On the Brink of Economic Revolution

Abstract

This chapter examines the economy of the late 1970s, as hopeful contenders for the White House make campaign plans. Supply-side economics began to make a mark with many Republican politicians and some Democrats. The problem Keynesian supporters faced was the growing number of people who believed Keynesian economic theory had led to one failure after another. Its content underscores the importance of Ronald Reagan giving political expression to a modern version of classical economics at a time when stagflation was weighing down the economy.

Tom Bethell’s economic education began in the late 1950s when his Oxford University tutor assigned him Paul Samuelson’s “heavy textbook” as a source for an essay assignment on money. Bethel found the textbook’s articulation about money of no use and his attendance at an academic economics lecture soon after was equally disappointing. Twenty-one years later, he visited Oxford to discover his economics tutor was still in residence, ready to offer him a glass of sherry and conversation. When asked, however, the tutor was unable to offer his assessment of the Laffer curve because he was unfamiliar with it. Bethel wrote: “As I looked out of the mullioned windows, I confess, thoughts of ivied towers crossed my mind. I had a suspicion that I might have been keeping up with the dismal [economic] developments a little more enthusiastically than the professor.”¹

The Laffer curve and supply-side economics caught many by surprise. Rather than Arthur Laffer-types, the best-known free-market economist throughout most of the 1970s was Milton Friedman who also gained television stardom in 1980 with his PBS-sponsored Free to Choose series. Bethel wrote that those Keynesians who were aware of the rise of supply-side economics were not too happy, including Samuelson who disparaged the “Washington hot air about ‘supply-side economics.’” The Keynesian macroeconomics of the past, which depended on computer models and fine-tuning, was clearly under assault by those who favored “a return to micro, or classical, economics.”

Macroeconomics favors mathematics, statistics, and computer models, but it is microeconomics that comes closer to economic reality because “it deals with such unmeasurable qualities as motive, desire, aspiration, and expectation.” To clarify his criticism of Keynesianism, Bethell cited economist Henry Hazlitt who argued that the mistakes of Keynes’s The General Theory was because of his focus on “averages and aggregates that conceal the very causal relations he is trying to study. This aggregate, in-block, or lump thinking is the exact opposite of economic analysis.”²

In his Nobel-prize lecture in 1974, Friedrich Hayek identified the problem of economists believing they had “exact knowledge” to solve inflation and unemployment. He declared that “economists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted, has been brought about by policies which the majority of economists recommended and even urged governments to pursue.”³ Keynesian theory sputtered at the end of the Carter years as one after another major economic episode signaled it was time to consider new thinking. The best-known politician supportive of supply-side thinking was Ronald Reagan who became a believer in late 1976. For him, supply-side economics projected a philosophy more hopeful than the dour budget-balancing of old-school Republicanism. He and other supply-siders pushed aside the ineffective policies of the Democratic Party and gave political expression to a modern version of classical economics that warranted serious consideration.

I

In a 1978 conference paper, economist Robert E. Lucas of the University of Chicago discussed the collapse of “Keynesian macroeconomics .” He said that Keynesianism was victim to the faulty thinking behind the Phillips curve, which said people spent the money overprinted by the government without considering that their real income did not rise. Lucas argued that currency overprinting caused people to be doubtful about the value of their money. His work offered a credible approach to better understand stagflation .⁴ It was another example of Keynesianism losing ground in academic circles. Additional damage to Keynesian theory came from individuals who had both academic credentials and real-life business experience.

Ira G. Corn was born in 1921 at Little Rock, Arkansas . In 1948, he received a master’s degree in business administration from the University of Chicago and was a professor at Southern Methodist University in Dallas until 1954. Next came a successful business career in which he founded or cofounded 24 companies. In 1969, Corn outbid others and paid $404,000 for an original copy of the Declaration of Independence .⁵ His testimony was representative of many entrepreneurs who went beyond economic theory on paper and achieved business success. Published in Imprimis in January 1980, his economics lecture at Hillsdale College linked creative capitalism with “personal and collective freedoms.”

An important aspect of those freedoms was the economic freedom that meant less poverty and a higher standard of living. In Corn’s interpretation, the terrible economic state of many Irish people during the 1840s was mainly the result of a feudal society not yet unshackled by the entrepreneurial spirit of the industrial revolution . England experienced greater employment opportunities and more food and goods, “a gift from the young entrepreneurs of the budding Industrial Revolution—no doubt seeking their own narrow ends—who had the wit and resources to devise new instruments of production and new methods of administering industry.” This change was mostly positive. As capitalism increased in England and elsewhere, it was “possible for children to be excluded from the productive work force.”⁶ Many families no longer depended on their children’s labor, and there were greater opportunities for women to work outside the home as new types of jobs did not necessarily favor the physical strength of men.

For Corn, American history also was illustrative of the positive aspects of entrepreneurialism. By the twentieth century, America’s economic standing was the model for the world with the post-World War II period especially impressive. As Keynesian thinking dominated economic policy, Americans witnessed a rate of economic growth and accumulation of wealth never seen before. So why was America struggling during the 1970s? Corn believed that those critical of business were themselves blind to the problem of Keynesian government growth, including how its dominance reduced the personal freedom of many Americans. Going beyond their original mission and prodded by special-interest groups with their favorite pet projects, bureaucracies expanded to justify new hirings and larger budgets.⁷

Even Secretary of Commerce Juanita Kreps acknowledged how bureaucracies thrived on minutia complicated by the need “to delegate an important problem to several departments or agencies, each of which tend to study it endlessly and report at great length.”⁸ Keynes’s idea of priming the economic pump during downturns occurred nonstop rather than when needed. Missing was the necessary political will to reign in bureaucratic excess; politicians benefited handsomely when they colluded with special-interest groups and the growing bureaucracies. Citing one comparison, Corn noted the modest 15 percent turnover rate in the House of Representatives from one Congress to the next, far less than the average 50 percent rate of the previous century.⁹

Another notable Imprimis article presented the analysis of an African American scholar who drew from daily experience and academic research. In his sharp criticism of government intervention, Temple University economist Walter Williams blamed government coercion and the lack of free markets for many of the problems that poor people faced. For example, the high unemployment of young black people was a “national scandal” especially because unemployment of young African Americans had been much lower (and about the same as young whites) in the immediate post-World War years. Did the rate of unemployment of black youths more than triple from 1948 to the 1970s because of greater racial discrimination, lower education of blacks, or changing economic cycles? No, Williams argued.

