The New American Economy: The Failure of Reaganomics and a New Way Forward
By Bruce Bartlett
(Palgrave MacMillan, 272 pages, $28)
The title of Bruce Bartlett’s book, The New American Economy: The Failure of Reaganomics and a New Way Forward, is misleading. The first six chapters of the seven-chapter book aren’t about the “new” economy, but rather serve as an economic history of the United States from the Great Depression to the current economic crisis. And it really isn’t about Reaganomics failing, either. Instead, Bartlett, the disillusioned supply-side economist and former Treasury official during the first Bush administration, acknowledges that Reaganomics was a smashing success, but insists that it outlived its usefulness. While he makes some valid warnings about the looming entitlement crisis, unfortunately Bartlett reaches a warped conclusion that conservatives need to accept the reality of the welfare state, and focus on the best ways to raise taxes to finance it.
Bartlett’s advocacy of higher taxes is not the only way in which he breaks from conservative orthodoxy. Unlike conservatives who argue that Franklin D. Roosevelt’s reliance on Keynesian economic theory prolonged the Great Depression, Bartlett insists that FDR never really listened to Keynes during the 1930s. As most economists acknowledge, Bartlett writes, the Federal Reserve Board bungled the early days of the economic crisis by allowing the money supply to contract significantly. But once the crisis became severe, the Fed was unable to pump more money into the economy, because even lower interest rates did not motivate the private sector to spend more. Lowering taxes wouldn’t have been effective either, Bartlett argues in agreement with Keynes, because people would simply save most of the extra income. Instead, he writes, the only way to stimulate the economy and solve the monetary crisis was for the government to start spending money and running up deficits. But FDR resisted implementing this solution as intended, Bartlett recounts, and it wasn’t until World War II that Keynes-ianism was attempted on a large enough scale to work.
Despite being associated with modern liberalism, John Maynard Keynes was actually a conservative economist, according to Bartlett, because he wanted to make sure that economic crises were not used to discredit capitalism and advance socialism. Looking at the long body of Keynes’s work convinced Bartlett that Keynes was actually quite concerned about the threat of inflation and only believed in government deficit spending as a necessary evil in the case of a severe deflationary environment. The problem wasn’t with Keynes, Bartlett concludes, but that for decades that followed, policymakers repeated measures that were only intended for extraordinary circumstances, applying the lessons of the Great Depression to every economic problem that popped up. Eventually, the result was the massive inflation of the 1970s, which paved the way for the conservative counter-revolution in economics because Keynes-ians had no answers.
Economists Milton Friedman and Robert Mundell led the charge, with Friedman focusing on the importance of monetary stability and Mundell on how to achieve economic growth. Mundell proposed a two-pronged strategy to deal with the stagflation problem of the 1970s. The first part of his approach called for tightening the money supply to combat inflation, and the second en-tailed slashing tax rates to spur growth.
To counter critics who insisted that tax cuts would cause deficits, supply-siders argued that by spurring growth and thus increasing the tax base, tax cuts would recoup a portion of lost revenue. Or,
as economist Arthur Laffer, father of the famous “Laffer Curve,” described it in an interview with Jude Wanniski that appeared in a 1975 article in the Public Interest:
[W]hen taxes are zero, revenues are zero. When taxes are 100 percent, there is no production, and revenues are zero. In between these extremes there is one rate that maximizes government revenues.
The basic argument was also empirically corroborated by evidence from the tax cuts initiated by John F. Kennedy. Then-Rep. Jack Kemp studied the Kennedy cuts when he teamed up with Sen. William Roth in 1977 to work on a broad-based tax relief proposal (which would later become the basis for the Reagan tax cuts). Also in 1977, Walter Heller, who was chairman of Kennedy’s Council of Economic Advisers, testified before the Joint Economic Committee on the revenue effects of the Kennedy tax cuts, and said, “within one year the revenues into the Federal Treasury were already above what they had been before the tax cut….Did it pay for itself in increased revenues? I think the evidence is very strong that it did.”
