Resolved: It’s All Greenspan’s Fault

By David Stockman  |  July 17, 2018

And by that destiny to perform an act
Whereof what’s past is prologue, what to come
In yours and my discharge.

– William Shakespeare, The Tempest (Act 2, Scene I)

I know Larry Kudlow.

Larry Kudlow was a colleague of mine.

Actually, I brought Larry Kudlow into the Reagan administration.

Back then, he was part of the original team tasked with clearing four decades of Keynesian muck from the economic engine that is America.

Today, he’s making claims like the exploding federal deficit is actually “coming down rapidly.”

He’s saying the recent tax cut has jarred a tsunami of economic growth. He’s telling us the federal coffers will swell with new revenue.

I still embrace the supply-side gospel. In its pure form, it was the heart of the Gipper’s effort to unleash capitalist prosperity in America.

This gospel is based on “Say’s law,” a theory of classical economics.

Say’s law says, in short, that investment and production come first.

Income generated from these activities is the only sustainable source of “demand” and household consumption.

If government wants more economic growth and higher living standards for the people, it should remove state-imposed barriers to investment and production.

Here’s what supply-side economics is not: a magical theory of government finance scribbled on a napkin by a self-promoting charlatan named Art Laffer.

That’s what Larry Kudlow’s pushing today.

We Reagan-era supply-siders vehemently objected to the reigning doctrine of Keynesian “demand management.”

The idea that, by borrowing money to put in consumers’ pockets, government could make the economy grow faster had long grown stale.

We focused on the failures of the state, not the market.

Nothing was more Statist at the time than ultra-high marginal tax rates on individuals.

The rate on investment income was still 70%. That absurdity gave rise to a massive search for shelters and tax loopholes.

And these activities impaired growth due to misallocation and inefficiency.

The top rate of 50% on “earned” wage and salary income was clearly confiscatory when you added in state and local income taxes on top of it.

Also, inflation was running anywhere between 5% and 10% during the prior decade. It created a lot of “bracket creep” for all taxpayers.

That surely tarnished supply-side incentives to work, save, invest, and take a risk.

So, Ronald Reagan proposed eliminating the 70% rate on investment income and cutting all marginal tax rates by 25%.

We wrote a supply-side bill that would have cut taxes by 3.0% of gross domestic product (GDP).
It would have only just offset inflationary “bracket creep.”

It was modest.

It was responsible.

But, during the summer of 1981, lobbyists got in the game. And a giant “bidding” war broke out. When the smoke cleared, the core supply-side tax cut was bedecked with massive loopholes and incentives.

The question of fiscal tradeoffs – more spending cuts – never arose.

The thing soared to 6.2% of GDP.

At more than double the intended size, the 1981 tax cut generated self-fulfilling budget catastrophe.

Soon, it became clear to virtually everyone who was numerate. In a fit of madness, Washington had shot the fiscal moon.

And about 40% of the 1981 tax cut was rescinded. Ronald Reagan signed three consecutive tax-increase bills, in 1982, 1983, and 1984.

This bit of history is relevant.

Back then, Larry was pushing a three-legged stool of marginal rate cuts, sound money, and balanced budgets through offsetting spending cuts.

Today, his stool is missing a leg: There’s no balanced budget and no spending cuts. We’re just waiting for Laffer’s magic napkin…

This whole idea is at loose on both ends of the Acela Corridor.

It’s silly. In fact, it has potentially tragic consequences.

Contrary to decades of GOP revisionism, there was no “supply side miracle” during the 1980s.

And the factors that made it seem so haunt us to this very moment.

From 1981 through 1989, real GDP growth averaged 3.58% per year. From 1953 to 1980, which reflects several business cycles, it was nearly identical at 3.55%.

The public debt soared from 30% of GDP to 50%. Ronald Reagan added twice as much to the national debt as did his 39 predecessors during the first 192 years of the republic.

Indeed, the U.S. economy was heading for a cliff in 1987 when Alan Greenspan landed at the Federal Reserve.

“Crowding out” was happening. Paul Volcker had refused to monetize the trillions of new debt stemming from the fiscal debauch then underway.

Deficits remained above 4% of GDP, and the U.S. economy was near full employment.

From January 1987 until the stock market crashed on October 19 – “Black Monday” – the yield on the 10-year Treasury note soared by more than 40%.

Had Greenspan not panicked – had he not opened the Fed’s printing presses – the Gipper would’ve ridden out of office during the “Reagan Recession.”

The supply-side miracle myth would’ve never gotten off the ground.

The Maestro’s save was indeed just the beginning of something.

The trouble is that “something” is the era of Bubble Finance.

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David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR