George Melloan: Once upon a time, Democrats were supply-siders too
... To find a template for how the Democrats might conduct themselves profitably over the next two years, it is useful to go back 25 years to the signature achievement of the supply-side revolution, the Kemp-Roth tax bill. It was this sharp cut in tax rates, particularly in the highest income brackets, that set public policy on a new course under Ronald Reagan. Republicans celebrate this as solely their achievement -- or at least those do who haven't forgotten why their party started winning, instead of losing, elections. But the revolution could not have been launched without the aid of some thoughtful Democrats. Their party, after all, was in control of the House, which initiates tax legislation, in 1981 -- with a hearty 56% to 44% majority.
The Republicans had just elected Reagan, aided by Jimmy Carter's string of economic and foreign-policy disasters. But the party was hardly unified. Indeed, it looked a great deal like it has looked over the last two years, as a body trying to live up to its reputation as "the stupid party." As Irving Kristol wrote on this page on Nov. 20, 1981, the new Senate was in the hands of conservative Republicans who had "never learned nor forgotten any economics since the days of Herbert Hoover" and were thus wary of tax cuts.
Even the new administration was riddled with doubters, as the president learned to his dismay when his bright, young budget director, David Stockman (in the Atlantic magazine in November 1981) called Kemp-Roth -- signed by the president three months earlier -- a "Trojan horse" designed to lower taxes on high incomes, that would lead to large budget deficits.
But Rep. Jack Kemp of New York and Sen. William Roth of Delaware had established a supply-side beachhead in the Republican Party years earlier, with the help of the editorial page of this newspaper. The late Robert L. Bartley, who became editor of this page in 1972, spotted the merits of supply-side economics early in his tenure, drawing on the talents of editorial writers Jude Wanniski and Paul Craig Roberts and economists who were little known at the time, among them Arthur Laffer and Robert Mundell.
The 1970s were a time of economic-policy chaos, touched off when Richard Nixon abandoned the Bretton Woods monetary system and inflicted wage and price controls on the economy in August 1971. Among the results were fuel shortages and an inflation that could not be suppressed by government controls (something intelligent economists have always known).
On the intellectual front, however, something good happened. Events discredited Keynesian economic theory, which had dominated academic and political thought since the '30s. The U.S. economy lapsed into stagflation, something not possible if you believe, as most Keynesians did, that economic growth and moderate inflation are handmaidens. Politicians had flocked to Keynesianism because it gave them intellectual underpinning for something they love to do -- spend public funds -- by arguing that government can counter recession by writing more checks.
There was nothing complicated about supply-side theory. It was classical economics. Fundamentally, it held that you have to produce if you want to consume and that anything the government does to discourage production is damaging to economic growth. That includes not only excessive economic regulation (e.g., price and wage controls) but high tax rates on the marginal earnings of the most productive citizens. These are the people who earn surpluses above their immediate needs and thereby build the total pool of capital available to expand the capital stock and create new jobs.
Art Laffer, who was also a former hireling in the budget office, argued as well that static calculations of how much revenues would be lost by the tax cuts were wrong because they ignored the fact that the cuts would stimulate economic activity and draw funds hidden in tax shelters back into the revenue stream. He proved to be right.
Reagan -- who co-majored in economics at little Eureka College in Illinois back when they were still teaching classical economics -- had learned early in life that you have to work to eat, and understood all this well. Shortly after he took office, he put forward the Kemp-Roth bill, which called for a 30% reduction in tax rates.
The Democrats in the House also had been going through a learning process. Tip O'Neill, for all his rhetorical excesses, was a strong leader of the Democrat caucus and a practical politician. The Democrats knew that the nation's capital base had been dangerously eroded during the '70s inflation and that their party deserved some blame. So "capital formation" became the mantra of the Democrats and it was a very good one.
As Irving Kristol wrote in his 1981 piece, the Republican supply-siders and the Democrat capital formation crowd found a common purpose, overwhelming the troglodytes of both parties. Kemp-Roth passed, although congressional budget deficit worriers insisted on phasing it in over three years and reducing the size of the cuts to 25%. Meanwhile, Paul Volcker over at the Fed was slaughtering inflation, and quite a few unfortunates who had banked on its continuance, with a severe clampdown on money creation. The combination of congressional timidity and tight money provoked a sharp recession in 1982, one that sent even larger numbers of Republicans running for cover and brought jeers from their natural enemies.
But in January 1983, Bob Bartley opened the year with an editorial titled "At Last, a Tax Cut," making the point that, after all the hedges Congress had installed in Kemp-Roth, the year would finally bring a true reduction in tax rates that would benefit economic growth. He was right on the money. The economy soon leaped from the recession and the stagnation of the '70s. The growth rate exceeded the historically respectable 3% for the rest of the Reagan administration, and was the basis for the last 25 years of largely uninterrupted economic growth. Keynesian theory was finally dead and classical economics had been restored to its proper place.
