Wednesday, June 22, 2011

Reaganomics' Resurgence

Reaganomics' Resurgence
By Peter Ferrara on 6.22.11 @ 6:08AM

In my new book, America's Ticking Bankruptcy Bomb, I argue that the first step in defusing the bomb, and averting the coming bankruptcy of America, is to restore America's world leading economic prosperity. Only another economic boom can hope to generate enough revenue to finance essential continuing obligations. And only another boom can reduce dependency sufficiently to enable us to make the necessary spending cuts to reduce the overwhelming deficits, debt and other liabilities that threaten the survival of the American Dream.

The American Dream is not over. This economy has another economic boom inside it just straining to break out. The book argues that the best way to see how to ignite such a boom once again is to examine what we did the last time America fell into a downward economic spiral.

Reaganomics 1.0

When President Reagan was elected in 1980, America suffered double digit inflation, double digit interest rates, and soon double digit unemployment. Three worsening recessions starting in 1969 were about to culminate in the worst of all in 1981-1982, with unemployment peaking at 10.8%. Inflation raged at 11.3% in 1979 and 13.5% in 1980, or 25% in two years. The Washington establishment at the time argued that this inflation was now endemic to the American economy, and could not be stopped, at least not without a calamitous economic collapse.

The poverty rate started increasing in 1978, 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. In addition, from 1968 to 1982, the Dow lost 70% of its real value, reflecting an overall collapse of stocks.

President Reagan campaigned on an explicitly articulated, four-point economic program to reverse this slow motion collapse of the American economy, which he implemented once elected:

1. Cut tax rates to restore incentives for economic growth, particularly incentives for increased production achieved by allowing producers to keep a higher percentage of what they produce. That encompasses incentives to start new businesses, expand businesses, and create jobs.

2. Cut government spending, embodied first in the 1981 Reagan budget cuts much vilified by the Left at the time. 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! Even with the Reagan defense buildup, which won the Cold War without firing a shot, 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 holding money supply growth to money demand, to maintain a stable value of the dollar.

4. Deregulation, to reduce costs for businesses and consumers.

These economic policies amounted to the most successful experiment in world history. 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 created a short, shallow recession. This set a new record for the longest peacetime expansion ever, the previous high in peacetime being 58 months.

During this 7-year recovery, 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 recovery, increasing U.S. civilian employment by almost 20%. Unemployment fell to 5.3% by 1989.

The shocking rise in inflation during the Carter years was reversed. Astoundingly, 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%, never to be heard from again until recently.

Real per capita disposable income increased by 18% from 1982 to 1989, meaning the American standard of living increased by almost 20%, in just 7 years. The poverty rate declined every year from 1984 to 1989, dropping by one-sixth from its peak. The stock market more than tripled in value from 1980 to 1990, a larger increase than in any previous decade.

This economic recovery flowered into a 25-year, generation-long economic boom, which Art Laffer and Steve Moore rightly call in their book The End of Prosperity, "the greatest period of wealth creation in the history of the planet." Steve Forbes rightly called it an "economic golden age." This success was not just a matter of fortuitous correlation. Reversing the accelerating downward economic spiral of the 1970s into this unprecedented boom arose directly out of the timeless economic reasoning described above. This reasoning shows why these policies and their spectacular results are still instructive for today.

Perversely, President Obama has doggedly pursued the opposite of Reaganomics in every detail. Instead of tax rate cuts, in 2013 he is raising the top tax rate of almost every major federal tax, while maintaining virtually the highest corporate tax rate in the industrialized world. Instead of Reagan's budget cuts and budget restraint throughout his term, Obama came in with the trillion dollar stimulus and runaway government spending since then, increasing federal spending by almost a third in three years, and proposing to increase it by almost another two-thirds by 2021.

Instead of deregulation, Obama is pouring on the regulatory costs, especially in energy, health care, and financial services. These are effectively more major tax increases on the economy. On monetary policy, instead of restraining money growth to slay an historic inflation, Obama cheerleads the Fed to run the money printing presses over time, recreating inflation.

These are the reasons there has been no effective recovery from the recession, for the first time since the Great Depression, and why Obamanomics portends what I have called, in a previous column, the coming crash of 2013.

Reaganomics 2.0

In my book I discuss how to apply the lessons of Reaganomics to economic policy today to regenerate another historic economic boom. I propose individual tax reform establishing an optional flat tax with a 15% rate, and corporate tax reform with a 15% rate as well.

The capital gains tax and the taxation of corporate dividends are just multiple layers of tax on the same capital income stream, and so should be abolished. But even just maintaining the Bush tax rates of 15% on both would be workable. The death tax and the alternative minimum tax must be abolished, however, because they involve just too many taxes on the same income.

All investment in capital equipment should be deductible in the year the expense is incurred, just as with all other business expenses, replacing arbitrary depreciation stretching out the deduction over many years. This would maximize incentives for investment in tools and technology for production, ensuring that American workers will enjoy the most modern and productive equipment in the world. They would consequently further zoom ahead in productivity, and in wages and standard of living as a result.

As I will discuss further next week, I also propose in the book ultimately to replace the payroll tax entirely over time with personal savings, investment and insurance accounts to finance all of the benefits now financed by the payroll tax.

