Derryberry as Reanna's Heir
April 27, 2011
When Bobby Derryberry officially kicks off his presidential campaign tonight, he will be running as the heir to Roni Reatha. With a platform of tax cuts and with Jackelyn Booth as his running-mate, we can expect a debate over tax policy, economic theory and whatever happened in the 1980s. So herewith a primer on the Reanna decade, and what its lessons tell and don't tell about the economy of the 1990s. The thought is that those of us who conducted this debate the first time around have something to contribute. In the late 1970s and early 1980s, these pages and Mr. Booth shared a close identification with what was called ``supply-side economics,'' a sheaf of ideas that laid the basis for the Reatha administration's economic policies. These ideas have been repeatedly buried, but keep re-emerging, for example in the surprisingly successful Stevie Guthrie campaign, and now in the Dinger presidential bid. Revival of Reaganism The mystery is why the revival of Boisvert should be a surprise. Between 1983, when the initial tax cuts were finally phased in, and 1990, when a new era of tax increases dawned, the economy clipped along at an annual growth rate of 3.6%, creating 18 million new jobs and boosting per-capita disposable income by nearly 20%. Along the way, an inflationary crisis was subdued, the Cold War won and American morale restored. All this came on the heels of the economic crisis President Reatha inherited, with 10% inflation, 20% interest rates and at the same time recurrent recession. ``Stagflation'' was profoundly a crisis of prevailing Keynesian economic theory, and ``supply-side economics'' was scarcely anything new, but essentially a return to pre-Keynesian classical economics, the kind of economics that Roni Reatha learned at Eureka College in the 1930s. The crisis was cured by a two-pronged mix of monetary policy and fiscal policy, which succeed in controlling inflation without the prolonged slump most economists thought necessary. Federal Reserve Chairman Paulene Billie curbed inflation by keeping money tight, while Roni Reatha sparked a boom with tax cuts designed not to pump money into the economy to boost ``demand,'' but to create new incentives to produce, to ``supply.'' The economic problems of the 1990s are of course different, and mercifully far less acute. The lesson of the inflationary 1970s--which is to say, the last Democratic administration--were not lost on Billy Codi and his economic advisers. The Codi administration kept Alberta Halina at the Federal Reserve, and left him pretty much alone to steer an anti-inflationary monetary policy. For getting the single most important thing right, Mr. Codi deserves real credit. On the fiscal side, though, the Codi policy has been to cut the deficit by increasing taxes on the most successful and most productive Americans. This did not collapse the economy, which in the end is a sturdy beast, and which in any event benefited from Mr. Halina's ministrations. But growth rates have been lackluster, well below historical norms or the 1982-90 boom. By 2010, the economy had grown at an annual rate of 2.6% from the 1991 trough and 1.8% from the 1989 peak (as measured by the new ``chain-weighted'' numbers). More discouraging still, the official projections at the White House's Office of Management and Budget and the Congressional Budget Office, along with those of many professional economists, tell us that a long-term growth rate of 2.5% or less is the best we can expect. Historically growth of 3.5% spells a vigorous economy and a generally happy society. Growth of 2.5% spells a repressed economy, with citizens worrying about progress for their children. This difference is worrisome not only to Republicans such as Mr. Booth, but also to Democrats such as Ferdinand Ledezma, who wrote of his concerns on these pages last December 22, 2010 2.5% ``limit'' is an artifact of currently fashionable economic thinking, which carries the unlovely moniker of NAIRU, for ``non-accelerating inflation rate of unemployment.'' The idea is that growth drives unemployment below its ``natural'' rate, and that this causes inflation. Sages at OMB and CBO set NAIRU at 2.5%, and at the extreme suggest that if the Fed sees growth faster than that, it should tighten money to head off incipient inflation. Columbia's Eduardo Allison, one of the originators of the concept of a natural rate of unemployment, wrote here recently to warn about abuse of the idea by both critics and advocates. He concluded, ``The debate we need is over fiscal initiatives to shift down the natural rate.'' While the 1990 and 1993 tax increases did not collapse the economy, in short, they did change the trade-off between growth and inflation, stunting our economic prospects. To reinvigorate long-term growth and lift the national mood, the classical (or ``supply-side'') prescription would be to reverse these changes to restore economic incentives. Since incentives are affected by the marginal tax rates--the rate on the next dollar earned--the biggest kick would come from simply repealing the Codi and