Many economists have been warning that the policies of the last few years under the Bush administration followed by the coming economic populism of Barack Obama will lead the U.S. back into a 1930s-style Great Depression. That group includes my friend and coauthor Arthur Laffer. I wouldn't go so far. Our current constellation of policies—bailouts, a weak dollar, rising tax rates, windfall profit taxes, bloated economic stimulus bills, and reregulation of markets— looks to me more like a reprise of the 1970s. That decade wasn't the Great Depression, but the economic results were plenty rotten, delivering the worst performance for the stock market and family incomes since the 1930s. Are we going to see a repeat?
The story actually begins on January 18, 1966. That was the day America hit a gold-plated economic milestone, celebrated as a symbol of post–World War II industrial might and productivity. On that red-letter day, the Dow Jones industrial average (briefly) climbed over 1,000 for the first time in American history.
The Kennedy tax cuts of the 1960s had helped fuel this stock market rally. The Vietnam War had not yet fully escalated or become unpopular, American manufacturing was at its peak, firing on all eight cylinders. Smokestack industries—autos, trucks, steel, chemicals, apparel—were global leaders. The "Made in Japan" label was a tipoff that you were buying an inferior product. Cities like Cleveland, Detroit, and even Newark and Gary, Indiana, were prosperous places and beehives of economic activity.
The American middle class was buying up Zenith color TVs (this was when TVs were still made in America), dishwashers, washing machines, electric garage door openers, and air conditioning for the first time—because it could finally afford such luxuries. John Kenneth Galbraith's "Affluent Society" had come into its own. And no society had ever experienced such affluence for the great preponderance of the population.
In the late 1960s growth seemed to be unlimited— even preordained. But here's how far America would slip. In 1966 the Dow stood at 1,000. In July 1982 the Dow hit its low point of just below 800. This meant that over 16 years the stock market lost 20 percent of its value. Adjusting for inflation, stocks lost more than 60 percent of their value. The era of America's post–World War II economic and military preeminence seemed to have vanished overnight. All you had to do was go back to Cleveland and Detroit and Newark and Gary to see the devastation— the boarded-up houses, the closed factories, the panhandlers, the public housing war zones, the unemployment lines, the drug use. And, perhaps the low point, the Cuyahoga River, which funnels into Lake Erie, caught fire due to residue of industrial waste—much to the delight of late-night comedians.
THE DECLINE STARTED UNDER Lyndon Johnson, who, for the first time in American history, spent more on both guns and butter simultaneously. While escalating the Vietnam War, LBJ unleashed the Great Society welfare state "to end poverty in America." These programs would go on not just to spend more than $2 trillion over the next two and a half decades, but to depreciate the value of work and family cohesion and create several generation of a permanent American underclass sucked into a cycle of welfare dependency. Poor families on welfare were pushed into 100 percent-plus effective tax rates, because they could lose more money in government benefits from working than they could earn on the job.
LBJ also began the reversal of the supply-side effects of the Kennedy tax cuts. In 1968 he signed a 10 percent income tax surcharge to finance the growing cost of the war in Vietnam. The top tax rate went back up to 77 percent.
At the end of the LBJ presidency came the infamous Alternative Minimum Tax. The Johnson Treasury Department discovered in 1968 that 155 tax filers with adjusted gross income of $200,000 ($1.2 million in today's dollars) were exploiting loopholes in the tax code to avoid paying any income tax. The Democrat-dominated Congress passed a new shadow tax system called the AMT—which remains a thorn in the side of millions of families today. After four years of the Great Society, by 1968 America wasn't feeling so great. Next came the Nixon years. Known mainly for Watergate and his foreign policy, Richard Nixon is less well remembered for his catastrophic economic policies. He launched the modern era of the regulatory state with passage of the Clean Air and Clean Water statutes. However well intentioned, they were heavy-handed blows to the solar plexus of American industry, with costs far exceeding benefits from the cleanup legislation.
