ECONOMY:Prepare for the Worst

Prepare for the Worst
By Peter Ferrara
Published 10/8/2008 12:08:08 AM


Just two weeks ago, a book on economic policy was released that will be a classic for the ages. Entitled The End of Prosperity, by Art Laffer, Steve Moore, and Peter J. Tanous, the book explains in full detail the economic disaster that will befall America if it takes a sharp left turn to neo-socialism under the leadership of the far left President Barack Obama, the ultraleft Speaker of the House Nancy Pelosi, Senate Majority Leader Harry Reid with 60 liberal Democrat Senators, and their pal the ultraliberal Howard Dean heading the Democrat party.

Indeed, one of the insights of the book is that a major factor already tanking the stock market and leading foreign capital to flee America is the threat of the economic policies promised by Obama. Obama proposes increases in every major federal tax, on savers, investors, employers, small business, big business, and anyone who would start a business. Obama also promises to add additional federal spending of almost $1.5 trillion over the next four years, including a new global war on poverty in which Obama would tax Americans and send the money to the UN to spend worldwide (already introduced by Obama in legislation). That would be on top of all the spending increases already scheduled for our exploding entitlements and other programs. Obama also promises a massive increase in regulatory controls, even though government regulation is already estimated to cost America over $1 trillion per year, about $8,000 in lost output for every U.S. household. Then there is Obama's attack on free trade and promises of protectionist trade policies that contributed so much to the Great Depression.

As the authors show, these retrograde economic policies are intellectually indefensible. They do not offer forward looking change, but would take us back to the policies of the disastrous 1970s and even worse 1930s. They would ultimately produce a deep, long term decline in America's standard of living, particularly for the middle class and working people. America would actually fall behind countries around the world that, exactly contrary to the left wing swing of the Democrats, have been racing to adopt precisely the hugely successful Reagan supply side policies of low tax rates, less government spending, deregulation, and anti-inflation monetary policies.


The Reagan Economic Boom
When President Reagan entered office in 1981, succeeding Jimmy Carter who had an overwhelmingly liberal Democrat Congress, the American economy was in shambles. Inflation had reached 11.6% in 1979 and 13.5% in 1980, a devastating 25% increase in prices in just two years. The prime interest rate had reached 21.5% in 1980, with home mortgage interest rates soon climbing as high as an absurd 14.7%. Unemployment began an upward climb during the Carter years that eventually peaked at over 10% in 1982.

The poverty rate actually started increasing in 1978 during the Carter years, eventually climbing by an astounding 33%, from 11.4% to 15.2%. A fall in real median family income that began in 1978 snowballed to a decline of almost 10% by 1982. Average real family income for the lowest income 20% declined by 14.2%. Indeed, during the Carter years (1977 to 1980), real income declined for every quintile, from the lowest 20% to the highest 20%. Real average income of U.S. households was, in fact, in a long-term decline, down rather than up from 1970 to 1980.

The Reagan economic policy to reverse this economic devastation consisted of the following:

1. Tax cuts to restore incentives for economic growth, involving first a reduction in the top income tax rate of 70% down to 50%, which probably produced a net increase in revenue by itself, and then a 25% across the board reduction in income tax rates for everyone. The 1986 tax reform then reduced tax rates further, leaving just two rates, 28% and 15%;

2. Spending reductions, including a $31 billion cut in spending in 1981, close to 5% of the federal budget then, or the equivalent of about $150 billion in spending cuts for the year today. In constant dollars, non-defense discretionary spending declined by 14.4% from 1981 to 1982, and by 16.8% from 1981 to 1983. Moreover, in constant dollars, this non-defense discretionary spending never returned to its 1981 level for the rest of Reagan's two terms! By 1988, this spending was still down 14.4% from its 1981 level in constant dollars. Even with the Reagan defense buildup, total Federal spending declined from a high of 23.5% of GDP in 1983 to 21.3% in 1988 and 21.2% in 1989. That's a real reduction in the size of government relative to the economy of 10%;

3. Anti-inflation monetary policy restraining money supply growth;

4. Deregulation, which has now saved consumers an estimated $100 billion per year in lower prices. Reagan's first executive order, in fact, eliminated price controls on oil and natural gas. Production soared, and the price of oil declined by over 50%;

5. Free trade, reflected in worldwide agreements to reduce tariff taxes.

This was the most astoundingly successful economic policy in U.S. history, turning around a rapidly declining economy into a raging economic boom. The Reagan recovery started in official records in November, 1982, and lasted 92 months without a recession until July, 1990, when the tax increases of the 1990 budget deal killed it. This set a new record for the longest peacetime expansion ever, the previous high in peacetime being 58 months.