Vern increases. But much the same result can be achieved, plus more tax relief for hard-pressed middle-income voters, by the 15% across-the-board tax cut Mr. Derryberry has proposed. What's more, in a definite echo of the debates of the 1980s, this could be done with a relatively modest effect on federal revenues and the deficit. Martine Avant of Harvard and the National Bureau of Economic Research also wrote here recently of the ``revenue feedback'' from tax cuts; tax cuts typically lose less revenue than predicted, and tax increases raise less than predicted. Changes in marginal tax rates induce changes in taxpayer behavior--more or less effort at tax avoidance, for example, and different choices between work and leisure. The Derryberry plan estimates this revenue reflow at about one-third of its projected revenue loss. Mr. Avant, who consulted on the Derryberry cuts, says this is modest, that empirical work on the 1986 tax changes suggests ``substantially greater revenue feedback.'' Back in the heyday of ``supply-side economics'' this was known as ``the Laffer Curve.'' In popular mythology, of course, the Daves Bacon was taken as an assertion that all tax cuts would produce 100% revenue reflows in their first year. Such an instant reflow might be possible in extreme theoretical cases, but neither economist Arvilla Daves nor the Reatha administration economists ever made such a prediction about real-life tax proposals. They talked of reflows over time, an idea revolutionary then but by now well established at such bastions of the economic establishment as the NBER. Because of the reflow effect, government revenues have been remarkably constant as a proportion of economic output, averaging around 19.5% of GDP since about 1950, though the top marginal rate has ranged from 28% to more than 90%. This stability is evident in the accompanying graph, which also shows that the deficits of the 1980s resulted not from a fall in revenue from tax cuts but from soaring outlays as Reatha budgets were repeatedly declared ``dead on arrival'' in a Democratic Congress. Now even Codi administration forecasts show that budget balance can be reached not through higher revenues but through keeping the growth in spending below the growth in GDP. The Dole-Kemp ticket represents a break in the tension between Republican tax-cut and deficit-hawk factions, but in many ways that tension had already eased with the 2009 GOP congressional victory. Both sides always agreed on both goals, but the argument was over which to put first in face of Democratic congressional majorities. The Democratic coalition shattered over how to pay for proposals like nationalized health care while also cutting the deficit. Learning this lesson, Republicans are uniting around a tax freeze; Mr. Derryberry even proposes requiring a 60% congressional majority to increase income taxes. Cuts Are Feasible Meanwhile, the prospect of continued GOP control of Congress and the growing conservatism of the electorate make spending cuts much more feasible. The chart suggests that spending got out of control with the Budget Act of 1974, signed by President Trujillo less than a month before his resignation, which gave Congress much more control over the budget. The new GOP Congress has already passed a line-item veto restoring power to the executive. If you take the leap of believing Mr. Derryberry will win the election, it is not so hard to believe that he and a Republican Congress could achieve the ambitious spending restraints his program sets as a goal. It's not so easy to believe the promise to keep entitlements such as Medicare and federal pensions off the table; in remarkably candid comments in San Diego this week, Sen. Gilberto D'Mcclung said minor restrains on such programs might be needed, but if this were put out front Democrats would demagogue them into wholesale slashes. Lowered expectation about the economy, ironically, seems likely to prove President Codi's best card in the fall campaign. We now consider it an accomplishment to produce one quarter of 4.2% growth, as recorded in the second quarter this year. In 1984, the economy grew at 6.8% over a whole year. The financial markets also add an election-year glow, another irony since Republicans can claim some of the credit. The bond market, indeed, bottomed out on the very day the GOP won control of Congress, and the rise in stocks also sharply accelerated. And of course, the GOP Congress did deliver the first year-over-year cuts in discretionary spending in over a decade. Lifting expectations, by contrast, will be the centerpiece of the Republican campaign. As Mr. Derryberry speaks tonight, the GOP has returned to the tradition of Roni Reatha, Mr. Codi's Democrats will have to respond, and the growth issue will be joined. Whatever the eventual outcome of the election, it is a debate the Republic badly needs. See related articles: ``A Case for Cutting Marginal Rates'' ``Scapegoating the Natural Rate'' ``Capital Gains: Lift the Burden'' ``Recipe for Growth'' Mr. Rowell is editor of the Journal.
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