The 1970s was to be the era of economic strangulation by regulation. In constant 2000 dollars, spending by federal regulatory agencies rocketed from $5.2 billion to $10.2 billion during Nixon's tenure. By 1979 the spending had zoomed to $13.5 billion. The federal government's army of snoopers was now regulating everything from the width of doorway entrances to speed limits to the flush capacity of toilets.
In 1971 Nixon closed the gold window—meaning that the U.S. was now officially off the gold standard. Nixon and his advisers believed that the standard was no longer sustainable and that the $35 fixed price of gold that had prevailed since the end of World War II could not be maintained. When the gold window was closed permanently, the dollar was no longer hinged to a hard commodity.
The dollar's value relative to gold melted down over the next 10 years. In 1971 gold was at $35 an ounce. By 1980 it was selling at more than $800 an ounce—25 times higher. The end of the gold standard began the era of hyper-inflation.
THEN IN AUGUST OF 1971 Nixon imposed one of the most radical interventions into the American free market system in U.S. peacetime history. Nixon's economic advisers hatched a plan officially titled "The New Economic Policy," and at its core was a 90-day freeze on wages and prices— which was eventually extended for 1,000 days. There was also a 10 percent tariff on all U.S. imports, in blatant violation of our trade agreements.
The freeze on salaries and prices of goods and services seemed to be an admission that inflation was uncontrollable and that since the market wouldn't hold down prices, the iron fist of the government would. These price controls exposed a fundamental lack of understanding of how the pricing system in a free market operates. If prices aren't allowed to rise when the market dictates they should, then shortfalls and waiting lines occur and producers have an incentive to produce less, not more. If prices are held too high, the economy produces too much of the product.
When the price controls were lifted, nine months of pent-up inflation exploded like the cork released from a shaken bottle of Dom Perignon. Clerks stood at ready to put new sticker prices on nearly everything once the clock struck midnight and the price freeze was officially over. At this time, Mr. Nixon and his economic team didn't understand that inflation was a result of too much money and a falling dollar, not insufficient government mandates. Nixon was also a big spender, with the federal budget up by 50 percent during his tenure. Nixon saw federal spending as stimulatory for the economy, and declared himself and all of us Keynesians. As economist Paul Craig Roberts has noted about that era: "The standard remedy was for government to increase total spending by incurring a deficit in its budget. GDP, it was believed, would then rise by some multiple of the increase in spending."
Gerry Ford's policies were hardly an improvement. After the midterm elections in November 1974, Ford faced a Democratic majority whose numbers were staggeringly large. To his credit, Ford vetoed more than two dozen of the Democrats' more left-leaning spending and regulatory measures, but many of those vetoes were overridden by Congress. But President Ford had no strategy for dealing with rising oil prices in the mid-1970s and so instead he did all the wrong things. In his 1975 State of the Union address he called for a windfall profits tax on oil companies. In December of that year he signed that tax into law as well as an energy bill with price controls and the first-ever fuel efficiency standards on cars. None of these policies worked; their main effect was to curtail domestic production, which played into the hands of the Middle East oil cartel, OPEC.
Ford's biggest failing was in misunderstanding how to combat inflation, which was still raging. Ford asked the nation in October 1975 to be "energy savers" and to wear Whip Inflation Now (WIN) buttons to try to slay the inflation beast, as if inflation were a state of mind, rather than a result of monetary policy run amok. On taxes, Ford and Congress refused to cut the high rates of the era, and offered up impotent tax rebates instead. The unemployment rate and inflation rate each hit 7 percent in 1976, and the nation wanted a change.
ENTER JIMMY CARTER — who had run on an appealing anti-Washington, anti-big government, pro-balanced budget campaign for the presidency. Yet once Carter was in the White House it became clear he had no idea how to lead the nation out of its deepening economic troubles. Lacking a core pillar of ideology, Carter proved to be a micromanager and a constant vacillator. In his one term he launched major economic programs— none of which worked and some of which contradicted each other.