During this 7 years, the economy grew by almost one-third, the equivalent of adding the entire economy of West Germany, the third largest in the world at the time, to the U.S. economy. In 1984 alone, real economic growth boomed by 6.8%, the highest in 50 years. Nearly 20 million new jobs were created during the boom, increasing U.S. civilian employment by almost 20%. Unemployment fell to 5.3% by 1989. Also in that year, labor force participation reached a record 66.5 percent, and a record 63 percent of the population was employed. Black labor force participation also hit a record 64.2 percent in 1989, with female labor force participation reaching an all-time record of 57.5 percent in 1990.

Real per capita disposable income increased by 18% from 1982 to 1989, meaning the American standard of living increased by almost 20% during the boom. The Carter decline in income for the bottom 20% of income earners was reversed, with average real household income for this group rising by 12.2% from 1983 to 1989. The poverty rate, which had started increasing during the Carter years, declined every year from 1984 to 1989, dropping by one-sixth from its peak.

The shocking rise in inflation during the Carter years was also reversed. Spectacularly, inflation from 1980 was reduced by more than half by 1982, to 6.2%. It was cut in half again for 1983, to 3.2%. The prime rate was cut by two-thirds by 1987 to 8.2%, on its way down to 6.25% by 1992. New home mortgage rates also declined steadily, reaching 9.19% by 1988, on their way down to 8% by 1992. Note that opponents of the Reagan tax cuts had argued that they would increase interest rates.

The stock market more than tripled in value from 1980 to 1990, a larger increase than in any previous decade. Real personal assets rose by nearly $6 trillion, from $15.5 trillion in 1980 to $21.1 trillion in 1990, an increase of 36%. Total real private net worth rose by $4.3 trillion from 1980 to 1989, totaling $17.1 trillion in constant dollars, an increase of one-third.

Even with the Reagan tax cuts, total federal revenues doubled from 1980 to 1990, growing from $517.1 billion to $1,031 billion, or just over $1 trillion. In Reagan's last budget year, fiscal 1989, the widely overballyhooed federal deficit had declined to $152.5 billion, about the same as a percent of GDP as in 1980. 2.9% compared to 2.8%. By 1989, the Soviet Union was collapsing. Reagan had won the Cold War without firing a shot, completing the most successful Presidency in U.S. history.


The 25 Year Reagan Boom
Laffer et. al point out that this Reagan recovery grew into a 25 year boom, with just slight interruptions by shallow, short recessions in 1990 and 2001. They write:

We call this period, 1982-2007, the twenty-five year boom -- the greatest period of wealth creation in the history of the planet. In 1980, the net worth -- assets minus liabilities -- of all U.S. households and business...was $25 trillion in today's dollars. By 2007...net worth was just shy of $57 trillion. Adjusting for inflation, more wealth was created in America in the twenty-five year boom than in the previous two hundred years.

They add, "The economy in real terms is almost twice as large today as it was in the late 1970s." Moreover:

In 1967 only one in 25 families earned an income of $100,000 or more in real income (in 2004 dollars), whereas now almost one in four families do. The percentage of families with an income of more than $75,000 a year has more than tripled from 9 percent to almost 33 percent from 1967 to 2005.

In addition, "A poor family in 1979 was more likely to be rich by the early 1990s than to still be poor." The authors cite a Congressional Budget Office study, backed up by a later Treasury Department study, finding that "from 1994 to 2004 Americans in the bottom 20 percent of income actually had the highest increase in incomes." The authors continue,

When you track real families -- real people -- over time, you find that people who are poor at the start...have the biggest subsequent gains in income. Amazingly, the richer a person is...the smaller the subsequent income gains. Those in the top 1% actually lose income over time.

Or, as Nobel Prize winning economic historian Robert Fogel wrote in 2004, "In every measure that we have bearing on the standard of living...the gains of the lower classes have been far greater than those experienced by the population as a whole." Under Reaganomics, the rich have gotten richer and the poor have gotten richer too.