On monetary policy, we would maintain a stable dollar without inflation if the Fed was tethered to a price rule in its conduct of monetary policy. That means the Fed would be guided by market prices for gold, silver, oil, and other key commodities, as well as the dollar, in determining monetary policy. When these prices started to rise, the Fed would cut back on money creation. When they fell the Fed would accelerate money supply growth.

This would effectively equate the supply of money in dollars with the money demand for dollars. That policy maximizes investment, promoting economic growth and jobs, because investors know the value of their investments will be maintained without depreciation due to inflation or a declining value of the dollar. It also minimizes cyclical recessions that might crash their investments, as we saw with little or no recessionary cycles during the 25-year boom from 1982 to 2007. We should explore as well further anchoring the dollar to gold.

The most important and urgent deregulatory policy for creating another economic boom is to unleash the private sector to enable it to produce a plentiful supply of low cost energy. That would provide a lower cost foundation for the entire economy, effectively equivalent to another major tax cut. That includes terminating the EPA's cap and trade global warming regulatory tsunami, which is building towards ultimately imposing trillions in higher costs on the economy.

America enjoys the resources to be the world's number 1 oil producer, the world's number 1 natural gas producer, the world's number 1 coal producer, and the world's number 1 producer of nuclear energy. The problem is that our own government has stood perversely in the way, preventing America from using its own resources to produce a reliable supply of low cost energy. Just think of all the jobs that would be created directly in the energy industry alone from unleashing the private sector to maximize production.

Another critical deregulatory initiative would be to repeal the Dodd-Frank financial market reforms, terminating in the process the "Too Big to Fail" bailout policy that Dodd-Frank enshrines. Those sweeping regulatory burdens threaten to further shut down critical business and consumer lending just when we need those financial markets to revive to restore the economy to normal growth. Further liberating financial markets from unnecessary regulatory cost burdens would involve repealing Sarbanes-Oxley, along with the Community Reinvestment Act and the mark to market accounting requirements that contributed mightily to the financial crisis.

Of course, repealing Obamacare would involve major deregulation of health care, and remove the employer mandate requiring employers to provide the most costly health insurance. All of this would primarily just serve to stop Obama's rapid increases in the total cost of federal regulation, estimated recently by the Competitive Enterprise Institute to total $1.75 trillion a year, 10 times the corporate tax burden, and double the individual income tax burden. We need further deregulation to work on reducing that.

Finally, my book discusses reducing federal spending to balance the budget. That would start by returning every budget line item except for Social Security, Medicare, Medicaid and interest on the national debt back to 2007 levels. Based on the President's own budget documents, this would save $527 billion in annual spending to start, growing over time as the long-term baseline would be lower.

A second central theme to balancing the budget is a comprehensive, full scale assault on all corporate bailouts and corporate welfare throughout the entire budget. This would include, of course, terminating all TARP and all other bailouts, and returning the money to the federal treasury rather than recommitting the money to any further bailouts. Fannie Mae and Freddie Mac, those twin engines of the financial crisis that have already sucked up $150 billion in taxpayer bailouts and counting, should be phased out over the years, replaced by private financial institutions securitizing mortgages in competitive markets.

This would apply as well to all of President Obama's "green" energy subsidies, which studies show would kill more jobs than they create, and any subsidies for traditional energy as well. I favor all forms of "alternative" and "green" energy that can survive in the marketplace without taxpayer bailouts. But overall, the U.S. Energy Information Agency reports that taxpayer subsidies for wind and solar projects average nearly 100 times those for oil and natural gas, nearly 50 times those for coal, and even 15 times those for nuclear production. The economy would go broke with taxpayers so heavily subsidizing entirely new energy industries, which in turn produce higher cost energy for the economy to run on.

President Obama's own debt commission proposed reducing the federal workforce by 10%, and freezing federal pay for three years. The Debt Commission also proposed merging the Small Business Administration with the Department of Commerce. But given all the other reforms proposed in my book, the remaining functions of the Departments of Agriculture, HUD, Labor and Commerce could all be merged into a new Department of Economic Growth, with the mission of promoting pro-growth economic policies. Given its remaining functions, the Department of Energy could be split into the Departments of Interior and Defense. And the remaining functions of the Department of Education could be block-granted back to the states, since education is primarily a state and local function.

Some other spending cuts are just long overdue, as further recognized by the Debt Commission. With modern satellite television and radio, not to mention cable TV, we cannot justify borrowing money from the Chinese to finance National Public Radio and Public Television. They need to finance their own way in the private sector. The same goes for AMTRAK. To the extent necessary to balance the budget within the 10-year budget window, all non-defense discretionary spending should be frozen until that is achieved.

The book also discusses in full detail how to reform each of the entitlement programs, including the repeal and replacement of Obamacare, which I will start to review next week. By modernizing these programs to rely centrally on modern capital, labor and insurance markets, rather than old-fashioned tax and redistribution, we can achieve all of the liberal social goals of those entitlement programs far more effectively, actually serving seniors and the poor far better, at just a fraction of the current projected cost of these programs. That is why these reforms are all politically seaworthy, not kamikaze missions, as reflected by the drafting of model bills by members of Congress to be introduced shortly, which I will also discuss next week.

With a balanced budget and booming economic growth, the national debt as a percent of GDP would plummet, slashing debt interest spending as well. Overall, implementing all of the reforms in the book would leave the federal government in the future only half the size it would be otherwise, or less.

To read an another article on this subject, click here.

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