For example, in Carter's first year in office he lobbied for a tax rebate to help the middle class and to stimulate the economy. But in the later years of his presidency he attacked tax cuts as unaffordable. He had pledged to "reform the tax code" but never put forward a coherent plan. The supply-side tax revolution was just getting started, but Jimmy and his incompetent treasury secretary Michael Blumenthal did everything they could to block it. The bipartisan Steiger capital gains tax cut of 1978 was denounced by Carter as "a huge tax windfall for millionaires and two bits for the average American." He declared that the Steiger bill was "the greatest hoax ever perpetrated on the American people." Blumenthal called the supply-side tax cuts "the millionaires' relief act." This was the birth of the left's class warfare rhetoric. The bill passed by such huge veto-proof majorities that Carter begrudgingly signed it into law. One side effect of the stifling inflationary spiral of the 1970s was that Americans were steadily pushed into higher tax brackets. This was called bracket creep: Americans' real incomes weren't rising but the taxman was automatically taking a larger share of a rising before-inflation income, but a falling after-inflation income.
Making matters worse, since the 1964 Kennedy tax cuts, there had been a few tax cuts (the Steiger capital gains cut, for example), but most taxes at the federal, state, and city levels had been relentlessly climbing. The payroll tax for Social Security had been rising due to scheduled rate increases, and so the combination of bracket creep and payroll tax increases meant a shrinking after-tax paycheck. This was explained well by James Gwartney, an economist at Florida State University, who examined the impact of taxes on the middle class in this period:
Between 1965 and 1978 taxes as a share of the taxpayer's adjustable gross income increased from 19.4% to 29.5% of AGI. By 1980 the average tax rate of a typical working couple with two children had risen to 20.9% compared with only 13.7% in 1965. More importantly for incentives, the couple's marginal tax rate jumped from 23.6% in 1965 to 35.13% in 1980. There has been a substantial increase in tax rates since the mid-1960s [through 1980] in the United States. President Carter did nothing to relieve this tax bite and opposed almost all efforts to alleviate it.
ANOTHER HUGE CARTER BLUNDER was his energy policy, even though it was his top domestic policy concern. Carter had declared that ending the energy crisis was for the nation "the moral equivalent of war." This was an era of gasoline lines—a time when motorists would start lining up at 6 a.m. on frigid winter mornings to be first in line to fill up the tank.
Throughout the 1970s, under Nixon, Ford, and Carter, OPEC severely restricted production of oil, contributing to a big spike in the price of heating oil and gasoline. The fall in the value of the dollar—and the loss of its purchasing power—played a key and underappreciated role here as well. By the late 1970s the price of a barrel of oil had more than tripled from $10 to $32 a barrel.
Jimmy Carter was pessimistic about America's ability to pull out of the oil price spike. Thoroughly a Malthusian, he gloomily predicted in 1977 that "we could use up all of the proven reserves of oil in the entire world by the end of the next decade."
Political panic during his administration spawned a potpourri of crackpot responses, including gas rationing; wellhead price controls; a "gas guzzler tax" on cars; an odd-even license plate system for rotating the days of the week that Americans could fill-'er-up; a voluntary policy urging stores and public buildings to turn the thermostat to a chilly 65 degrees in winter and a sweaty 80 in summer; a windfall profits tax imposed on producers of domestic oil, so that drillers could not "profit" from the OPEC price spikes; and a $2 billion "investment" in something called the Synthetic Fuels Corporation, an alternative renewable energy boondoggle that had produced not a kilowatt of electricity by the time it was closed down in 1982.
The one policy change that was desperately needed was decontrol of oil and natural gas prices— which Ronald Reagan was calling for on the 1980 presidential campaign trail. But Carter fought the idea and denounced proposed natural gas price decontrols as "immoral and obscene."