The Kennedy Tax Cuts
Reagan was not the first or the last to adopt sweeping tax cuts to boost the economy. It has happened four, perhaps five, times in the last century, with virtually the same results every time. One of these was adopted under President John F. Kennedy, who cut the top tax rate from 91% to 70%, seeking as well a 30% across the board rate cut for everyone else. Compared to national income and the total budget, the Kennedy tax cut was three times larger than the Bush tax cut, which only reduced the top tax rate a measly 4.6 percentage points from 39.6% to 35%. Kennedy said,

Our true choice...is between two kinds of deficits -- a chronic deficit of inertia, as the unwanted result of inadequate revenues and a restricted economy -- or a temporary deficit of transition, resulting from a tax cut designed to boost the economy, produce revenues, and achieve a future budget surplus. The first type of deficit is a sign of waste and weakness -- the second reflects an investment in the future.

Kennedy also said, "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 tax rates....[A]n economy constrained by high tax rates will never produce enough revenue to balance the budget, just as it will never create enough jobs or profits."

In response to the Kennedy tax cuts, the economy grew by 10% in just 2 years, with the annual economic growth rate increasing by 50%. More than 1 million jobs were created in the following 4 years, and unemployment fell to its lowest peacetime level in more than 30 years. Federal income tax revenues grew by 41% during those 4 years, with U.S News and World Report saying, "The unusual budget spectacle of sharply rising revenues following the biggest tax cut in history is beginning to astonish even those who pushed hardest for tax cuts in the first place."


The End of Prosperity
Laffer et al. explain why they think the end is now near:

[W]e are now witnessing nearly all of the economic policy dials that were once turned toward growth being twisted back towards recession. [O]ur politicians in both parties, but especially the liberal Democrats, are getting everything wrong -- tax policy, regulatory policy, monetary policy, spending policy, trade policy. We call this the assault on growth. The political class seems to be almost intentionally steering the United States economy into the abyss -- and, to borrow a phrase from P.J. O'Rourke, the American electorate, alas, seems ready and willing to hand them the keys and the bottle of whiskey to do it.

Obama promises across the board tax increases, America's corporate tax rates are already the second highest in the industrialized world, prices are already rising and the dollar is declining, America is turning its back on free trade, the federal budget is already spiraling out of control and entitlements threaten far worse, regulations already strangle energy production, producing high energy costs for the economy, cap and trade global warming regulations threaten to shut the economy down, unions calling for legal powers to force unionization, the left campaigns for costly but low quality socialized medicine, these are all indicators of a fatal economic heart attack for America. Laffer et al. explain what is behind the current financial crisis:

This list of economic body blows explains why, for the first time in years, hot capital is escaping over the borders out of the United States and flowing into China, India, Europe, and even Japan....[S]tarting in late 2007, foreigners started pulling their money out of the United States, and Americans started investing more abroad. Global investors are losing confidence in the U.S. The result is a falling stock market and a collapse of the dollar.

The threatened left-wing economic policies are all the more dangerous now because the rest of the world has shifted so sharply towards much lower tax rates and free markets, threatening to leave America in the dust as an uncompetitive wasteland mired in nostalgia for socialism. Since Reagan, income tax rates across the industrialized world have been cut by more than one-third, and corporate tax rates have been reduced by one-half. The flat tax has been adopted in 24 countries. Putin adopted a 13% rate for Russia that raises more revenue than the former system with a 50% top rate. From 1978 to 1998, China reduced its tax burden by two-thirds. A recent study found that "supply-side" countries that have cut their tax rates almost in half since the 1990s have grown three times as fast as countries that have raised taxes since that time.

It is, frankly, obvious that lower tax rates increase incentives for economic growth and productive activity, and that higher tax rates reverse such incentives. Nor is it hard to understand that increasing regulatory costs will slow the economy while reducing such costs will expand it. Obviously, ample supplies of low cost energy will help the economy, shortages of high cost energy will kill it. High government spending is clearly not good for the economy, lower government spending is. We know how to create an economic boom, and we know what policies will lead to economic disaster. The Left denies these obvious truths only because it craves more government power. If America does not wake up to what is happening, there will be much suffering through a long dark night.


Peter Ferrara serves as Director of Entitlement and Budget Policy for the Institute for Policy Innovation, and General Counsel of the American Civil Rights Union. He formerly served in President Reagan's White House Office of Policy Development, and as Associate Deputy Attorney General of the United States under the first President Bush. He is a graduate of Harvard College and Harvard Law School.


http://www.spectator.org/dsp_article.asp?art_id=14015