A better explanation was “foolish government intervention” and the introduction of minimum wage laws that “effectively discriminates against the unemployment of low skilled workers.” It seemed to him that those who benefited the most from “massive government programs” were politicians and bureaucrats.¹⁰ As someone with modest economic origins, Williams garnered the attention of those who sought a voice with both experience and education.¹¹ He was a black academic and libertarian economist offering fresh ideas on improving the daily economic experiences of ordinary people.

If the cozy relationship between politicians and bureaucrats hurt the economy, conservatives pointed to overregulation as further evidence of harmful intervention. Momentum for government regulation of business began in the late nineteenth century with the regulation of railroads and then extended to the trucking industry in the 1920s and 1930s. Other industries operated with various degrees of government regulation, all done with the intention of protecting the public interest.¹² Free-market economists argued that the opposite occurred, pointing out that regulation became a tool of both industry and labor in protecting narrow interests.

Economist George Stigler of the University of Chicago presented compelling arguments against regulation in his “The Theory of Economic Regulation.” A future Nobel-Prize winner, Stigler joined a growing number of respected economists who discouraged the overregulation of private monopolies.¹³ An AEI project led by Murray Weidenbaum of Washington University of St. Louis calculated the high costs of regulation, both time and money.¹⁴ The media also reported on the “regulation mess.” For example, one Illinois dairy company with 27 employers reported to “twelve different regulators.”¹⁵

Carter made some progress on the issue of government regulation with the appointment of Alfred Kahn as chairman of the Civil Aeronautics Board ; this signaled his openness to deregulation. Having established a well-deserved academic reputation as an expert on regulation at Cornell University , Kahn gained national recognition for his regulatory work as chairman of the New York Service Commission in 1974.¹⁶ His success in deregulating the nation’s airline industry was a notable achievement. There was less triumph elsewhere.

The story of Lido Anthony “Lee” Iacocca and Chrysler said much about regulation and the American automobile industry. Educated as an engineer, Lee Iaccoca switched to sales after he began working for the Ford Motor Company following World War II. By 1970, this son of immigrant parents was president of the company, but the final step to chairman did not happen as he planned. On June 13, 1978, Henry Ford II fired Iaccoca, telling him: “Sometimes you don’t like somebody.” Five months later, Iaccoca became president of Chrysler Corporation and in less than a year was the new chairman. In late 1979, American television viewers saw Chrysler’s new commercials showcasing Iaccoca himself. A man of contradictions—sometimes going on profanity-spiced meltdowns and at other times shy and insecure—his commercials helped Chrysler sell its new line of Omni-Horizon subcompacts.¹⁷

Despite these sales, Chrysler remained in financial trouble, and Iaccoca turned to the government for loan guarantees. Facing large federal penalties, Chrysler began retooling to make the larger models smaller even though there was greater consumer demand for large cars. In fact, many Americans bought commercial vans, initially exempted from mileage regulations, and turned them into family vehicles. The gas mileage was less than 10 miles a gallon, but they offered prized space to haul families and all their luggage and extras. Caught by surprise, Chrysler and other auto companies struggled to keep up with the demand for vans.¹⁸

Arguing that government regulations, in large part, were to blame for Chrysler’s decline, Iaccoca believed he had a good case.¹⁹ His first meeting with Speaker of the House Tip O’Neill did not go well. Iaccoca descended on O’Neill’s office with an entourage of Chrysler board members, lawyers, and lobbyists. After the meeting, Iaccoca referred to O’Neill as “the coldest bastard he ever met.” When he heard this, O’Neill replied: “Do you think I’m going to tell him how to get the job done in front of all those lawyers and lobbyists? They’ll just take credit for my ideas.”²⁰ The second meeting between O’Neill and Iaccoca went well and the Democrats fought for more money for Chrysler, not because they favored capitalists but because the automobile jobs were in jeopardy and union leaders’ pressure. With the United Auto Workers (UAW) and the Michigan governor behind him, Carter supported a $1.5 billion guaranteed loan to prevent a possible takeover by an “aggressive” Japanese automobile company.²¹ Iaccoca always favored the Republican Party, but this changed when he arrived at Chrysler: “There’s no question in my mind that if there had been a Republican administration in 1979, Chrysler wouldn’t be around.”²²

Responding to “the high-powered” Chrysler bailout campaign, Milton Friedman wrote “hogwash.” Clearly the misinformation and scare-mongering were profuse. Supporters of the bailout pointed to bankruptcy and the potential loss of 500,000 jobs—Chrysler employees plus those employed by automobile parts suppliers—if the government did not intervene. But then again, could bankruptcy be this disastrous? Friedman’s argument was that companies declaring bankruptcy generally continued production with court instructions to eventually pay off debts as much as possible. In other words, many companies survived the interim stage of bankruptcy going on to resume operations under new management.

Even if Chrysler was unable to survive intact as a single enterprise, its facilities would not stand idle. Other automobile companies or manufacturers would find value in the Chrysler properties, potentially running a more efficient operation that created new jobs. As for the automobile parts industry, it would continue operations for the revised Chrysler company and other car companies that would inherit any business lost by Chrysler. Friedman reminded readers that businesses seeking profits in the free-market system ran the risk of financial loss. Carter’s high-profile bailout was an indication of too much government control and a lack of understanding of how such control had reversed productivity during the 1970s.

