Reaganomics

By: Paul_Craig_Roberts

I admire Robert Reich, because he has a social conscience. However, if I were writing about the current Republican/Obama tax cut, I would not help the Republicans put Ronald Reagan’s name on it. Outside of progressive circles, which reflexively blame Reagan, the 40th president is still popular, because the 1980s were the last of the good times. Who prefers 21st century America to the Reagan 1980s?

In his recent article “Reaganomics Redux” in Reader Supported News (17 December), Reich writes that “Ronald Reagan came to Washington intent on reducing taxes on the wealthy and shrinking every aspect of government except defense.” As Reagan’s first Assistant Secretary of the Treasury for Economic Policy, often labeled both in praise and derision “the father of Reaganomics,” I would like to offer a different perspective.

Reagan came to Washington to put an end to stagflation and the cold war. Keynesian demand management had the wrong policy mix. Easy money pumped up aggregate demand, but high tax rates reduced the response of supply to demand. Consequently, prices rose. The problem was reflected in worsening “Phillips curve” tradeoffs between inflation and employment. As time passed, higher rates of unemployment were required to bring down inflation, and higher rates of inflation were required to boost employment.

Washington was concerned, including Democrats in Congress, because stagflation threatened every category in the budget.

The supply-side policy, which some label Reaganomics, reversed the policy mix. Monetary policy was tightened to lower aggregate demand, and marginal tax rates were reduced in order to boost the response of supply.

The policy worked. The economy ceased to experience worsening tradeoffs between inflation and unemployment. I described the policy change in my book, The Supply-Side Revolution, published after exacting peer review by Harvard University Press in 1984.

The Reagan tax rate reduction was modeled on the John F. Kennedy tax rate reduction, which was strongly supported by Reich’s Keynesian colleagues in Kennedy’s time. Both the Kennedy and Reagan tax rate reductions cut marginal tax rates (the rate of tax on additional income) proportionally across the board. Everyone got roughly the same percentage cut in tax rates.

Both the Kennedy and Reagan tax rate reductions raised distributional issues. As the higher incomes are taxed at higher rates, those with higher incomes pay far larger dollar amounts. Thus, when rates are reduced, those with higher incomes get more dollars back. But proportionally both tax rate reductions were equal for everyone. Progressives have focused on who got the most dollars back without acknowledging that lower income people were suffering the most from stagflation.

The Reagan tax rate reductions on earned income were proposed as 30% across the board phased in over three years. If memory serves, when enacted, they were a bit less. Using the 30% figure, the top tax rate on wages and salaries was reduced from 50%--the tax rate on a 19th century American slave--to 35%--a higher tax rate than that imposed on medieval serfs.

In 1980 the top tax rate on investment income (“unearned income”) was 70%. It was not Reagan, but the Michigan Democrat William M. Brodhead who put the amendment on the Reagan tax rate reduction bill to reduce immediately the top tax rate on investment income from 70% to 50%.

Reagan had rejected the Treasury’s proposal to reduce the tax rate on investment income. At 4:27 p.m.on February 13, 1981, the Dow Jones wire service reported: “The White House said President Reagan had rejected the Treasury proposal to reduce the maximum tax on unearned income.”

Supply-side economics did not originate with Reagan. Supply-side economics grew out of the policy process in the US Congress. During the 1970s, I was a member of the congressional staff, both House and Senate and personal staffs and committee staffs. My best Republican allies were Jack Kemp and Marjorie Holt in the House and Orrin Hatch in the Senate. My Democratic allies were far more powerful--Russell Long, chairman of the Senate Finance Committee, Lloyd Bentsen, chairman of the Joint Economic Committee, and Sam Nunn on the Senate Armed Services Committee.

Everyone forgets, but House Speaker Tip O’Neill, a Democrat, had an alternative tax cut bill to Reagan’s. O’Neill’s bill cut personal income tax rates by 15%, but had expensing--one year write-offs for business investments--in contrast to Reagan’s accelerated depreciation for business investment. My effort to have the Reagan administration compromise with Tip O’Neill in order to gain expensing was blocked by White House chief of staff Jim Baker.

