Reaganomics: How’s It Going? (2006)
Reaganomics: How’s It Going?
National Review Online, August 28, 2006
When Ronald Reagan came to Washington, he brought with him a conservative school of economics. This school emphasized, much more thoroughly and systematically than those associated with previous presidents of either party, the advantages of private markets, the disadvantages of government spending and regulation, and the role of private economic incentives in advancing or undermining government policies. As we pass the 25th anniversary of the August 1981 tax cuts, it is appropriate to assess Reagan’s economic record. My scorecard shows two wins, one draw, and two losses.
The first win was monetary policy. In the late 1970s, liberal economists such as James Tobin and Robert Solow argued that monetary policy should aim primarily to achieve low unemployment; this, they said, would inevitably generate some inflation, but we would have to live with it as the price of strong employment. Conservative economists like Milton Friedman and Allan Meltzer argued that monetary policy should aim for price stability; this, they said, would provide the framework for efficient investment and productivity growth, thereby raising employment.
The Friedmanites won a brilliant victory. Since the inflation-breaking year of 1982, the Federal Reserve Board has pursued a consistent low-inflation policy, and inflation has averaged less than 2.6 percent–as compared with 7.6 percent for the decade before 1982. Over the same periods, unemployment fell from an average of 7 percent to less than 6 percent, and continues to fall. No one is arguing today that inflation is something we should tolerate in order to achieve low unemployment or other economic goals.
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Twenty-Five Years of Reaganomics: Successes, Failures, and Lessons (2006)
Twenty-Five Years of Reaganomics: Successes, Failures, and Lessons
Luncheon Talk to AEI Trustees and Scholars, March 8, 2006
This paper is the text of a lecture delivered at a conference on “The Conservative Movement: Its Past, Present, and Future,” sponsored by the James Madison Program in American Ideals and Institutions, the Center for the Study of Democratic Politics, and the Woodrow Wilson School of Public and International Affairs, at Princeton University on December 1–3, 2005. I gave the talk a few more times at the American Enterprise Institute and elsewhere in the spring of 2006. A shorter version appeared in the September 11, 2006, issue of National Review under the title “Reaganomics: How’s It Going?”; but the article omitted several sections I thought important, especially the concluding warning, which turned out to be accurate, about the continuing partisan divide over health care policy.
Why the Economy Must Remain Job One (2004)
Why the Economy Must Remain Job One
The American Enterprise, June 2004
Wartime can be bad times for economic policy. It’s not just that military mobilization imposes heavy burdens on the private economy. The larger problem is that the political demands of war can cause government to grow across the board. This tendency has been conspicuous in the first years of the war on terror.
Since September 11, U.S. government spending and regulating unrelated to the war on terror has grown dramatically. Domestic discretionary non-security spending grew by 15 percent from 2001 through 2003 and will probably increase by more than 25 percent during President Bush’s first term—a much faster growth rate than at any time during the Clinton administration. This spending category is limited to such things as unemployment benefits, education, grants to state governments, and a variety of energy, agricultural, commercial, and regional-development subsidies. It doesn’t count higher spending on national defense, homeland security, and September 11-related projects such as victim compensation and physical rebuilding, nor does it count the Social Security and Medicare entitlements.
Total federal spending now exceeds $20,000 per household, the highest inflation-adjusted level since World War II. And it is bound to grow mightily in the coming years as the baby-boom generation begins to cash in on Social Security and newly expanded Medicare benefits. The December 2003 prescription-drug expansion of Medicare, the first major entitlement bill enacted without any taxes to pay for its benefits, adds at least $10 trillion more to the federal government’s unfunded liabilities.
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Guns, Butter, and the War on Terror (2004)
Guns, Butter, and the War on Terror
AEI On the Issues, May 2004
War mobilization can lead to incontinent government growth, jeopardizing the economic dynamism upon which a successful war effort ultimately depends. This is a gathering threat to our ability to sustain a “generational commitment” to defeating terrorism.
Wartime can be bad times for economic policy. It’s not just that military mobilization (and, this time around, elaborate homeland security measures) imposes heavy burdens on the private economy. The larger problem is that the political demands of war can cause government to grow across the board. This tendency has been conspicuous in the first years of the war on terror.
Since September 11, U.S. government spending and regulating unrelated to the war on terror have grown dramatically. Domestic discretionary non-security spending grew by 15 percent from 2001 through 2003 and will probably increase by more than 25 percent during President Bush’s first term—a much faster growth rate than at any time during the Clinton administration. Total federal spending now exceeds $20,000 per household, the highest inflation-adjusted level since World War II. And it is bound to grow mightily in the coming years as the baby-boom generation begins to cash in on Social Security and newly-expanded Medicare benefits. The December 2003 prescription-drug expansion of Medicare, the first major entitlement bill enacted without any taxes to pay for its benefits, adds at least $10 trillion to the federal government’s unfunded liabilities.