The effect of the Carter price control and windfall profits tax policies was that U.S. oil production fell from 11 to 9 million barrels a day from 1971 to 1980 (incredibly even as the retail price at the pump for gasoline more than tripled). Price controls made it unprofitable for domestic producers to increase output through more expensive processes, such as drilling deeper wells, fracturing, steam or water injection, offshore drilling, and so on. The other perverse effect of the price controls and profits taxes was that U.S. imports of foreign oil rose from 4 to 8.5 million barrels of oil a day from 1970 to 1977, as demand for oil rose and domestic production fell. In the final analysis, Carter's policies led to less conservation, less domestic production, more dependence on foreign oil, and higher long-term prices.
IT WASN'T JUST HIGH ENERGY PRICES that flummoxed Jimmy Carter—the rise in all prices became an irresistible force of nature during his presidency. Carter was a convert to the Phillips Curve belief that high inflation had to be tolerated to put people to work. So even with the money supply rising by 11 percent a year in 1977, he and his cadre of economists urged the Federal Reserve Bank to lower interest rates and quicken the pace of the printing presses to push more dollars into the economy. One of his chief economic advisers, Lawrence Klein, said, "We need faster monetary growth," even as inflation raged and monetarist economists argued just the opposite. In 1977 inflation was at an intolerable 7 percent, in 1978 it climbed to 9 percent, in 1979 it hit 12 percent, and in 1980 it shot up further to 14 percent. In 1980 the prime mortgage interest rate hit an astronomical high of 20.5 percent. The home building industry virtually shut down with interest rates that high. America was starting to resemble a Third World country in terms of monetary policy.
Carter had no solution. In 1978 he called the inflation bulge a "temporary aberration." Then in later years when the "temporary" nature of inflation suggested that the president suffered from a detachment from reality, Carter said that inflation wasn't his fault, but more of a moral affliction affecting American society because we had lost our capacity to "sacrifice for the common good." He declared in one speech that it was "a myth that the government can stop inflation." Americans scratched their heads and wondered if the Fed and Congress and the president couldn't stop inflation, then who could?
Carter was also a declinist. He scolded the nation in a TV address in 1979 that Americans now suffered from a crisis "that strikes at the very heart and soul and spirit of our national will. We can see this crisis in the growing doubt about the meaning of our lives and in the loss of unity of purpose for our nation. The erosion of confidence in the future is threatening to destroy the social and political fabric of America."
Then he continued with his mournful prose that "for the first time in the history of our country a majority of our people believe that the next five years will be worse than the past five years." Why? Because the biggest pessimist in America was sitting right there in the Oval Office. This was the "audacity of hopelessness."
MEANWHILE, THE U.S. ECONOMY continued to lose traction with each passing month. Carter himself acknowledged that "the productivity of American workers is actually dropping." So were their real wages. From 1978 through 1981 real family income for the middle class fell from $32,319 to $30,916. The Carter years were among the worst for family incomes in post–World War II history. Americans were getting poorer. Reagan used a line in the 1980 election campaign that resonated well with agitated voters: "The definition of a recession is when your neighbor is out of work. The definition of a depression is when you are out of work. The definition of recovery is when Jimmy Carter is out of work."
A new term crept into the American lexicon: stagflation. We hear about this today. It is the deadly combination of high inflation and high unemployment. It is exemplified by the misery index: the inflation rate added to the unemployment rate. In 1976 that was 14 percent and by 1980 the misery index had climbed to 21 percent (13.6% inflation and 7.2% unemployment).
What are the lessons of the 1970s? That price controls, profits taxes, high inflation, high tax rates, reregulation, a reckless monetary policy, and out-of-control spending can ruin the U.S. economy. The '70s produced the worst performance for incomes and wealth than at any other time since the Great Depression. Policy matters and policy mistakes can lead to grievous misery for American families and businesses. There is someone in the Obama White House or in the Democractic Congress who has proposed the return of every dimwitted and destructive policy of the 1970s. Be warned: if we repeat those mistakes, we will repeat the misery.
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