There were more supporters among Democrats in Congress for the supply-side solution to stagflation than there were on Wall Street. Indeed, Wall Street was the greatest problem that the Treasury team faced. Wall Street believed that the Reagan tax rate reductions would cause the double-digit inflation from stagflation to go even higher and destroy the values of their stock and bond portfolios. Wall Street’s two prestige economists, known as Dr. Gloom and Dr. Doom, along with Dow Jones’ Barrons, regularly beat me up in print as a “Keynesian inflationist.”

The reason for Reagan’s military buildup was to bring the Soviets, with their broken economy, to the negotiating table to end the cold war. That was Reagan’s second great achievement. The military/security complex was opposed to ending the cold war because of the implied cut in the vast military budget. It was Reagan’s chief-of-staff Don Regan who got the deal done during Reagan’s second term.

It was later administrations that reneged on the deal Reagan struck with Gorbachev and created a new war against “Muslim terrorists” and courted former Soviet republics as members of NATO.

I did not support the Bush tax cuts, because they have nothing to do with the economy’s problems since the collapse of the Soviet empire two decades ago. Reich does not acknowledge the devastating impact on American incomes and employment of the offshoring of middle class jobs in manufacturing and professional services. The Soviet collapse caused socialist India and communist China to decide to get on the winning side of “the end of history.” Consequently, for the first time US corporations had access to the massive supplies of Indian and Chinese labor. The large excess supplies of labor in those countries meant that US corporations could hire workers at wages far below their productivity. Thus the savings from replacing American workers with Chinese and Indians translated into higher stock prices, higher shareholder earnings, and large bonuses for managements, thus worsening the income distribution.

It is the before-tax incomes of corporate CEOs that have exploded from 30 times the average wage to 300 times. Annual Wall Street bonuses from extreme debt leverage now exceed the lifetime earnings of workers. To blame the worsening income distribution on tax rate reductions is to ignore the facts.

Jobs offshoring has resulted in both manufacturing jobs and professional service jobs, such as software engineering and IT, being sent to India and China with a corresponding decline in US employment, income and consumer demand.

Reagan’s supply-side economic policy has nothing whatsoever to do with the post-1991 offshoring of American manufacturing jobs and tradable professional services.

None of us in the Reagan administration had any inkling that the Bill Clinton and George W. Bush regimes would deregulate the financial sector and unleash greed and debt leverage to levels that the world has never before experienced.

No one in the Reagan administration realized that the demise of the Soviet Empire would result in an American Empire whose annual trillion dollar military budgets would be financed by cutting Social Security, Medicare, and income support programs for the poor.

None of us in the Reagan administration, with the exception of the neoconservatives whom Reagan fired, would have supported the policies of the George W. Bush administration or the Clinton administration, which launched a war against Serbia on false premises just as Bush did against Afghanistan and Iraq,

Reagan was not perfect--especially Ed Meese’s war on drugs and the neocon’s plots--but the Reagan administration had no intention of establishing American hegemony over the world. Empire is a neoconservative goal, not a conservative one.

Supply-side economics is a necessary modification to Keynesian demand management, not a conspiracy to enrich the rich.

Paul Craig Roberts [ email him ] was Assistant Secretary of the Treasury during President Reagan's first term.  He was Associate Editor of the Wall Street Journal .  He has held numerous academic appointments, including the William E. Simon Chair, Center for Strategic and International Studies, Georgetown University, and Senior Research Fellow, Hoover Institution, Stanford University. He was awarded the Legion of Honor by French President Francois Mitterrand. He is the author of Supply-Side Revolution : An Insider's Account of Policymaking in Washington ; Alienation and the Soviet Economy and Meltdown: Inside the Soviet Economy , and is the co-author with Lawrence M. Stratton of The Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the Constitution in the Name of Justice . Click here for Peter Brimelow's Forbes Magazine interview with Roberts about the recent epidemic of prosecutorial misconduct.

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