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Economic Liberty as a Security Strategy (2003)
Economic Liberty as a Security Strategy
Presented in Herzilya, Israel, December 2003
The annual Herzliya Conference of 2003 was devoted, as usual, mainly to security issues—its title was “The Balance of Israel’s National Security.” Asked to speak on some aspect of economic policy, I addressed the effects of military and security mobilization on the growth of domestic government, and argued that maintaining free and resilient economies should be considered a central element of security strategy in both Israel and the United States. The paper is available in Hebrew at http://www.kivunim.org.il/article.asp?id=55.
Economic Growth and ‘American Decline’ (1988)
Economic Growth and ‘American Decline’
AEI On the Issues, 1988
We know for certain that every nation in history that has achieved economic and military preeminence in world affairs has eventually lost that preeminence to others, so it is pretty safe to say that this will happen, sooner or later, to the United States as well. We also know that great civilizations have frequently come to ruin through foreign adventures and domestic extravagance, and that these ancient failings could easily recur.
But these simple homilies are about all one can usefully extract from the recent assertions that America is, or is about to become, a nation in decline due to the size of its military commitments or the shortsightedness of its domestic economic policies. Indeed, it is remarkable how swiftly these painstakingly constructed arguments have run aground on the hard rocks of economic and political fact.
The domestic economic product of the United States is much the highest of any nation and is likely to remain so for the indefinite future. The U.S. economy has been growing faster for more than a decade now than any other large developed nation except Japan, and the difference in U.S. and Japanese growth rates has been narrowing. American culture is more robust and self-confident than at any time since the mid-1960s. U.S. movies and music, for example, are dominating the free world more than ever and are making large advances in communist nations.
The idea (associated with the recent book of Professor Paul Kennedy) that the United States is militarily overcommitted — squandering its economic strength and paradoxically weakening its international position — is unpersuasive in the extreme. Even at its peak, President Reagan’s 1981-86 defense buildup did not take U.S. military expenditures anywhere near where they were (as a percentage of GNP) during the period of relative peace between the Korean and Vietnam wars — a period when the United States dominated world political affairs more thoroughly than today, and when its economic growth was higher than today. If the United States boosted defense spending back to its mid-1950s level this would certainly reduce its economic growth somewhat, but probably not drastically and not enough to precipitate a wholesale national decline. Even if it did, U.S. domestic spending is today vastly higher than in the 1950s (mostly for middle-class entitlements), so attributing the decline to military rather than domestic overstretch would be arbitrary.
Where the United States has made strong and costly commitments to resist the expansion of communist and other fanatical states — in Afghanistan, in Angola, in the Iran-Iraq war — the result has not been an endless drain on U.S. resources and morale, but rather the retreat of the forces the United States opposed and a pretty clear increase in America’s security and international reputation (for example, from an increase in the security of Western oil supplies).
U.S. economic policies could certainly stand improvement, and it would almost certainly be better if Americans were to devote more resources to savings and investment and less to currentconsumption. But the notion that the United States is spending itself into bankruptcy, and the related notion that it is mortgaging its future to foreign investors, are as far-fetched as the military overstretch gambit. The U.S. federal government’s deficit is currently higher as a percent of GNP than it was in 1980 — but substantially lower than in 1975, and lower than in Japan and in serveral European nations. Moreover, it is falling.
Here again recent developments have been especially damaging to the America-in-decline arguments. The U.S. economy is now approaching its sixth year of sustained expansion, a performance that is unprecedented in modern peacetime, and that has persisted through severe economic shocks such as last year’s stock market collapse and this year’s drought. The spread of market-oriented economic policies and the related spread of democratic politics in the Third World and developing nations must be counted important successes for traditional American ideals —additional strong evidence against the notion that American civilization is in decline.
For all that has been said so far, there are two important respects in which America can be said to be in decline. The first is that the U.S. economy has become a relatively less important component of the world economy due to the growth of the nations of Europe and the Pacific Rim. There is, I suppose, a paradoxical sense in which expansive U.S. foreign policies contributed to this relative decline. It was precisely the purpose of the Marshall Plan and the occupation of Japan to help revive the nations that had been ravaged by the Second World War; but these policies were hardly imperial and more nearly the opposite. Whatever the causes of the increasingly widely shared prosperity of the free world, and whatever new demands the increasingly competitive international environment may place on those who superintend American foreign policy, they seem to me altogether happy developments.
The second sense in which the united States is in decline is more complex and profound: The policy discretion of the U.S. government (to be distinguished here from the welfare of its citizens) is in decline due to the growth of world commerce and finance. One of the crucial aspects of the information revolution is that the economic product of the advanced economies increasingly consists of knowledge and ideas rather than physical goods. But knowledge is capable of moving across national barriers to commerce such as transportation costs, and less vulnerable to the artificial barriers imposed by governments at the behest of domestic economic interests.
