U.S. Intellectual History Blog

Conservatism, Stagflation and Supply-Side Economics

o'connorThe following is a guest post from Mike O’Connor, the seventh and, unfortunately, the last in a series–see the sixth in the series here. But fortunately for all of us who have enjoyed this series, we can read a whole lot more on this topic from this author. Mike’s book, A Commercial Republic: America’s Enduring Debate over Democratic Capitalism, is due out with the University Press of Kansas in just a few weeks! The book’s Facebook page can be found here, and information from the publisher is available here. Congratulations to Mike!

Cutting taxes is at the heart of the contemporary conservative economic agenda. Two years ago, the negotiations over the “fiscal cliff” were significantly constrained by the fact that the vast majority of Republican congresspersons had taken a pledge never to raise taxes under any circumstances. The widespread public distaste for that episode did little to dispel the enthusiasm for the pledge: among Republicans in the current Congress, 93% of representatives and 87% of senators have signed it. Congressman Paul Ryan (R-WI), the most recent Republican vice presidential nominee, recently published an op-ed on CNN’s website in which he associated “return[ing] power to the people” with “cutting tax rates.” The section of Senator Marco Rubio’s (R-FL) webpage that deals with the economy calls for six separate tax cuts, while a similar page on Senator Rand Paul’s (R-KY) site expresses the desire to replace the current system with a “low-rate flat tax.” It is no exaggeration to say that the centerpiece of economic conservatism is a commitment to cutting taxes.

The conservative passion for lowering taxes is so ubiquitous today that one might be surprised to learn that it is a relatively recent innovation. In the middle part of the last century, conservatives expressed far more anxiety about the possibility of budget deficits than they did about the burden of taxation. There is little concern with the issue to be found, for example, in Frederich Hayek’s foundational 20th century conservative text The Road to Serfdom (1944). Milton Friedman’s influential Capitalism and Freedom (1962) contains a short section advocating a flat tax, but does not otherwise devote much attention to taxes. Barry Goldwater’s Conscience of a Conservative was considered somewhat incendiary when it was released in 1960. The Arizona senator was generally unhappy about government economic intervention, blasting federal farm subsidies and the growing welfare state. But as “a practical matter,” he wrote, “spending cuts must come before tax cuts,” in order to avoid “deficit spending” and its inevitable “inflationary effects.” During Goldwater’s 1964 presidential run, Ronald Reagan gave a popular speech in support of the candidate that paved the way for Reagan himself to assume the mantle of conservative leadership after Goldwater’s defeat. Called “A Time for Choosing,” the talk, according to Reagan biographer Lou Cannon, was “more controversial and hyperbolic in content than any which Goldwater had given for himself.” Yet even this conservative broadside did not contain a call for lowering taxes. Later, in 1975, Reagan criticized President Ford when he abandoned his push for a deficit-reducing tax increase in favor of the economic stimulus of a tax cut.

What intervened to transform conservatism into a movement focused on the evils of taxation was the economic conditions of the 1970s. In 1969, the inflation rate began to rise. It fluctuated at elevated levels throughout the next decade, recording a high in 1980 of 13.5%. At the same time, employment declined. This combination confounded economists. Rising prices are typically caused by an increase in the consumption of goods, which would usually lead to an increase in hiring. Thus inflation and unemployment should not exist at the same time. Contemporaries had to coin a new word for their economic situation: they called it “stagflation.”

Conventional wisdom had no remedy for stagflation. The consensus economic philosophy since the Great Depression was rooted in the Keynesian approach, but Keynes had been concerned with depression rather than inflation. His solution to the problem of joblessness—increasing aggregate demand through government spending—would most likely have exacerbated the primary problem.

Whenever demand is greater than supply, inflation will result. The typical cause of this rise in prices is an “overheating” economy, in which people are doing well and consequently want to purchase lots of goods. In response, producers manufacture more goods, raise prices and wages, and hire extra workers. Employees have more money to spend, and consume more goods. As long as this cycle continues, everything will keep getting more expensive. But the situation in the seventies was characterized by inflation combined with a dearth of jobs. It was unprecedented, and no one had any answers. This intellectual void was filled by a new philosophy founded by economists Robert Mundell and Arthur Laffer, and publicized by journalist Jude Wanniski. Known as “supply-side economics,” this school issued prescriptions that deviated markedly from the Keynesian orthodoxy. The supply-siders reasoned that the current inflation was caused less by “too much” demand than by “not enough” supply. For some reason, they believed, producers of goods were unwilling to take on new projects. As a result, both jobs and goods were scarce. When diagnosed this way, the problem admitted of an obvious solution: production must be increased.

But what was the cause of the unwillingness to produce? The supply-siders believed that the problem was rooted in the fact that taxes were too high. Under the progressive tax code, they argued, earnings above a certain level were taxed at such a high rate that there was little point in earning money. (This was no idle concern: the highest marginal income tax rate throughout the 1970s was 70%. Today, by comparison, it is 39.6%.) Business leaders had no incentive to produce, nor wealthy individuals any reason to invest. Under this interpretation, lowering taxes would make production more attractive, leading to more employment, a greater supply of goods, and lower prices. Wanniski effectively announced the movement’s arrival with a 1974 editorial in the Wall Street Journal titled “It’s Time to Cut Taxes.” There he called for a tax cut of $30 billion. (For comparison’s sake, note that Gerald Ford would shortly thereafter negotiate a $9 billion tax cut with Congressional Democrats.) Within a few months, Mundell and Laffer published an article arguing for a $60 billion cut.

Wanniski recognized that tax cuts could also pay politically: if the Democrats had been promising social welfare programs to one sort of voter, Republicans now had tax relief to offer to a different sort. Before long, supply-side economics became attractive to up-and-coming conservative politicians, most notably Jack Kemp and Ronald Reagan. The latter, of course, took that approach into the White House. Reagan became the most significant figure in the history of supply-side economics, effectively making it synonymous with conservatism.

Supply-side economics transformed the conservative movement. Tax reduction had not been a priority of mid-century conservatives, but today it defines the conservative approach. Yet this program was developed at a specific time to confront a specific problem, and the commitment to cutting taxes remained an important part of conservative thinking long after that particular condition had passed. Unmoored from its original purpose, tax cutting has hardened into an ideology in which it is always the answer, no matter what the question.

Moreover, Reagan has become the most significant political figure of the age. His influence has continued well past his death in 2004, and today conservatism is the dominant public philosophy. The center has moved to the right: liberals avoid identifying as such, and the Republican Party is split between moderately conservative and radically conservative factions. Under these conditions, supply-side economics sets the parameters for the discussion of economic issues not just among conservatives, but nationally. It is important, then, to recognize this worldview for what it is.

The emphasis on reducing taxes is the contemporary focus regarding government economic intervention. Previous periods have been characterized by different preoccupations, but in each of them many saw their particular concerns as an insight into the true nature of economic liberty, or as the long-awaited solution to a perennial problem. The historical perspective suggests, however, that they were wrong to believe that. Instead, the ideas that animated these moments generally arose out of local concerns, and their transformation into cant often marked the point at which they began to outlive their usefulness. It has been 34 years since Ronald Reagan was elected to the presidency on a supply-side platform. Though predicting the character of the next era of government economic intervention is impossible, we may not have to wait long to see it.

5 Thoughts on this Post

  1. Mike, very neat stuff. Hope to see you at the Policy History. Here’s the WSJ in 1953: “Eisenhower and Taft have the right idea. The way to talk about tax reductions is to talk about spending reductions. So long as we have a $75-79 billion budget and a $5-10 billion deficit, it’s a waste of time to talk about lower taxes. When we have a budget in balance tax reductions can follow automatically. You can’t unlock the door with any other key.” Interestingly, Robert D. Novak was the one writing most of the WSJ news articles during JFK’s push for a tax cut, while Robert L. Bartley was getting his start at the paper. In Econoclasts, I suggested that it was Bartley’s acquaintance with Wanniski at Dow Jones that got Bartley “thinking things over” (to use his predecessor, Vermont Royster’s phrase). Novak of course became a very avowed supply-sider. I’m wondering if Novak and Bartley’s work together in the 1960s didn’t begin the shift.

    • Since I learned everything I know about supply-side economics from your book Econoclasts, Brian, I very much appreciate your feedback. I love the WSJ quote: it really underscores the point well. You know much more about Novak and Bartley than I do: maybe you can explore that relationship in a paper at the S-USIH conference this October! (The submission deadline is Friday.)

  2. It is no exaggeration to say that the centerpiece of economic conservatism is a commitment to cutting taxes.

    “Fiscal responsibility” paints a more complete picture: the difference between tax revenues and government spending cannot be sustained, and saddling future generations with unmanageable debt is immoral.

    Cutting spending [or more accurately, arresting its growth] is equally if not more imperative.

    The impetus for tax cuts lies in the Laffer Curve, which holds that after a certain optimal tax rate, economic activity becomes distorted, as businesses and individuals make financial decisions based not on what is most economically productive, but what avoids the most taxes. At the moment, we’re rather in a narrow habitable zone whether Bill Clinton raised taxes a bit or Bush cut them slightly.

    Despite the heat of the rhetoric from either side, the needle moves not much either way.


  3. “a dearth of jobs” in the 70’s, or maybe a surplus of baby boomers entering the labor market?

    If memory serves there were also periodic tax cuts through the 60’s, because inflation pushed people into higher brackets. I think it was Nixon who got the tax code changed to index the brackets against inflation, thus eliminating those “cuts”.

  4. Once again, this is really fascinating stuff. I can’t see conservatism’s reliance on tax cuts abating anytime soon, but just as intriguing, I think, is the lack of a response from liberalism to any of this (as you pointed out above in the section on how liberalism and conservatism have changed so much in recent history).

    At the very least, there’s nothing the media is willing to take seriously from the Democratic Party except a mix of targeted tax cuts and a few tax hikes on the very wealthy. I think of the “People’s Budget” that was proposed a few years ago by the Congressional Progressive Caucus, and which received very little attention beyond left-wing and progressive periodicals. http://cpc.grijalva.house.gov/the-peoples-budget/

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