The sad reality, according to Friedman, was that short-term political gains mattered more than a lasting and sound economy.²³ Federal deficits got larger and continued to distort the allocation of resources, cause unstable financial markets, and inhibit capital investment in the private sector.²⁴ The American people did not need to understand the intricacies of economic policy to recognize economic malaise and the failure of government to respond effectively . A Gallup Poll in August 1979 revealed that a record 84 percent of Americans believed that the United States was on the wrong track.²⁵

In 1980, journalist Ken Auletta wrote what few others in the media admitted: “To the public, government dispenses protection but also programs, grants and subsidies the way a counterman dispenses mashed potatoes and meat loaf…. Politicians know that few care about the chef’s wisdom, judgment or diet recommendations.… They know the press tends to focus on now, on politics not government.” Farmers expected their crop subsidies; tenants looked for their rent subsidies; big businesses anticipated federal loan guarantees; and cities, counties, and states counted on federal grants.²⁶ All this was apparently fine with those who stood solidly with government.

The poor results of government action did not slow enthusiasm for government intervention whether it was social programs or price controls. Throughout the 1970s, the federal government funneled hundreds of millions of dollars to fight poverty , but the results were discouraging with net poverty at 6.2 percent in 1979, down only by 0.1 percent from 1972. An equally troubling statistic concerned the percentage of the population dependent on government transfer payments, referred to as the “latent poor.” The percentage was 19 percent in 1972 and 22 percent at the end of the decade.²⁷ Conservative critics claimed that welfare programs for the well-being of the poor and unemployed, despite the best intentions, strained traditional family life, resulting in a diminishing role of husbands supporting the family.

Nonetheless, another problem for government programs was the reality of an inflating dollar that got worse in the last stage of Carter’s presidency. Further evidence of economic malaise was the struggles of New York City where politicians ignored the fiscal crisis and continued to stuff budgets with goodies. Burdened with a huge deficit, city officials returned to Congress with hat in hand.²⁸ With many groups demanding assistance, federal spending remained rampant, so Carter had no success reaching his objective of a balanced budget; the federal deficit in 1980 was $60 billion compared to $45 billion in 1977.²⁹

Economist Alan Blinder , no champion of conservative economics, wrote in 1979 that politicians “did not learn to steer clear of wage-price controls.”³⁰ Alfred Kahn’s appointment as chairman of the Council on Wage and Price Stability (COWPS) suggests the pressure for Carter to solve high inflation was greater than the burden for him to stay pure to Keynesian ideas as defined by the more liberal wing of the Democratic Party. Inflation czar Kahn clarified the enormity of fixing inflation: “I knew that I was taking on something that probably any God could do.” He explained that inflation was more than an economic problem; it was a disturbing social problem “in which individuals and groups seek their self-interest and demand money compensation and government programs that simply add up to more than the economy is capable of supplying.”³¹

Kahn was a curmudgeon whose brashness irked others including the White House staff and Barry Bosworth , the director of COWPS; however, the American public saw him in a favorable light. In typical independent fashion, he declared Carter’s wage and price controls “a catastrophe.” He was pessimistic about inflation, informing the president “that neither your economic nor your political advisors are ever going to present you with the solution to the problem of inflation, readymade.”³² In February 1979 Kahn declared: “I suggest that if my earlier diagnosis of the unhealthy condition of the anti-inflation program is at all close to accurate, your political and economic advisors had better bestir themselves to think of some dramatic actions [that could have an immediate impact on prices].”³³ The best answer he had was to reimburse workers with real wage insurance to offset the detrimental effects of inflation.

An assessment by Charles Schultze in March was grim: “While we expected high inflation to continue in the first part of 1979, before the anti-inflation program had time to bite, price increases in the last several months have actually accelerated.”³⁴ There was a significant increase in home ownership costs, but the reported numbers made it appear worse than was the case. A flawed method of calculating the Consumer Price Index (CPI) by the Bureau of Labor Statistics in turn distorted the numbers for wage increases in union contracts.³⁵ In late 1979, Kahn warned Carter not to wait until January—after the State of Union address—to introduce additional anti-inflationary measures.³⁶

Seeing low industrial productivity as a major cause of inflation, Schultze suggested the implementation of a $6–8 billion “productivity package.”³⁷ Henry Aaron acknowledged the “climate of doubt about the capacity of government” to effectively tackle the economic problems of the 1970s. Yet he remained hopeful: “[S]ober attempts rationally to solve increasingly complex problems may be advanced if we retain a bit of that sense of mutual obligation and community that flowed from” the Great Depression and World War II .³⁸

II

One of the most consistent defenders of government action was the Nation , the small weekly magazine founded in New York City in 1865. In 1977, the yearly cost of the magazine to service its approximate 25,000 subscribers with 47 issues was $250,000. For the year, the Nation lost more than $120,000, consistent with other small opinion journals that almost always ran at a deficit.³⁹ Progressive thinkers writing in the Nation saw that the solution for full employment and price stability was “a smarter crowd in the White House.” On economic matters, the magazine found the “mumbling mumbo jumbo” of conservativism and the misuse of popular resentment by the “right-wing extremists” tragic.

To counter these “hyenas of economic life,” it was critical to enact immediate and comprehensive progressive action. With the assistance of his undergraduate students, Hunter College Professor Bertram M. Gross prepared a 10-point anti-inflation program to prevent corporate control of society.⁴⁰ Price controls were essential and, according to Robert Lekachman, something the American people wanted. On whether to save Chrysler , Lekachman preferred “outright nationalization,” but he understood America was not quite ready for “this clean-cut resolution.”⁴¹

Lekachman had many biting words for conservatives, including Jewish ex-leftist Norman Podhoretz who broke ranks with radicalism and became an influential neoconservative writer in Commentary magazine. Lekachman wrote of Podhoretz’s “crass egocentricity,” his “utterly humorless” and “leaden prose,” his rejection of reform, and his inflated college grades of A+; he asked: “Did Lionel Trilling and Fred Dupree really award A+s to our Norman?”⁴² The prominence of neoconservatives was not because of their “intellectual power and originality.” Rather it was the patronage of the business community that explained the status of these “superficial purveyors of the scraps.”⁴³

It was simple; the intelligence of those who promoted conservative economics was suspect. Nation writer E. L. Doctorow questioned the intellect of Ronald Reagan, someone who was “a third-rate student at a fifth-rate college.”⁴⁴ Missing in progressive literature, however , was serious analysis of the work of former radical Thomas Sowell whose publications on the promise of the free market began to receive national attention.⁴⁵ More substantive than personal, Ralph Nader’s critique of those who challenged government intervention in the Nation was far-ranging. In March 1980, he called for the business class and corporations “to stop stealing, stop deceiving, stop corrupting politicians with money, stop monopolizing, stop poisoning the earth, air and water, stop selling dangerous products, stop exposing workers to cruel hazards, stop tyrannizing people of conscience within the company and start respecting long-range survival needs and [the] rights of present and future generations.”⁴⁶

In a similar vein , City University of New York professor Robert Engler told Nation readers that popular organization was paramount to realize the “global cooperation and global planning” necessary to deal with oil resources and environmental protection.⁴⁷ Also from City University of New York, economist William K. Tabb and author of Marxism and the Metropolis discussed the plans for deregulation and lower social spending in the United States and pointed to the conservative governments in Canada , Britain, and much of Europe that attempted “to prosper by reducing living standards.” Tabb said that a “left opposition” was vital to point out that “organized greed” was behind the lack of economic growth in America.⁴⁸ James Crotty of the University of Massachusetts was another economics professor who saw “national economic planning rather than laissez faire” as the remedy for America’s economic crisis. The “reign” of monetarism and supply-side economics, he predicted, would likely be “short-lived.”⁴⁹

The Nation took opportunities to undermine popular conservative initiatives, such as Proposition 13, that resulted in California experiencing an economic boom. Approximately one year after California ushered in lower taxes, freelance writer Barbara Koeppel reported in the Nation that tenants who voted for Proposition 13 were angry to learn that the legislation was good for landlords but not for them when they experienced higher rental costs. Rising inflation and subsequent increased labor and operating costs pushed landlords to increase rents. A comparison of rents before and after Proposition 13 is instructive.

In 1974, one California couple paid $125 a month for their two-bedroom, but with new owners the rent went to $315 in 1977, $450 in 1978, and $550 by February 1979. This trend of escalating rents meant more tenants became permanent renters, unable to break into the housing market of cities. David Morrison , formerly of the California Department of Housing and Community Development, declared that renters had become second-class citizens. They were victims of rent gouging and faced eviction without good cause. According to Koeppel, a tenant movement began to push for rent control legislation, a long overdue action given that less than five percent of America’s tenants lived under rent control laws. She lamented that only a few cities were fortunate enough to have rent controls—New York City since World War II, Boston, Washington, DC, Miami Beach, and others in more recent years.⁵⁰

In the wake of Proposition 13, city councils in Los Angeles and Beverly Hills passed “stop-gap rent freezes” while Berkeley and Davis voters won rent rollback initiatives, and Santa Cruz approved an anti-speculation tax in November. In May 1979, there were enough Santa Monica voters to approve rent control. Yet, most initiatives attempted in other California cities failed. Supporters of rent control, such as David Morrison, were upset by how opponents defeated their efforts with expensive public relations campaigns: “If you have unlimited funds you can buy talent and run a very sophisticated propaganda campaign—and win.” By Koeppel’s calculation, the San Francisco rental industry outspent tenant organizations $500,000 to $11,000. As she explained, the words “rent control” sent “shivers down the spines of landlords from Long Island to Los Angeles.”⁵¹

Were rent controls effective? Koeppel acknowledged the example of New York City that showed skyrocketing rents despite long-standing rent controls. There were several key arguments against rent controls: they reduced new construction; they triggered unemployment for construction workers; and they caused “property decline, abandonment, severe housing shortages and higher taxes.” If the real estate tax base does not rise enough to support government spending, homeowners are hit with higher taxes.

Opponents of rent control called for more construction as the solution for housing shortages and high rents. It was uncomplicated, stated Ted Dienstfrey of the California Housing Council: “Builders must be allowed to build—what they know how to do best.”⁵² The differing solutions came down to opposing views on what government could achieve. Koeppel and politicians wanting rent controls saw government intervention as essential. The Nation’s focus on rent control offered a better story than any discussion of job creation in the aftermath of Proposition 13. The doom predicted by liberals was incorrect, including UCLA economists who forecast a job loss of 450,000. Instead, there was a gain of about a half million jobs and 18 months of economic growth after the passage of Proposition 13. Surprising too was the climb in aggregate tax revenues.⁵³

The New Republic was another forum for progressive analysis of the economy. Irving Howe lamented the William Buckley-types who never had to worry about getting a job and were too willing to promote conservative economic solutions that reduced the size of government. For Howe, it was honorable to defend government regardless of the financial cost: “If a dose of bureaucracy is the price we must pay for humane social arrangements, then the price is worth paying.” Howe’s concern for vulnerable Americans in financial need was genuine, and he was ready to demonstrate on the streets “against the current menace from the right.”⁵⁴

Perhaps unaware of the financial struggles of Milton Friedman’s early life, Anne Colamosca wrote of Friedman’s privileged life preventing him from understanding the shortcomings of the free market. She claimed that Friedman would be wiser if he was a female academic fighting to get tenure, raising a family, and keeping the home in order: “[U]nfortunately he does not have to cope with free-market malfunctions on such a personal level.”⁵⁵

New Republic writers had faith in and wanted “aggressive” government, particularly a “liberal inflation program” that could bring “a government-guaranteed job for anyone who can work, and a guaranteed decent minimum annual income for everyone.”⁵⁶ The benefits of a “stiff tax” on energy, “say a dollar a gallon on gasoline,” would be rebates for the poor and money for “massive government” research to solve the energy crisis.⁵⁷ Taking the position that government controls “look very appealing,” the New Republic saw Edward (Ted) Kennedy , who wanted widespread controls, as “the only leading presidential candidate who offers a serious inflation program.”⁵⁸

Economist Lester Thurow’s argument that “planners possess all the technical tools for implementing whatever form of recovery the political system might settle upon” earned the praise of New Republic book reviewer Herbert Gintis , economics professor at the University of Massachusetts , Amherst. Gintis was hopeful that America would witness the coming of “social democratic politics” soon with Thurow as its “economic guru.”⁵⁹ In defending Keynesian or democratic socialist economic models, intellectuals were clear on one point: supply-side economics was a bad option that for the most part benefited the rich at the expense of other Americans.

