A review of Econoclasts: The Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity , by Brian Domitrovic
Econoclasts is the inspiring story of how a few entrepreneurial scholars and thinkers turned economic orthodoxy on its head and brought unprecedented prosperity to America, and much of the world, for almost two generations. Arthur Laffer, Jude Wanniski, Robert Bartley, Jack Kemp, Robert Mundell, and many others—but most importantly, President Ronald Reagan—saved the world from the devastations of stagflation, runaway inflation, unemployment, and deindustrialization. The supply-siders, as they were called, were radical rebels who argued that Keynesianism was a fraud. They were regarded as mad men, lunatics, as are all great thinkers who topple the establishment.
The book is an amazing history of one of the most important chapters in the evolution of economic thought, and it's a wonder the story hasn't been told before now. To this day, modern economics textbooks treat the supply-side movement as a fad and even as a failed experiment. My teenage son's textbook describes Reagan's economic policy as a belief that tax cuts would balance the budget and revive the economy, but instead they brought record levels of debt and widened the income gap between rich and poor. (If they think Reagan brought us debt, I can't wait to hear historians spin the Obama presidency, where deficits are already twice as large a share of GDP as the highest deficits under Reagan.) Slate columnist Michael Kinsley calls supply-side economics "the classic Republican phony theory." The liberal blog page Daily Kos refers to supply-side theory as "the greatest lie ever told over the last 30 some odd years."
Brian Domitrovic, assistant professor of history at Sam Houston State University, narrates in great detail just how savagely the supply-siders were ridiculed and ostracized by the establishment Keynesians. Throughout the 1970s supply-siders were regarded as mere nuisances, until Reagan was elected and the new theories put in place, to the establishment's horror. The young Arthur Laffer was the butt of jokes by Paul Samuelson, the Nobel prize-winning godfather of neo-Keyensianism and author of the macroeconomics textbook two generations of Americans were forced to read in college. Samuelson presented a paper called "Why They Are Laughing at Laffer," mocking a GDP prediction that Laffer made while working as an economist in the Nixon Administration—a GDP prediction which turned out to be almost precisely correct.
The supply-siders had the insight that incentives matter, that all the effects of policy are at the micro-level, not the macro-level. They argued that people work to earn income, not pay taxes, and when taxes get too high, they won't work. Money's chief function, they said, is to be a storehouse of value and to retain that value over time. The Laffer Curve is at the heart of the theory. It shows that when tax rates get too high, work, effort, and even tax revenues are reduced.Econoclasts recounts Laffer's historic first drawing of the Curve on a cocktail napkin at a meeting in the early 1970s with Dick Cheney, Donald Rumsfeld, and Wall Street Journal associate editor Jude Wanniski. That napkin belongs in the Smithsonian Institution.
It wasn't only Republicans who signed up for this new economic theory. Domitrovic reminds us that the economic wrong-headedness of the '70s had led the nation into a ditch of high inflation, high unemployment, and slow growth—or as they called it in those days, "malaise." Many Democrats revolted in the late '70s and early '80s: Sam Nunn, Dick Gephardt, Lloyd Bentsen, Bill Bradley, and Phil Gramm (before his Republican switch) subscribed to the idea that tax rate reductions could regenerate American economic might. In 1980 the House's Joint Economic Committee under Senator Bentsen issued a report entitled "Plugging in the Supply-side." The House and Senate passed a supply-side income tax cut in 1979 that was vetoed by President Carter. If Carter had signed that bill, there might never have been a President Reagan.
But of course it was Reagan who carried the day for the Kemp-Roth tax cut, chopping the income tax rate from 70% to 50% and then to 28%, and cutting the capital gains, dividend, and estate tax rates, too. Just as important, Domitrovic reminds us, was the disinflation of the 1980s under Federal Reserve chairman Paul Volcker whose monetary policy brought the annual rate of increase in the Consumer Price Index from 14.5% down to 3%—something no one thought possible.
Yale's James Tobin, the dean of the neo-Keyensians, had warned that Reagan's tax cuts and tight money policies were like two trains pulling in opposite directions, "working at cross purposes." But he and the Keynesian orthodoxy were wrong. Reaganomics worked. Oh my, how it worked. Between 1982 and 2007 the U.S. gained some 40 million new jobs—five times more than Europe. The net wealth of the nation rose from $18 trillion to $57 trillion by late 2007. This period saw an entrepreneurial boom in which small start-ups became mega-firms with mega-profits. Domitrovic mentions Microsoft, Wal-Mart, Apple, Intel, Dell, Cellular, Starbucks, Goldman Sachs, Federal Express, and Google as beneficiaries of the supply-side revolution. Incomes shot up for nearly everyone as America enjoyed more than a generation of general prosperity with the economy growing an astounding 95% of the time. Inequality grew only because some grew rich much faster than others.
The triumph of supply-side policies seems hard to refute in retrospect. As Robert Lucas, the Nobel Prize-winning macroeconomist, initially skeptical of supply-side economics, wrote in 1990, "The supply-side economists have delivered the largest genuine free lunch I have seen in 25 years in the business and I believe we would be better off if we listened to their advice." Then in a 2007 requiem on supply-side economics in the Wall Street Journal, he wrote that as a result of the "two macroeconomic changes of the last fifty years that really mattered," by which he meant massive disinflation and tax rate reductions on capital and labor, America achieved "steady GDP growth, low unemployment, and low inflation rates—once thought to be an impossible combination."
Alas, maybe there isn't such a happy ending after all. Sure, the supply-siders have been vindicated by the actual performance of the economy. They helped pull millions of people in the U.S. and around the world out of poverty. They conquered inflation. But instead of listening to their advice, U.S. politicians today (including President Obama, Harry Reid, and Nancy Pelosi) are set on a course of anti-supply-side policies. Tax rates are going way up in 2011—on capital gains, dividends, personal income, and estates. There is talk of a wealth tax or a value added tax to close massive deficits. Some high-level Democrats have advised increasing the top tax rate to 50% or more. "We have tried tax cuts, and they do not work," President Obama declared when he unleashed his $800 billion spending plan. Will someone please deliver this book to his doorstep?