those workers. In other words, if it’s not profitable to hire workers, it’s not going to happen.

Second, it takes money to create jobs. More specifically, labor isn’t very useful or productive unless investors are providing capital. Truck drivers won’t get jobs unless someone has invested to buy trucks. Software programmers aren’t worth much if their employer doesn’t buy computers for them to work on. Even the green-energy companies the White House favors can’t hire workers unless somebody (ideally venture capitalists rather than taxpayers) provides seed money.

The problem is not a lack of capital. Businesses have plenty of extra cash — with the Federal Reserve reporting this month, for example, that nonfinancial firms are sitting on $1.8 trillion, about a quarter more cash-on-hand than when the recession started.

The key issue is whether companies have a reason to invest. In other words, if they start spending money and hiring workers, will they make money?

Unfortunately, almost everything Washington’s done the last 18 months has sent the opposite message.

• The “stimulus” boosted federal spending, thus draining funds from private-capital markets and diverting resources from the productive sector of the economy. The main jobs that it “saved” were employees of state and local governments — shielding the public sector from pain even as it inflicted more agony on the private sector.
• The health-care law is a cornucopia of new taxes, mandates and regulations — directly increasing the cost of hiring new employees (as well as of keeping old ones on). By telling employers that the cost of hiring is set to rise sharply in the years ahead, it makes them far more cautious about hiring.
• The new bailout legislation, though labeled “financial reform,” raises costs for financial firms, meaning loans will be more expensive. That is, investing in that truck or computer for that new hire will cost you more.

To be fair to President Obama, the problem began before his inauguration. President George W. Bush signed a big minimum-wage hike that has hit hard at less-experienced and lower-skilled workers. If a worker is only worth $6.50 per hour, then a required wage of $7.15 is a one-way ticket to the unemployment line.

And Bush was responsible for the TARP (Troubled Asset Relief Program) bailout, which has squandered precious capital by steering it to such inefficient firms as Citigroup and General Motors, which are unlikely to create jobs over the long run.

Of course, Obama supported these and other Bush economic policies, so the “mess he inherited” is also a mess he helped to make. All that matters from a jobs perspective, though, is that government has made it more expensive to hire workers and more expensive to provide the capital needed to make workers productive. This is a bad combination — whether politicians call themselves Democrats or Republicans.

What Else Is Washington Going To Hit Us With?

Investors, entrepreneurs and other job creators also look into the future. If they think economic conditions will improve and that they can make money by expanding employment, they’re more likely to take that risk. But what’s happening in Washington gives them little reason to feel optimistic.

A big challenge is that tax rates are going to rise. The 2001 and 2003 tax cuts are scheduled to expire as the ball drops in Times Square on New Year’s Eve. This means higher income-tax rates, higher dividend-tax rates, more double-taxation of capital gains and a reinvigorated death tax. Each provision will increase the cost of productive behavior and specifically make it more expensive to provide the capital needed for job creation.

But that’s just part of the story. On top of the scheduled tax hikes, the alternative-minimum tax is a ticking time bomb waiting to explode. Millions more Americans are on track to be swept into this surreal world where you have to calculate your taxes twice and then pay the government the larger of the two amounts.

The White House claims it wants to alter the law to avoid that — but any reforms to reduce the impact of the AMT probably will be financed by some other form of tax hike.

And let’s not forget that the White House wants higher payroll taxes to bail out Social Security. We don’t know how big the tax hike will be, just as we don’t know what taxes it would raise to “fix” the AMT, but it all just adds to the uncertainty and makes it hard for business owners to create jobs.

Last but not least, we have the looming threat of a European-style value-added tax, which may even be part of the post-election surprise package being concocted by Obama’s so-called Deficit Reduction Commission. Nobody in the administration has explained, however, why making America more like France is a good idea — especially since growth tends to be slower on the other side of the Atlantic and unemployment tends to be higher.

The final straw — and it’s a big one — is the potential for a radical global-warming bill that would give politicians sweeping powers to control and limit energy consumption. Even for those who think it will lead to good climate effects, there’s no hiding from the fact that direct and indirect energy taxes will have a dampening effect on production and competitiveness.

Further fueling uncertainty is the fact that the administration may try to seize those powers even if it can’t get a bill through Congress — by having the Environmental Protection Agency treat the gases said to cause warming as pollution.

A Not-So-Silver Lining

The good news is that the economy is creating some jobs. This is to be expected — the private sector is naturally self-correcting and capable of withstanding lots of bad policy. It takes a lot of missteps in Washington to keep an economy in recession.

The bad news is that the United States is gradually becoming a European-style welfare state. This means that we’ll have growth in most years, but it will be tepid growth. It means jobs will be created — but probably not enough to move the unemployment rate from its unacceptably high level.

To get truly robust job creation, we need to stop growing government and start getting it out of the way.

Many governments have responded to the economic downturn by increasing the size of the public sector. It was remarkable how quickly they resuscitated the theory that assumes more government spending can boost economic growth.

Popularized by John Maynard Keynes in the 1930s, the theory is based on the notion that government can “prime the pump” by spending money, which then begins to circulate through the economy. Keynesian theory sounds good but it overlooks the fact that, in the real world, government can’t inject money into the economy without first taking money out of the economy.

Any money that the government puts in the economy’s right pocket must be borrowed, which means the money comes out of the economy’s left pocket. Keynesianism doesn’t boost national income, it merely redistributes it.