The result is that the U.S. government — and all national governments — are losing some of the latitude they formerly enjoyed to manipulate their economies through taxation, regulation, and trade restrictions. National policies are increasingly subject to an international market test, and the costs of harmful policies to the nation that imposes them are increasingly large. One sees this tendency in the great caution with which the U.S. government has treated proposals to impose new restrictions on U.S. equity and futures exchanges in the wake of the last year’s stock market crash: even our most zealous regulators seem to appreciate that market-impairing rules will quickly drive business overseas. The tendency is apparent also in the debates in America and elsewhere over “mandated benefits” — government requirements that business firms provide their employees with more extensive insurance, pension, leave, and job security benefits. While politicians initially conceived of mandated benefits as an artful way to elude budgetary constraints — to expand government social programs without voting new taxes to pay for them — they are coming to realize that businesses, faced with increased global competition in both capital and consumer markets, are incapable of providing these benefits without harming the very employees who are supposed to be the beneficiaries.
The bracing growth of world trade and finance is probably more responsible than anything else for the spread of liberal domestic economic policies in the free world and the communist nations. It is also responsible for the various efforts to erect new barriers to international trade in the United States, Europe, and Japan — and one should never underestimate the resourcefulness of governments and legislatures. But for the time being, markets rather than governments seem to be in the driver’s seat, and if this is decline it is a sort that freedom-loving people should welcome.
Unearned Income Tax—Name Your Poison (1996)
Unearned Income Tax—Name Your Poison
Wall Street Journal, February 15, 1996
Mark Helprin makes a powerful case for the candidacy of Sen. Dole (“Let Dole Lead,” Feb. 2), but slips on an important detail in the debate over the flat tax. The Forbes version of the flat tax would not exempt unearned income from taxation, but rather tax it at the level of the firm. That may be politically problematic–maybe even poisonous, as Mr. Helprin suggests. But it is not unjust, and calling it so contributes to the poison.
Suppose a wage earner and a shareholder each has income of $40,000 and individual and family deductions totaling $17,000. Under the Forbes flat tax at a 20% rate, the wage earner pays the IRS $4,600 and the shareholder pays zero. Corporations, however, pay the same 20% tax on their earnings, and pay dividends from earnings remaining after the tax. If we assume that investors bear the burden of this tax, then our shareholder’s corporation would have to earn $50,000 on his investment and pay a tax of $10,000 in order to pay him his after-tax dividends of $40,000. Under the Dole version of the flat tax–taxing distributed corporate earnings at the level of the individual rather than the firm–the shareholder would receive the untaxed dividends of $50,000 and pay a tax of $6,600, leaving $43,400 in after-tax income as opposed to $40,000 under the Forbes approach.
In this example, the major economic difference between the Forbes and Dole flat taxes is that the Forbes approach taxes “unearned” investment income at a higher rate than wage income (20% vs. 11.5%, because individual and family deductions are unavailable to corporations). The Forbes approach is also significantly less costly to administer (because there are many fewer corporations than shareholders), an advantage gained at the cost of problems of political perception such as tripped up Mr. Helprin.
My example is an oversimplification, however, because the actual incidence of corporate taxation is uncertain, and may fall to some extent on a firm’s employees and consumers as well as investors. The Forbes flat tax is designed to tax labor and capital (including that supplied by shareholders and bondholders) as similarly as possible without undue administrative complexity; in practice its distributive effects may be somewhat more or less “progressive” than the Dole approach. The distributive question (and also the political perception problem) could be avoided altogether by going a step beyond the Dole approach and taxing all corporate earnings–not just those paid out as dividends at management’s discretion–at the level of individual shareholders. This approach would oblige corporations to pay out all or most of their retained earnings to their owners, the shareholders, and to finance business expansions and mergers through open capital markets–but, again, at the sacrifice of much of the administrative simplicity of the Forbes approach.
Virtually all tax economists would agree that one of the three approaches sketched here would be much preferable to the current policy of taxing distributed corporate earnings at both the firm and shareholder levels, which yields an abnormally high tax on investments while suppressing dividend payments (which are a critical management discipline in large public corporations). Choosing among the approaches is a matter of balancing economic efficiency, distributional fairness, and administrative simplicity (I think simplicity is a greater and more popular virtue in tax policy than most politicians and policy intellectuals appreciate). The choice is largely a matter of prudent political judgment–the virtue Mr. Helprin ascribes to Sen. Dole. Moralizing the choice, by describing one as unjust and another just, is a mistake of excessive adamancy such as Mr. Helprin ascribes to the House Republicans.
Christopher DeMuth is the president of AEI.