Posted on September 14, 2012

With the Economy So Bad, Why is Obama Likely to Win the Election?

After all, a majority of Americans have disapproved of Obama’s handling of the economy and many report they feel worse off today than four years ago. This may be so, but four years ago, Lehman was going bankrupt, the stock market was in free-fall, the housing market was collapsing and Hank Paulson and Ben Bernanke were wondering how they could get remedial emergency measures through the Congress, let alone the G-20.

Clearly the economy has been an albatross for Obama and it is unlikely to improve much in the next 52 days. Yet, Obama is leading in the polls by a meaningful margin. It looks like he will hold the Democratic majority in the Senate and the House is becoming more of a toss-up. The fact is incumbent presidents have an enormous advantage and a Republican victory was never going to be easy.

A recent analysis by The Washington Post political analyst, Ezra Klein, and political scientists from George Washington, Yale and UCLA proves the point.

Their research concluded that it isn’t the level of economic activity that matters most in the re-election of an incumbent president, but the direction of change and his approval rating.1 The U.S. economy is growing at a frustratingly slow pace and job growth is tepid, but the economy is improving, however slowly. While there have been many complaints about Obama, the public’s view of the Congress is even worse.

According to a recent Gallup poll, Congress has posted its lowest approval rating in 38 years at roughly 10%. And it hasn’t passed 20% in more than a year. Obama’s approval rating, on the other hand, recently moved above 50%. According to the model described in the Post, Obama has more than an 80% chance of winning the election even with real GDP growth averaging only 1.7% in Q1 through Q3. Many Americans apparently blame the financial crisis and ensuing economic collapse on George W. Bush. Based on U.S. data since 1948, incumbent parties in growing economies almost always win the election. Romney, to be sure, has done himself no favours. His campaign seems to have hit the skids in several different ways. Arguably, the Republican National Convention was poorly orchestrated with Christie and Rubio talking more about themselves than about the candidate.

In contrast, Obama came out of his convention with a huge bounce. As well, Romney appears to be backtracking (or flip-flopping) on Obamacare, suggesting on Meet the Press last Sunday that he supports insurance coverage of all pre-existing medical conditions—a very popular provision. However, he should have realized that can’t happen unless you mandate the purchase of healthcare insurance by everyone, which he and his party adamantly oppose. So his campaign now says he supports coverage of all pre-existing conditions for those who have had continuous health insurance coverage, which was already the case in any event and leaves tens of millions of Americans with no coverage. In addition, the Romney-Ryan budget plan is coming under intense scrutiny and it just doesn’t add up. Their plan is to cut marginal personal income tax rates for everyone by 20%, reduce the top rate for corporations to 25% from 35%, eliminate the Alternative Minimum Tax (AMT) and estate tax, end capital gains taxes for people making less than $200,000 a year, and maintain dividend tax rates at the Bush-tax-cut level of 15%. They argued that they would make up these tax losses by curtailing tax breaks on the rich; however, restricting tax breaks for the rich would generate nowhere near enough revenue to make up for the tax cuts. The Republicans argue they would make up the shortfall through stronger growth.

The Romney-Ryan ticket enlists tax reform to broaden the base and increase revenues, but they will not specify which loopholes and exemptions will be restricted, obviously because they are all very popular and each has a strong constituency. The bipartisan Bowles-Simpson plan did detail the specifics of tax reform and hit a huge political backlash. For example, the plan called for the restriction of deductions for charitable contributions, mortgage interest, state and local taxes and employer-provided healthcare benefits, which is why the Obama administration did not support it; neither did Paul Ryan who was on the Bowles-Simpson Commission. Bottom Line: Balancing the U.S. budget will require many tough, unpopular actions.

Nevertheless, the odds favour a major budget package in 2013, regardless of the election outcome. It would be easier for a second-term president to take the political heat in 2013, as all too quickly, his clout will diminish as he is seen as a lame duck. Without a major budget plan next year, Moody’s has said the U.S. will lose its triple-A credit rating. Neither candidate wants this to happen. Gridlock in 2013 would bear considerably painful ramifications. The next president must put in place a credible plan to eliminate the deficit and cut the debt ratio over the next 10 years. Bernanke knows this and it is one reason why the Fed was willing to offset some of the fiscal tightening with very easy monetary policy for the extended future.