The supply-side approach of tight monetary policy coupled with large tax cuts formed the foundation of the economic polices that the Reagan administration adopted in the early 1980s, which managed to stamp out inflation at a much lower economic cost than anybody anticipated. Inflation fell from 12.4 percent in 1980 to 4 percent in 1982, while the economy recovered in 1983 and grew at a 4.5 percent clip that year.
But Bartlett argues that just as Keynes’s followers misapplied his economic theories in the decades following World War II, conservatives have incorrectly concluded from the success of the early 1980s that the solution to any economic problem is more tax cuts. This all culminated in the second Bush administration, which “represented a bastardized version of supply-side economics that had more in common with the caricature of it depicted by its opponents than anything approximating its core principles.”
Not only did the Bush tax cuts come during a different set of circumstances, but they also violated several fundamentals of supply-side theory, Bartlett contends. While the original supply-siders believed it was important to cut tax rates, the bulk of the Bush tax cuts involved rebates and tax credits that are much more like government subsidies. And though supply-side theory emphasized that tax cuts had to be permanent to have an economically beneficial impact on individual’s incentives, Bush, out of political necessity, agreed to make those cuts temporary. Originally, supply-siders only argued that a portion of the lost revenue was recovered from cutting taxes, but the Bush administration gave the impression that all tax cuts pay for themselves in all cases.
A key lesson Bartlett draws from the Bush years is that the supply-side argument that depriving the federal government of tax revenue would force spending cuts (a theory known as “starving the beast”) was wrong. Even though the U.S. has implemented several rounds of tax cuts since 1981, spending has increased dramatically, and it exploded under Bush, who even created the largest expansion of entitlements since the Great Society in the form of the Medicare prescription drug plan.
In the wake of the Bush years, Bartlett notes that the U.S. is facing a long-term deficit of $90 trillion from Medicare and Social Security alone. Since Republicans have proven themselves unable to do anything to rein in the cost of these programs and it’s unrealistic to think that they will behave any differently in the future, he argues that it’s time for conservatives to give up their stubborn resistance to tax increases. Instead, he urges supply-siders to “design a new tax system better able to raise higher revenues at the least possible cost in terms of economic growth and political freedom.” If conservatives don’t begin this process now, he writes, then liberals will simply raise taxes anyway, only in ways that will be much more destructive to the economy.
MANY OF BARLETT’S points are valid. The fiscal recklessness of the Bush administration is undeniable, and conservatives will have to come up with better solutions to address the looming entitlement crisis. It’s also true that many conservatives have misconstrued supply-side theory. The “Laffer Curve,” for instance, posits that there’s some optimal tax rate, and if taxes are above that point, they actually stifle economic activity and lead to lower revenue. But when Reagan took office, the top tax rate stood at 70 percent — given that it’s now down to 35 percent, it’s harder to make the argument that additional tax cuts will boost revenue. At some point, cutting taxes decreases revenue, even under supply-side theory.
But Bartlett’s thinking is also schizophrenic, as he vacillates between admiring supply-side theory and relishing his role as a conservative provocateur. He argues for a Keynesian approach to severe economic crises such as the Great Depression and the current economic predicament (he viewed President Obama’s economic stimulus package as necessary). But he is also sympathetic to the supply-side critique that lag times inhibit lawmakers from responding to signals in the economy immediately and delay for years the point at which government spending is actually injected into the economy. He says the sooner the government acts, the better. But in the early stages, how can policy makers determine if a recession is severe enough to warrant a Keynesian response? How do they know that they aren’t mis-applying Keynes the way policy makers did in the decades after World War II, and thus setting us up for the same inflationary problems of the 1970s?
