Doug Holtz-Eakin served as director of the Congressional Budget Office from 2003-2005, as John McCain’s chief economic adviser in the 2008 presidential campaign, and is now president of the American Action Forum. This is the second in what will be a series of interviews with prominent right-leaning economists about what they consider to be the key problems with, and right solutions for, the American economy. The first, with Columbia’s Glenn Hubbard, is here.

Ezra Klein: Growth is low. Unemployment remains high. So at this point, what’s holding us back?

Doug Holtz-Eakin: The paramount fact is that we have badly damaged balance sheets in the household and government sectors. The household sector came into the recession with a lot of debt. Since then, it’s seen its portfolios battered and its housing values continue to decline. In those circumstances, its both sensible and desirable for them to save more and fix their balance sheet. And they’re doing that. But that means they’re not powering a strong upswing. And consumer spending is 60 percent, 70 percent of the economy.

But it also means that if you look at the potential for growth in the Casablanca fashion, by rounding up the the usual suspects, households are out. Governments are in terrible shape. Exports would be nice, but the rest of the world isn’t there for it. That leaves you with the business community. They’re the sector with trillions of dollars on their balance sheets and so they could kick off more rapid growth.

EK: But why would they kick off more rapid growth before either households or governments are supplying some level of predictable demand for their products? As I understand it, this has been the problem for the last two years: they have the money, but they don’t see much upside in spending it until their customers have money, too.

DHE: There is a standard business cycle recovery mechanism that has worked in the past and will eventually work here, and it’s driven by investment. That takes the form of replacing worn out machines, and that takes the form of buying from other businesses, and that becomes demand. So that’s happening. But it’s not enough for everyone to feel good about. And while there are limits to what you could do, there’s nothing in the policy agenda helping it right now.

EK: So that gets us to the policy agenda. What should be done?

DHE: This is just the right-wing crank complaining about the administration, so bear with me: economic growth is not a bill. It’s not a speech. Growth is a priority. So when we make policy decisions, we should put growth at the top, particularly right now. We shouldn’t let the health agenda or the labor agenda or the green agenda trump growth. And at every close call, the administration has gone the other way. It’s not that those other policy values are wrong. It’s that growth is coming in last place with this administration and now they’re paying for it.

EK: To play devil’s advocate on this, I think you would agree that the Obama administration doesn’t really see it that way. They think they produced a growth-focused stimulus plan, and while they waited for that to begin spending out, they tried to address long-term impediments to growth, like health-care costs. You may not agree with how they went about it, but plenty of Republican politicians and policy wonks say our projected future deficits, which are mostly from health care, are a threat to growth now. And now that the first stimulus is done, the administration is pushing the American Jobs Act, which they see as a bid to support growth next year.

DHE: What they need to remember, and they’re smart enough that they’ve forgotten, is if you go to Macroeconomic Advisers or Moody’s, you get out of those models what you put in. In those models, government spending can’t fail. So they go there for their advice and they get out what they put in and it doesn’t work and they’re shocked.

It can’t be considered pro-growth to be sailing right towards a financial crisis. So let’s say you want to do something sensible to avert it. Why not do Social Security? That would have zero contractionary impact. We can all agree we’re not going to do anything to current beneficiaries. It would be good for the budget. It would send a signal to world capital markets that we could take on the traditional third rail of American politics. So what’s the one thing the administration left out of their recommendations to the supercommittee? Social Security.

EK: That puts us neatly back on the question of policy recommendations. What else would you like to see right now?

DHE: Tax reform. I would take a much better tax system even if it raised more revenue. But we need a better tax system. If you look around the globe at countries that have successfully dealt with our problem — big debt, slow growth — it’s tax reform, and cut spending but not all spending. You want to preserve education and infrastructure and defense and research, but you cut federal payrolls and transfer programs. The policy agenda for the next president is not going to be one they can choose. They do tax reform or entitlement reform, or we explode.

EK: But tax reform and entitlement reform, though I agree that they’re necessary, are both solving long-run problems. Those are policies you would have wanted in 2006 and 1999. Do the extraordinary economic circumstances we’re in now require any unusual policies that you wouldn’t be advocating outside this moment?

DHE: We already did them. We have crossed policy lines we never dreamed we’d cross. That sense of throwing anything at the wall and seeing what sticks, that’s what we did during TARP and stimulus. We have been growing for two years now. We’re not in freefall. Now we need to get back to our knitting and have better growth.

And this is the thing. We know that permanent policies are better than temporary ones. They’re more powerful. If you’ve got a problem now, why not do a permanent change and take the benefits now? We need a lower corporate rate. So let’s do that. Don’t do things that are short term that you then have to unwind for the long-run. If the Democrats want to talk about infrastructure, and there’s a legitimate case for it, they should be more serious about reforming the programs. We have hundreds of different programs that don’t talk to each other.

EK: Would you support an infrastructure bank as one of those reforms?

DHE: I think it’s a classic case of textbook elegance ignoring political reality. If the money comes from a congressional committee into the infrastructure bank, the committee will follow. You can’t insulate it. So I’m not a fan.

EK: Do you see any policies where there could actually be a compromise? So far, both sides agree on the problems, but not the solutions. Are there policies you could see a Republican president passing with Democratic support?

DHE: I certainly wish Bowles-Simpson had been taken seriously. But that ship has sailed. Right now, the one thing I can see which has support on both sides of the aisle is repatriation for corporate profits. It is a step towards a territorial system. And no, it isn’t anyone’s first-best idea of corporate tax policy. It’s temporary, holidays usually aren’t a great idea, but in these circumstances, I would do it.

EK: Could you see any movement on housing policy?

DHE: I don’t think there is any economically rational, large-scale housing policy that’s politically feasible. I think at this point, the rest of the economy will save the housing market and not the reverse. Let the housing market clear and move on.

EK: You’ve mention tax reform a few times. How would you like to see that go?

DHE: I’m a progressive consumption tax guy in the end. You should have a tax system that reflects a philosophy and mine is people should be taxed on what people take out, not what they contribute. Americans have a deep-seated desire for progressivity in the tax code and that should be respected. In the end, you can get the distribution people want. And in the process, we would tax things at the source, before it got into the financial system. So that’s where I think we have to go. I was taught by the late David Bradford, the greatest tax economist I’ve ever know, and this is his X-tax.

EK: Let’s say all the policy moves as you hope it will. How much does that do for growth over the next few years?

DHE: I think you could move 2012 by half a percentage point and 2013 by one percentage point. Confidence is at extraordinarily low levels. If the administration and Congress could show the American people they could run the nation’s business, they would feel a lot better about where things are.