As the economy struggled, some radicals distanced themselves from left politics to become professionals in law, academics, journalism, medicine, and business. A well-known leader of the New Left during the 1960s, Todd Gitlin wrote that as “the movement’s moral imperatives grew more burdensome, many wearied of the life of the professional radical.” It was time to move one. One of those who “set out on the track that middle-class upbringing and education had prepared us for before Sixties politics intervened,” Gitlin returned to graduate school to study sociology at the University of California , Berkley.⁶⁰ What happened? According to Gitlin, the “millennial, all-or-nothing moods of the Sixties proved to be poor training for practical politics.” Moreover, he said idealistic leftists had “no clean hands. The idea of a unitary Left destined to save the world because it was born on the side of the angels is grotesque blindness. Even benign social democracy … loses much of its allure if for no other reason than that capital goes on strike and a weak economy cannot satisfy the demands an aroused democracy makes.”⁶¹ Whether progressives changed their politics or not, new ideas about the economy were worthy of examination for some exploring why Keynesianism fell short in correcting a faltering economy.

III

Irving Kristol’s economic articles of the 1970s published in the Wall Street Journal, Commentary , and The Public Interest influenced many to take supply-side ideas seriously.⁶² A former Trotskyite—“a member in good standing of the Young People’s Socialist League”—who graduated from City College in New York in 1940, Kristol had a wry sense of humor and a sharp intellect that scored points for the conservative movement he found himself supporting. One of his definitions of a liberal was a person who approved the work of an 18-year-old girl in a pornographic film on the condition that she received, at least, the minimum wage.⁶³

Kristol believed that the survival of capitalism hinged on whether businessmen could go beyond a stark, self-seeking approach to business and practice genuine “social responsibility” and “business ethics.” Although flawed as all economic theories were, supply-side economics appeared to Kristol to offer a legitimate path where capitalism and the wealth it generated made room for noble aims. Key was economic growth: the creation of wealth that allowed the financing of necessary programs to help Americans. Supply-side economics also meant lower taxes and the number of economists who held that higher taxes were good for the economy was declining.⁶⁴

By the late 1970s, supply-side economic theory was attractive and straightforward. The reduction of income taxes and investment taxes put more money in people’s hands and encouraged job-creating investments. As former leftist Michael Novak wrote: “Lower tax rates tease money out of bank vaults, where it sits uninvested and unused. Lower tax rates awaken ‘animal spirits’—keen-eyed spirits, eager to invest in new businesses in order to bring new technologies to market and create new jobs.”⁶⁵ Those who embraced this argument cited President John F. Kennedy’s surprising tax cuts of the previous decade that ushered in a stronger economy. In 1977, the think tank AEI invited Novak, a Catholic theologian, to join its team. There the Democrat Novak found the arguments of Irving Kristol and other pioneer supply-siders compelling. He remembered Kennedy’s statement that captured the logic behind supply-side economics: “It is a paradoxical truth that tax rates are too high today and tax revenues are too low, and the soundest way to raise the revenues in the long run is to cut the rates now…. The purpose of cutting taxes now is not to incur a budget deficit, but to achieve the more prosperous, expanding economy that can bring a budget surplus.”⁶⁶

When Novak met Republican congressman Jack Kemp, who invited him to a Young Republicans meeting in Minnesota in 1979, he gained additional knowledge of economics. Novak looked to the former Buffalo Bills star quarterback as “an extraordinarily gifted teacher.” Kemp took economic theory and explained it in an understandable manner: “I believe in incentives. I trust you with your own money.” He asked his constituents: “If you do hard, sweaty work in the mills your whole life so your kids can go to college, do you want the government to take a big chunk of it, just to give it to people who maybe did not sacrifice as much as you have?”⁶⁷ Kemp told the story of his garbage man who stopped him at the curb to encourage him to keep fighting the Democrats and prevent them from changing the rules “just as my kids start to get ahead.”⁶⁸

With the tempting incentives of lower taxes and a more welcoming climate of business, entrepreneurs eagerly jumped to invest in businesses and advance new technologies, all of which generated new jobs. A notable feature of supply-side economics was its rejection of the “limits of growth” viewpoint held in Keynesian circles. Conservative Republicans were confident of getting the country on track, whereas liberal Democrats “took on the crabbed countenance of Herbert Hoover.”⁶⁹

Milton Friedman was no supply-side economist, but he by and large was supportive of the bill forwarded by Jack Kemp and William Roth that would reduce tax rates over a three-year period. He understood that federal tax rates as high as 70 percent resulted in taxpayers buying tax shelters even if this denied them investing in more profitable activities. Simply put, taxpayers were willing to buy shelters for 50 cents on the dollar to avoid paying a federal tax of 70 cents on the dollar. By sharply reducing individual and corporate taxes, the Kemp-Roth bill would result in more taxpayers paying the tax and investing “their funds in the most profitable ventures.”