The Obama Administration claimed that spending more money would keep the unemployment rate below 8% in the United States, yet it climbed to 10%. The United Kingdom and Canada also suffered continued stagnation after adopting so-called stimulus packages. Ironically, statist nations such as France and Germany that resisted the siren song of Keynesianism better weathered the global economic storm.

The recent trend toward bigger government is particularly worrisome because most nations have oversized public sectors. Government spending in industrialized nations now consumes, on average, nearly 45% of GDP with Canada and the United States slightly below average. Australia, Switzerland, South Korea, and Slovakia are the only nations where the public sector claims less than 40% of economic output.

The bad news is that most government spending today is devoted to programs for what is known as transfer spending and consumption spending.

To put these numbers in context, government spending in the industrialized world consumed about 30% of economic output in the mid-1960s, less than 20% of GDP between the First and Second World Wars and only about 10% of GDP during the golden century between the end of the Napoleonic wars and the First World War.

While many factors influence economic performance, the negative impact of government spending is one reason why small-government jurisdictions such as Hong Kong (where the burden of the public sector is below 20% of GDP) have higher growth rates than nations that have medium-sized government, such as Canada and the United States. The same principle explains in part why big-government countries such as France often suffer from economic stagnation.

Interestingly, a large body of academic work attempts to measure the growth-optimizing level of government. This research is based on the notion there is not much prosperity in a state of anarchy. Governments solve this problem by imposing the rule of law (courts, police protection, etc). Those governmental functions cost money, but they yield big benefits. Moreover, government spending on “public goods” such as basic infrastructure also can facilitate the functioning of a market economy.

That’s the good news. The bad news is that most government spending today is devoted to programs for what is known as transfer spending and consumption spending. These outlays dampen economic growth, according to the research, largely because they displace private sector activity and also require punitive tax rates. Most studies using current economic data show that economic performance is maximized when the public sector is less than 20% of GDP. And if historical data is used, the evidence suggests that government should be even smaller.

Ironically, John Maynard Keynes might not be a Keynesian if he was alive today. He certainly would not be a proponent of big government. In correspondence with another British economist, he agreed with the premise of “25% [of GDP] as the maximum tolerable proportion of taxation.”

Canada and the United States are already far above that level and the burden of government in both nations will climb above 50% of GDP in the future in the absence of real reform. Unfortunately, there is no way to have a European-size welfare state without also enduring European-style economic stagnation.

The temporary increase in the national debt ceiling approved this month — combined with the prospect of a huge trillion-dollar-plus increase early next year — has once again prompted criticisms of President Obama for runaway spending and record deficits.

All this borrowing is only necessary, we are told, because Obama ran up $1.4 trillion of debt in his first year.

It’s true that the White House is pushing big spending items, not least of which is his multitrillion-dollar scheme for government-run health care. But many critics, either out of ignorance or malice, are blaming Obama for deficits that are not his fault.

Some Republicans, for instance, complain that Obama tripled the budget deficit in his first year. This assertion is understandable, since the deficit jumped from about $450 billion in 2008 to $1.4 trillion in 2009. As this chart illustrates, with the Bush years in green, it appears as if Obama’s policies have led to an explosion of debt.

But there is one rather important detail that makes a big difference. The chart is based on the assumption that the current administration should be blamed for the 2009 fiscal year.

While this might make sense to a casual observer, it is largely untrue. The 2009 fiscal year began Oct. 1, 2008, nearly four months before Obama took office. The budget for the entire fiscal year was largely set in place while President Bush was in the White House.

So if we update the chart to show the Bush fiscal years in green, we can see that Obama is mostly right in claiming that he inherited a mess.

Some readers, particularly Republicans, are probably thinking I’m letting Obama off the hook too easily.

What about the so-called stimulus, they will ask, with its $787 billion price tag? Or the omnibus fiscal-year 2009 appropriations bill? And how about Cash for Clunkers and Obama’s expansion of the children’s health insurance program? Didn’t these all boost spending in 2009?

The answer is yes. But these boondoggles amounted to just a tiny percentage of FY2009 spending — about $140 billion out of a $3.5 trillion budget — as the pie chart nearby illustrates.

There are some subjective aspects to this estimate, to be sure — I didn’t count $25 billion in extra defense spending, for example, because Bush would surely have asked for that as well; ditto bailout for car companies — but the net effect of all the judgment calls isn’t to Bush’s disadvantage.

On the revenue side, for better or worse, Obama hasn’t tinkered much. Obama’s so-called stimulus did include a handful of Keynesian-style tax cuts, but his CHIP bill contained some tax increases. The net effect is a slight reduction in tax revenue for FY2009, but not enough to make a noticeable difference.

So what’s the final score? Let’s use an analogy. Obama’s FY2009 performance is like a relief pitcher who enters a game in the fourth inning trailing 19-0 and allows another run to score. The extra run is nothing to cheer about, of course, but fans should be far angrier with the starting pitcher.

That having been said, Obama has been serving up softballs to the special interests in Washington, so his earned run average may actually wind up being worse than his predecessor’s. He promised change, but it appears that Obama wants to be Bush on steroids.

This is where Obama’s critics should be directing their attention. Big government won’t work any better for Obama than it did for Bush. America’s fiscal problem is excessive government spending, and deficits are merely a symptom of that underlying disease. If Obama wants to rejuvenate the economy, he should abandon the Bush policies of big government and interventionism and instead go with free market policies that actually work.