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The New American Economy

December 14th, 2009 at 5:39 pm David Frum | 5 Comments |

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At the beginning of Bruce Bartlett’s career, the U.S. economy was gripped by failure and crisis: high inflation, sluggish economic growth.

Three presidents had struggled with the problems of the 1970s, and three had failed.

President Nixon had gripped the economy with price controls: that had not worked.

Gerald Ford had (unsuccessfully) attempted to cut government spending, while exhorting Americans to consume less. Failure again.

Jimmy Carter had spent money on job creation schemes while proposing central planning of the energy sector. Three-quarters of the way through his presidency, he abruptly reversed course, tightening money while trying to balance his budgets.

Through those painful years, a small group of dissident economists had developed a new set of ideas about to reignite non-inflationary growth. Their ideas came to be nicknamed supply-side economics. Much of Bartlett’s new book, The New American Economy, consists of a sophisticated defense of the supply-siders’ intellectual and policy achievement.

Today again the U.S. economy has tumbled into crisis. Today again the policies of the president do not look very effective. Today again the country craves a credible conservative alternative.

But the more you understand why supply-side economics succeeded in the 1980s, the more ill-directed it looks as a response to the problems of today.

Back then, neo-Keynesians insisted that inflation and recession counter-acted each other. It was impossible to suffer both at the same time. But what was impossible in theory was occurring in reality. Why?

The supply-siders noticed that inflation was pushing people into higher and higher tax brackets. In 1979 the tax code prescribed 11 brackets, if I remember right. As Eugene Steurle details in his all-important book, The Tax Decade, a typical American family paid a marginal tax rate of 20 or 22% at the beginning of the 1970s, and a rate almost double by the decade’s end.

Here was the secret of the stagnation that attended inflation, the supply-siders argued. They recommended instead a policy combination of tight money (to quell inflation) and marginal tax cuts (to stimulate growth). The Nobel-winning Yale economist James Tobin complained that such a combination would be like trying to board two trains at the same time, one bound for Boston, the other for New York-. Bob Bartley of the Wall Street Journal would later taunt Tobin: “yet here we are, arrived in both Boston and New York.”

Bartley and the supply-siders had reason to feel vindicated. For a quarter-century after 1983, the United States enjoyed strong (and sometimes very strong) growth without inflation, punctuated by only two very mild recessions, in 1991 and 2000.

Supply-side tax cuts were not a universal elixir, prescribed for all ailments. They were elegantly designed to counter stagflation. Other problems required other solutions. And boy, do America and the world now face other problems: deflation, debt, and the failure of economic growth to translate into rising incomes for most Americans.

A free-market economic policy for our time would stress reflation to combat deflation and a payroll tax holiday to spur job creation. It would propose health reforms to control costs and thus boost middle class incomes and slow the rise in government spending. It would, as Bartlett has done, call for consumption taxes to balance the budget and avert the payroll and income tax increases that will otherwise befall.

Such a policy would depart from present conservative orthodoxy. But the supplysiders departed from the conservative orthodoxy of their day, and we admire them for it! We do not honor them by refusing to emulate them.

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5 Comments so far ↓

  • mlloyd

    A fine post.

    It’s also worth noting that the insight of 1970s conservatives was simply that “cutting taxes from too-high marginal rates can help growth.”

    No rational person anywhere ever has concluded that “cutting taxes is always good, and raising taxes is always poison.” Reagan in 1982 and Clinton in 1993 raised taxes because they were concerned about the deficit. That’s politically difficult, and very easy to rail against, but in neither case was it damaging to the economy– especially in 1993!

    No one is contemplating returning rates to their pre-Reagan levels. But today’s mainstream conservatives are fighting their battles like it’s 1979.

  • joemarier

    Actually, it’s more like we got on one train with a sign that said “Boston”, and it kept doubling back and occasionally derailing. But, as a wise philosopher once said, the sign pointing to Boston doesn’t have to go there.

  • James Cody

    “Today again the policies of the president do not look very effective.”

    What? GDP has gone from contracting 5+% annually to growing almost 3%. Unemployment claims are down 20%, job shedding is down by 100s of 1000s to 11,000, and the unemployment rate dropped last month from 10.3% to 10%. The overwhelming majority of economists agree that the stimulus has worked. See, e.g., the Wall Street Journal survey of economists, Mark Zandi (McCain economics adviser), and that guy named Bruce Bartlett. I find it simply absurd for conservatives to continue to argue that the stimulus hasn’t worked in the face of all facts to the contrary. They sound exactly like — and I mean exactly like — liberals/Dems arguing the surge didn’t work in crushing al Qaeda in Iraq. Now, if conservatives wanted to argue we’re going to double dip, fine (just as it would have been fine for liberals/Dems to argue that the surge was still a bad idea because Afghanistan was more important), but to argue that it hasn’t worked thus far seems to me to be absurd.

    “They recommended instead a policy combination of tight money (to quell inflation) and marginal tax cuts (to stimulate growth). The Nobel-winning Yale economist James Tobin complained that such a combination would be like trying to board two trains at the same time, one bound for Boston, the other for New York-. Bob Bartley of the Wall Street Journal would later taunt Tobin: “yet here we are, arrived in both Boston and New York.””

    As I believe Bartlett himself has pointed out repeatedly, the economy began to grow again in 1983 despite Reagan raising taxes in 1982 and after (and because of) Volker slashing interest rates. I believe that the better argument supporting supply side tax cuts is that it had long term benefits (it takes awhile for the increased work, savings, investment, and productivity to develop) but was unlikely a direct cause of turning the economy around in the mid-80s. The turnaround likely was due to Volker crushing inflation (causing the double-dip recession) and then cutting rates when the beast was safely killed. Also, I would argue Tobin was right: jacking up interest rates to restrain liquidity is at odds with cutting taxes, and the interest rates possibly was higher than always would’ve been necessary (a counterfactual that can never be proven, but interest rates were so high, it seems to me that Bartley’s boast is hardly proven correct).

  • Link Fest | Republicans United.

    [...] David Frum reviews the new book by supply sider Bruce Bartlett who things Reaganomics won’t save us this time. [...]

  • theCardinal

    Bartlett’s book in invaluable – all Republicans should read it, which is not to say that all Republicans and conservatives would agree with it. He does a great job not in distinguishing the supply-side cuts and the tax code riddling of the W years. His prose is clear and his economic arguments contra the pseudo supply-siders is devastating. Where Bartlett falls short is his idea of “reality.” He throws up his hands at the size of the welfare state and subscribes to the same notion made in “The Death of Conservatism” – that the conservatives job is to check leftist over-reach and to run the welfare state responsibly. He then proposes that we push a VAT to save the welfare state. Ok, maybe he is right that Americans don’t actually want to reduce the size of government but do they really want a VAT? Maybe cutting down on entitlements is a pipe dream but no greater than a VAT.

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