In the end, the supply-siders believed the government would generate more revenue, although Friedman was not as confident on this point. More significantly, Friedman argued that the bill needed to take an extra step—a limit on government spending. Given that the “total tax burden on the American people is what the government spends, not those receipts called ‘taxes,’” it was important to have both tax reduction and spending reduction. American economic history demonstrates that governments “will spend whatever the tax system will raise—plus a good deal more.” Greater revenue for the government to continue wasteful spending was not the answer.⁷⁰

From the vantage point of the late 1970s, economists were aware that the Kennedy tax was a resounding success when implemented during the Johnson administration. Nonetheless, supply-side theory, referred to some as “economic snake oil,” had a tough fight to convince political leaders raised on Keynesianism. Victories were incremental. Kemp became the first supply-side politician in 1975. The following year, the Republican National Committee was cool on any revolutionary ideas on tax cutting, favoring instead a more traditional approach of balancing expenses and revenues. Certainly, few policymakers believed tax cuts could revitalize the economy; if there were tax cuts, they would come after other policies ushered in a stronger economy.⁷¹

Economist Paul Craig Roberts was a major pioneer who charted the rise of supply-side ideas within the Republican Party. With an economics Ph.D. and after being a fellow at Stanford’s Hoover Institution , he joined Jack Kemp’s staff in 1975. He had a soft voice, but opponents who tangled with him discovered that he was tenacious and had a high standard of intellectual integrity.⁷² Roberts marked February 23, 1977, as key to the emergence of supply-side policy and the resurrection of the Republican Party. With a booming voice, Republican John Rousselot introduced a substitute amendment on the floor of the House of Representatives that gave every American “a simple across-the-board tax reduction.” In the past, Republicans had acted on rising deficits by voting against Democratic spending and promising fiscal sanity when they returned to power.

Surprising both Democrats and many Republicans, Rousselot did not offer the typical balanced-budget talk of the Republican Party but instead focused on a permanent tax reduction he believed would stimulate productivity and investment more effectively than the Democrat’s proposed stimulus package of a one-year $50 rebate. Keynesian theory held that a good economy relied on healthy government spending, but here was a Republican amendment adding to the deficit (although not as much as the Democrats’ proposal). Much drama and irony followed as Democrats, aware of the Republican soft spot, criticized Rousselot for risking a bigger deficit with a permanent tax cut. The explanation for the Democratic Party’s double standard was its opposition to any tax cuts, in part because Keynesian analysis viewed that “a dollar of tax cuts results in less additional demand than a dollar of spending.”

In addition to the issue of demand, Democrats argued that a tax reduction favored the rich over lower-income Americans. “Battling Jim” Wright , the Democratic majority leader, cited Budget Committee numbers to push the narrative of “the old trickle-down economic theory.”⁷³ It did not matter that in the field of economics there was no such thing as a trickle-down economic theory.⁷⁴ Nevertheless, no one could deny that an equal cut in taxes meant a family earning $50,000 would see a larger percentage of saving than a family earning $25,000.

At the same time Democrats resisted supply-side thinking, Republicans hurt their cause with internal squabbles. The day before Rousellot presented his amendment, Arthur Laffer advised Jack Kemp not to support it because Rousellot did not go far enough and make the argument that tax cuts would pay for themselves. Roberts worried that the exaggerations of Laffer and Jude Wanniski blanketed “the supply-side movement with hyperbole” thus causing disunity between congressional insiders and outsiders. Roberts rushed over to Kemp’s office and convinced him to stay in the game with Rousellot. Still, friction remained because of Wanniski’s editorial “JFK Strikes Again” (Kemp had the same initials as Kennedy) that gave no credit to other House Republicans who worked hard to advance tax cuts. When Roberts challenged Wanniski for his “tactless editorial,” the Wall Street Journal editor replied: “We will sacrifice you to the revolution.”⁷⁵

Despite this friction, five months later Kemp and Senator William Roth took an important step and introduced their bill proposing the reduction of personal income tax rates by 30 percent in stages. There were several reasons for the progress of supply-side economics. People began to speak up. Freshman Senator Orrin Hatch (Republican) on the Joint Economic Committee (JEC) became an unpopular figure because of his opposition to the rise of spending and the growth of government. He found it irresponsible that lawmakers continued to oppose lowering personal income tax rates: “Each time those of us who pushed for a tax reduction were told that there was no room in the budget. There was not any room in the budget for the spending programs either. But that did not keep us from spending.”⁷⁶

Keynesians stonewalling Republican Hatch was one thing, but doing the same to a powerful Democrat was another thing. Democratic Senator Russell Long , chairman of the Senate Finance Committee , not only wanted to cut the tax on capital gains but he also challenged the Treasury’s argument that higher taxes resulted in more revenue for government. In June 1977 at a hearing of the Subcommittee on Taxation, he stated: “It would be my guess if you would reduce your top rate to 50 percent, you actually would make money.” It was a remarkable development that a powerful Democrat spoke supply-side language. Senator Long’s decision to give entrepreneur Michael Evans the task of creating a supply-side model to get more accurate revenue estimates for the Senate Finance Committee opened the floodgates.⁷⁷

The tide turned as the worsening economy of Carter’s final two years spurred interest in supply-side ideas.⁷⁸ One advantage for its proponents was the shortcomings of Keynesian economic models, devised by Lawrence Klein and Otto Eckstein , that stressed spending and did not consider the role of incentives in economic growth. Consequently, they forecast that tax cuts would cause a decline of the Gross National Product (GNP). But then again, how reliable was a model that failed to have a good answer to the problem of stagflation ? Other Keynesian ideas appeared suspect.

