Tuesday, January 15, 2008

Is Reaganomics dead?

James Pethokoukis, writing in U.S. News & World Report wonders if supply side economics is washed up:

"Supply-side economics had a good run, but continual tax cuts can no longer be the centerpiece of Republican economic policy," New York Times columnist David Brooks recently opined. "Smart Republicans are groping for a new economic model, and as they do, Republican economic policies are shifting. The entrepreneur is no longer king. The wage-earner is king. As the presidential campaign rolls into Michigan, it's clear that Republicans are adjusting their priorities to win back the anxious middle class."

Specifically, this "new model" of Republicanism would focus less on taxes and more on worker worries about education, healthcare, job volatility, and America's long-term debt burden. And indeed, parts of such a new approach can already be seen creeping into the agendas of the various GOP candidates. Mitt Romney wants government to spend more money on basic scientific research. Mike Huckabee wants to create a prevention-based healthcare system. John McCain advocates a
"wage insurance" program for workers. Fred Thompson wants to slash projected increases in Social Security payments.

National Review writer Ramesh Ponnuru is another advocate of this new domestic agenda, noting that since many Americans pay no income tax once they take advantage of various credits and deductions—more than a third of tax return filers vs. fewer than a fifth when Ronald Reagan took office in 1981—tax cuts have waning political oomph. Ponnuru would instead like to see a dramatically bigger child tax credit to relieve the financial stress on families.

McCain may be the purest example of this "new Republican." Yes, he is for extending the 2001 and 2003 tax cuts, even though he voted against them. But McCain is clearly no supply-sider. Recall this moment from the recent South Carolina presidential debate. Moderator Chris Wallace of Fox News asked McCain the following:

Senator McCain—and you have 90 seconds to answer this full question—some of these ideas that are being talked about, like education and research and development, are longer term. If we're talking about a recession in the next few months, in 2008, what kind of short-term, more immediate government fixes would you propose to try to keep the slowdown diminished or to reverse it? And would you support them even if they added to the government deficit?'

McCain's response:

Well, the first thing we need to do is stop the out-of-control spending. Out-of-control spending is what caused the interest rates to rise. It causes people to be less able to afford to own their own homes. We need to stop the spending. And that way we can get our budget under control and we can have a—basically a strong, fundamental fiscal underpinning.

That isn't Reaganomics. It's more like Clintonomics (or Rubinomics, really), the belief that fiscal prudence—whether through higher taxes or lower spending—encourages bond investors to accept lower rates of return, thus lowering interest rates and boosting economic growth. (
Here is a reality check on Clinton economic policy.)

The data show McCain is wrong. When President Clinton left office on Jan. 20, 2001, the 30-year U.S. treasury bond was trading at 5.55 percent. Since then, we've had six straight years of budget deficits, totaling more than $1.5 trillion in red ink. Yet as I write this entry this morning, the 30-year bond is actually yielding 4.33 percent—more than a full point lower than it was when Clinton left office, despite a return to deficit spending, not to mention the continued lack of action on America's growing entitlement problems.

Yet there are plenty of reasons to think tax cuts will continue to be a powerful political issue:

1) International tax competition. Nope, it's not the world's most boring Olympic event. Rather it's how globalization is driving down tax rates around the world, since both labor and capital are more mobile and can search for relative tax havens. Corporate tax rates, for instance, have been falling in many countries. The United States is one of only two countries in the Organization for Economic Cooperation and Development not to reduce their corporate tax rate from 1994 to 2006, according to the Tax Foundation. Note, too, the rising popularity of the flat tax, particularly in the former captive nations of the Soviet Union.

2) Democrats in charge. Democrats have already said they want to repeal at least part of the Bush tax cuts as soon as possible. But what other taxes might a Democratic White House and Congress want to raise? House Ways and Means Chairman Charles Rangel has suggested a 4.6 percent surtax on high incomes, while Barack Obama wants to eliminate the income tax cap on payroll taxes. If all that happened, tax rates on labor would be nearly as high as they were before the 1981 Reagan tax rate cuts.

3) The investor class. Since 1981, U.S. gross domestic product
has more than doubled to nearly $12 trillion, while total stock market capitalization has increased 14-fold. The real economy—the one that pays wages—just isn't growing as fast as the financial economy. Americans need to be more exposed to the stock market to improve their standard of living and to save enough for their children's college education and their own retirement. In the future, there may be more pressure to eliminate investment taxes by moving toward a consumption tax, whether in the form of a national sales tax, like Huckabee's Fair Tax, or simply a system where investment income is not taxed, as Romney proposes for middle-class savers.

If John McCain wins tonight's presidential primary in Michigan—he's currently neck and neck with Romney—the victory could well propel him to the GOP nomination and put a new brand of economic policy on the Republican agenda.

How on earth did the Republican Party sink to this level?