The most flawed aspect of Bartlett’s reasoning is his conclusion that conservatives need to embrace a value-added tax. “Once in place,” he writes, “the VAT could be raised gradually to pay for the baby boomers’ retirement.” The problem is, while he makes a convincing case that “starving the beast” didn’t work, he fails to disprove the argument against “feeding the beast.” In reality, giving lawmakers a new pot of money to dip into will, at a minimum, reduce their need to decrease spending, and will likely encourage them to spend more. A perfect example is the Social Security payroll tax, which was initially set at 1 percent each on employees and employers (or 2 percent combined) in 1935. It has been hiked 20 times since then (including during the Reagan years) and now the combined tax rate is 12.4 percent. Despite all of these attempts to get Social Security’s fiscal house in order through tax increases, it remains effectively bankrupt, as Bartlett himself acknowledges.
Bartlett undermines his case even further when he argues that in order to win over critics who believe a consumption-based VAT hurts poor people, who spend a higher proportion of their incomes, law-makers could pass universal health care as a trade-off. The argument is that lower-income Americans would receive more government benefits in exchange for their higher taxes. So, even though Bartlett excoriates Bush for creating a new entitlement program, and dismisses those who argue that raising taxes will lead to a further expansion of government, he accepts as fact that a whole new entitlement may have to be created to build support for his new tax that would not only fund this new entitlement, but help dig us out of the $90 trillion hole we’re already in from existing entitlements. Who’s he trying to kid?
A LESSON FROM THIS YEAR’S health care debate also contradicts Bartlett’s argument against Republican stubbornness about raising taxes. When the initial health care proposals were being drafted in Congress, they were being given price tags in the $1.5 trillion range. But Democrats could only find a few hundred billion dollars in Medicare cuts and other “savings” to finance their proposals, and because they knew they’d be skewered if they had to implement across-the-board tax increases, they had to scale back their plans dramatically. (A Finance Committee proposal was eventually valued at around $800 billion.) Had Republicans abandoned their opposition to tax cuts and embraced the idea of the VAT as Bartlett suggests, it’s undeniable that it would have given Democrats the money — as well as political cover — to adopt an even more ambitious proposal.
Bartlett argues, as if it’s supposed to be reassuring, that we shouldn’t fear a VAT tax because they’re common in Europe, and “many European countries have tax/GDP ratios far higher than here without suffering particularly ill effects.” Even though conservatives have spent decades fighting against the adoption of European socialism in America, Bartlett is making the case that the right needs to embrace the same economic model, and by extension, the chronically high un-employment, slower growth, and lower per capita income that come along with it.
As shaky as his policy rationale is, Bartlett’s political calculus is perplexing. “In the end, the welfare state is not going away, and it will be paid for one way or another,” he concludes his book. “The sooner Republicans accept that fact, the sooner they will regain political power.” Yet Bartlett offers absolutely no evidence that there is a political constituency for Republicans who advocate higher taxes. The closest he comes is the mention of a Wall Street Journal/NBC poll that found Americans trusted Democrats more than Republicans on taxes, but such results reflect the fact that Democrats regained power by running away from their traditional image as tax hikers. During the presidential campaign, Barack Obama pledged to give tax cuts to 95 percent of Americans, while he ran ads blasting John McCain’s health care proposal as a tax increase. A CBS/New York Times poll taken just weeks before Election Day found that more Americans thought McCain was going to raise their taxes than Obama, by a 51 percent to 46 percent margin. One can only imagine how much worse the results would have been had McCain run on Bartlett’s VAT proposal.
The current political paradox is that Democrats want to increase government services without acknowledging that broad-based tax increases are required to do so, and Republicans want to cut taxes without acknowledging that dramatic cuts to government services will be necessary to do so. This is clearly an unsustainable path. But if there are political risks associated with either tax hikes or spending cuts, it should be the role of conservatives to press Republicans into attacking spending. Ultimately, Bartlett loses sight of the fact that conservatives’ opposition to taxes is rooted not merely in economics or politics, but in a moral belief that individuals have a right to the product of their own labor.