Economist Lester Thurow reasoned that people would work regardless of the level of taxation until they reached a targeted amount of wealth. If there were high taxes, they worked harder and longer. But such thinking put Keynesians in a bind. For example, if a Keynesian economist called for a tax cut to stimulate higher spending, by Thurow’s logic people with lower taxes would work less. This would decrease the total production of goods and services—the opposite goal of Keynesianism.⁷⁹

In contrast to Keynesian claims, there was evidence that a high marginal tax rate discouraged people from working longer. Once workers approached income earnings that put them in a higher tax bracket, there was less incentive to earn additional taxable income. In commonsense terms, supply-side proponents stated additional examples of deterrents. Even a modest marginal tax rate put a drag on the economy. For example, if a worker had a 25 percent marginal tax rate, he kept $75 of the $100 he earned that day. But he faced a decision if he wanted his house painted and the cost of a painter for the day was $80. Painting the house himself meant a saving of $5, but this option shrunk the tax base by $180. Lost to the government was the tax revenue from the $100 that the worker chose not to earn and the $80 that he did not pay the painter.⁸⁰

Supply-side economists explained that a progressive income tax rate designed to “soak the rich” was also “a barrier to upward mobility” for many Americans. Why strive for your best if the rewards were progressively less? Keynesians began to lose the debate as more people saw the logic of supply-side analysis. Their argument that higher taxes would compel Americans to work harder and longer seemed to be backward thinking. By 1978 there was more evidence of Democrats flirting with supply-side ideas. In the fall, Democratic Senator Sam Nunn saw his amendment to reduce the personal income tax rate and to limit the growth of federal spending receive three-to-one support in the Senate.⁸¹

In addition, the 1979 report of the JEC under the leadership of Senator Lloyd Bentsen embraced a supply-side approach that, in the words of Paul Craig Roberts, “created a new ballgame.” Remarkably, the title of the JEC’s 1980 report was “Plugging in the Supply Side”; here was “Reganomics before Reagan.”⁸² Facing the challenges of the Congressional Budget Office (CBO) and econometric models protecting Keynesian thinking, supply-side economics had gained strength on both sides of the aisle.

IV

America was on the brink of an economic revolution and the most serious threat to Keynesian politicians was Ronald Reagan. The Californian was the key transformative figure putting political clothing on supply-side theory; he was one the first Republican leaders to embrace the Kemp-Roth bill.⁸³ There are, however, various interpretations on the timing and how specifically Reagan embraced supply-side ideas. After the 1978 midterm election, supply-sider Jude Wanniski wanted Jack Kemp to pursue the GOP presidential nomination because Reagan and the other candidates were “traditional austerity Republicans.” Reagan’s subsequent speeches praising Kemp and supply-side ideas proved Wanniski wrong. In early summer 1979, Kemp met with Reagan at a dinner party held at Arthur Laffer’s home in California. After probing Reagan’s understanding of economics and commitment to supply-side ideas, Kemp pledged his allegiance to Reagan. As Laffer admitted to Wanniski, Reagan was “eighty-five percent with us on the issues, which doesn’t give me reason to go against him.”⁸⁴

Nevertheless, Wanniski was skeptical, and he believed Reagan gave too much attention to traditional Republican economic ideas. It took months before he was comfortable that Reagan’s commitment to supply-side economics was genuine . With a group of 25 meeting in Los Angeles in January 1980, Wanniski witnessed Reagan’s impressive discussion of economics: “Reagan was so thoroughly in tune with the day’s discussion that the thought struck me with full force that he had the basic model before we arrived, indeed before any of the Kemp group was born.”⁸⁵ Wanniski appeared to relish the limelight and he either exaggerated his role in advancing the supply-side movement or made inconsistent statements. Keeping with his reputation as a “wildman,” he gave a curious interview to the Village Voice in April, stating that Reagan lost focus on supply-side economics without the encouragement of Kemp.⁸⁶

David Stockman’s version is that “Reagan had been successfully ‘converted’” in Los Angeles by Kemp and other supply-siders in attendance. Stockman, who viewed Reagan as a “cranky obscurantist,” was unhappy with the news that Kemp had given his allegiance to Reagan. He was unsure whether to laugh or kick his desk.⁸⁷ If he had no confidence in Reagan as a supply-side champion, he probably had not read Reagan’s articles over the years calling for lower taxes. Critics called Reagan many things, but Stockman was the only person in America who labeled him “cranky.” Flirting with supply-side theory for a short term and serving in Reagan’s administration even more briefly, Stockman garnered the attention of cartoonists who portrayed him as a cold and bloodless policymaker.⁸⁸

Political journalists Rowland Evans and Robert Novak appeared to want it both ways, presenting analyses that Reagan was and was not an ardent supply-sider. They wrote that Reagan was “ambivalent” about his support for the Kemp-Roth tax bill, but they also stated that he viewed it as “serious policy” and that he “began to unveil himself as the political leader of the supply-side movement.”⁸⁹ According to Evans and Novak, even though Reagan’s commitment to supply-side theory was “nearly” as strong as Jack Kemp’s, the Californian was “vague” on details, causing Kemp and other supply-siders some concern.⁹⁰

Edward Meese , one of Reagan’s closest friends and political confidants, took issue with those implying Reagan was a passive figure with no economic policy who had had supply-side thinking foisted on him. Reagan’s philosophy of limited government , his wide-ranging reading of economic literature, and his life experiences shaped him to be a “‘supply-sider’ long before the term was invented.” Rather than converting Reagan, Kemp “was basically pushing on an open door.”⁹¹

Martin Anderson agreed, calling the drama over the question of supply-side economics a “great myth” pushed by those who wanted to discredit supply-side economics by claiming there was a major rift between supply-siders and other economists advising Reagan.⁹² Anderson knew that someone fed the media this false narrative, but he was unable to discover the person’s identity: “Reporters will go to extreme lengths to protect the identity of their sources, including going to jail, even when they have been lied to. And that is why someone can betray or misrepresent the views of colleagues with virtual impunity.”⁹³ Paul Craig Roberts also disputed the idea of Reagan falling into the hands of “Lafferite snake-oil salesmen” who supposedly filled a void when other Republicans kept their distance from “a right-wing contender for the Republican nomination.”⁹⁴ Forgotten was the reality that a broad range of Republican politicians began to see supply-side economics as a winning political issue.