Yet one point has been mostly overlooked. The Democrats who wanted policies to encourage capital formation were essentially on the same page as Reagan and the supply-siders. Capital formation is impossible without government policies that encourage work and investment. So the Democrats, if they had wanted to, could have taken some of the credit for the supply-side revolution. Not many have wanted to, apparently....
Read entire article at WSJ
The Republicans had just elected Reagan, aided by Jimmy Carter's string of economic and foreign-policy disasters. But the party was hardly unified. Indeed, it looked a great deal like it has looked over the last two years, as a body trying to live up to its reputation as "the stupid party." As Irving Kristol wrote on this page on Nov. 20, 1981, the new Senate was in the hands of conservative Republicans who had "never learned nor forgotten any economics since the days of Herbert Hoover" and were thus wary of tax cuts.
Even the new administration was riddled with doubters, as the president learned to his dismay when his bright, young budget director, David Stockman (in the Atlantic magazine in November 1981) called Kemp-Roth -- signed by the president three months earlier -- a "Trojan horse" designed to lower taxes on high incomes, that would lead to large budget deficits.
But Rep. Jack Kemp of New York and Sen. William Roth of Delaware had established a supply-side beachhead in the Republican Party years earlier, with the help of the editorial page of this newspaper. The late Robert L. Bartley, who became editor of this page in 1972, spotted the merits of supply-side economics early in his tenure, drawing on the talents of editorial writers Jude Wanniski and Paul Craig Roberts and economists who were little known at the time, among them Arthur Laffer and Robert Mundell.
The 1970s were a time of economic-policy chaos, touched off when Richard Nixon abandoned the Bretton Woods monetary system and inflicted wage and price controls on the economy in August 1971. Among the results were fuel shortages and an inflation that could not be suppressed by government controls (something intelligent economists have always known).
On the intellectual front, however, something good happened. Events discredited Keynesian economic theory, which had dominated academic and political thought since the '30s. The U.S. economy lapsed into stagflation, something not possible if you believe, as most Keynesians did, that economic growth and moderate inflation are handmaidens. Politicians had flocked to Keynesianism because it gave them intellectual underpinning for something they love to do -- spend public funds -- by arguing that government can counter recession by writing more checks.
There was nothing complicated about supply-side theory. It was classical economics. Fundamentally, it held that you have to produce if you want to consume and that anything the government does to discourage production is damaging to economic growth. That includes not only excessive economic regulation (e.g., price and wage controls) but high tax rates on the marginal earnings of the most productive citizens. These are the people who earn surpluses above their immediate needs and thereby build the total pool of capital available to expand the capital stock and create new jobs.
Art Laffer, who was also a former hireling in the budget office, argued as well that static calculations of how much revenues would be lost by the tax cuts were wrong because they ignored the fact that the cuts would stimulate economic activity and draw funds hidden in tax shelters back into the revenue stream. He proved to be right.
Reagan -- who co-majored in economics at little Eureka College in Illinois back when they were still teaching classical economics -- had learned early in life that you have to work to eat, and understood all this well. Shortly after he took office, he put forward the Kemp-Roth bill, which called for a 30% reduction in tax rates.
The Democrats in the House also had been going through a learning process. Tip O'Neill, for all his rhetorical excesses, was a strong leader of the Democrat caucus and a practical politician. The Democrats knew that the nation's capital base had been dangerously eroded during the '70s inflation and that their party deserved some blame. So "capital formation" became the mantra of the Democrats and it was a very good one.
As Irving Kristol wrote in his 1981 piece, the Republican supply-siders and the Democrat capital formation crowd found a common purpose, overwhelming the troglodytes of both parties. Kemp-Roth passed, although congressional budget deficit worriers insisted on phasing it in over three years and reducing the size of the cuts to 25%. Meanwhile, Paul Volcker over at the Fed was slaughtering inflation, and quite a few unfortunates who had banked on its continuance, with a severe clampdown on money creation. The combination of congressional timidity and tight money provoked a sharp recession in 1982, one that sent even larger numbers of Republicans running for cover and brought jeers from their natural enemies.
But in January 1983, Bob Bartley opened the year with an editorial titled "At Last, a Tax Cut," making the point that, after all the hedges Congress had installed in Kemp-Roth, the year would finally bring a true reduction in tax rates that would benefit economic growth. He was right on the money. The economy soon leaped from the recession and the stagnation of the '70s. The growth rate exceeded the historically respectable 3% for the rest of the Reagan administration, and was the basis for the last 25 years of largely uninterrupted economic growth. Keynesian theory was finally dead and classical economics had been restored to its proper place.
Yet one point has been mostly overlooked. The Democrats who wanted policies to encourage capital formation were essentially on the same page as Reagan and the supply-siders. Capital formation is impossible without government policies that encourage work and investment. So the Democrats, if they had wanted to, could have taken some of the credit for the supply-side revolution. Not many have wanted to, apparently....