As a Hollywood star reaching the 94 percent tax bracket during the 1940s, Reagan understood the negative upshot of high taxes. Why take extra work for only 6 cents of each dollar? It may have been easier to do fewer films, but others were hurt when he worked less: “If I decided to do one less picture, that meant other people at the studio in lower tax brackets wouldn’t work as much either; the effect filtered down, and there were fewer total jobs available.” Reagan concluded that as the government took more for taxes, people lost the incentive to do extra work and businesses lost motivation to maximize profits and instead found tax shelters and loopholes that did little for economic growth. It was a lesson Reagan never forgot and his support of supply-side thinking made sense: “If, on the other hand, you reduce tax rates and allow people to spend and save more of what they earn, they’ll be more industrious; they’ll have more incentive to work hard, and money they earn will add fuel to the great economic machine that energizes our national progress.” The result, he explained, was “more prosperity for all—and more revenue for government.”⁹⁵ This was no somber economic message.

Before he became a candidate for the Republican nomination, Reagan delivered numerous radio addresses to the nation about taxes. In October 1977, he told listeners there would be more tax revenues and jobs if the government lowered the tax rates for businesses and individuals. The economists he cited included Arthur Laffer, and the politician he wanted the people to support was Jack Kemp . The following year he spoke of the good work of Kemp and William Steiger in attempting to give all Americans “a real tax break.” Still, the White House pushed Democrats in Congress to block those promoting tax relief of the wrong kind.

Carter wanted to increase the progressivity of income taxes so that those making more than $20,000 paid more. But Reagan worried about the consequences of steepening the tax brackets for those who worked, earned, and made the country run. Without citing the Laffer curve in another radio message, he outlined the effect of high taxation on working people who faced less employment opportunities when business leaders withdrew capital from productive businesses.⁹⁶ By arguing for lower taxes as an antidote to inflation, Reagan was on track for reaching blue-collar Democrats dissatisfied with the economy and willing to hear a new message that sounded more appealing than the traditional austerity ideas of past Republicans.⁹⁷

The health of the bond market was one of many markers of economic trouble. Having an inverse relationship with interest rates, bond prices fall when interest rates rise. In the final stage of the Carter government, there was gloom in the bond market. Setting time aside for a meeting with the press, one senior officer at a bond-trading house told his secretary to hold all telephone calls. He only lasted 30 minutes before bolting to the trading room: “I have to see how much money we’ve lost while we were talking. The way things are going, it could easily be $2 million or $3 million.” In February 1980, the Wall Street Journal reported that the high interest rates led to “a staggering $400 billion in paper losses on bondholdings.”⁹⁸ Double-digit inflation resulted in a stunning drop of bond prices in 1979 and 1980. Bondholders discovered that inflation and taxation wiped out the fixed rate of interest of the bond.⁹⁹ Books on the woeful economy were big sellers, notably Howard J. Ruff’s How to Prosper During the Coming Bad Years (1979) and Douglas R. Casey’s Crisis Investing: Opportunities and Profits in the Coming Depression (1980).¹⁰⁰

The issue of high taxes reduced faith in Keynesian theory, and Henry C. Wallich, a governor of the Federal Reserve Board, predicted that within a decade “universities and government will be overrun with monetarists and neo-classical economists devoted to free markets and deeply skeptical of activist macroeconomic management.” Many Keynesians bristled at the claim that their ideas were incorrect. Well-known Arthur Okun of the Brookings Institution responded: “I’m nobody’s vestigial remnant.”¹⁰¹ In the New Republic , both Okun and Lester Thurow argued that the answer to inflation was government intervention. Okun wanted incentive tax benefits for those who voluntarily held down wages and prices, and Thurow sought wage subsidies to employers who hired minorities because it was an “unequal structure of unemployment” that promoted stagflation.¹⁰² In another New Republic article, John Kenneth Galbraith reminded readers that “God is a Keynesian Democrat”; he opposed tax cuts opting instead for the proper “use of the powers of the state.”¹⁰³

The problem Keynesian economists faced was the growing number of people who believed the economic theory had had one failure after another. The good Keynesian decades of the 1950s and 1960s were history. The focus was now on Carter’s economic programs driven by Keynesian thinking. “We were good Keynesians once, but we had to change our minds,” acknowledged Thomas Sargent of the University of Minnesota . Sargent witnessed rhetoric undermined by reality: “The raw fact that hits everybody is that the economy has just not behaved according to the best Keynesian models.”¹⁰⁴

By the late 1970s, tax reduction and deregulation became key Republican planks while liberals failed to achieve a consensus on how best the government could legislate an objective society.¹⁰⁵ Tom Bethel argued that it was long overdue for economic commentators and politicians to acknowledge the role rewards and incentives played in generating economic growth. Another advantage of supply-side theory for Republicans was that it allowed the party to move away from the balancing-budget focus of the past and the heavy political cost that often followed. The tools of the budget-balancers were cutting spending and raising taxes. Unless you had dozens of lawmakers like Senator Orrin Hatch , Bethel stated, one could forget the “pipe dream” of Congress cutting spending. Besides, raising taxes was not a winning strategy. High tax rates did not win votes, were not effective revenue collecting devices, and stifled commerce. On the other hand, the supply-side argument was politically feasible, Bethel said: “Politicians won’t cut spending, but they don’t mind cutting taxes—cutting tax rates, I should stress.”¹⁰⁶

The constant ace card for Reagan and supply-siders was the poor performance of Keynesianism . An increasing number of Americans faced money problems as both inflation and unemployment rose. What mattered for average citizens was whether the economy functioned—that is, whether one could make a living with a good job, have money to buy things, and keep the fruits of their labors.¹⁰⁷ Stagflation left them to wonder whether Carter knew what he was doing. Were conservatives correct when they described Democrats as foolish for thinking that employees stood to benefit if employers became poorer? America was on the brink of an economic revolution, but first the people needed to decide with their votes. Perhaps there could be a victory for a presidential candidate who embraced the Hayekian slogan: “We can get government off our backs, out of our pockets.”¹⁰⁸