REASON Interview: Paul Craig Roberts


Paul Craig Roberts is one of the key architects of supply-side economics. An economics professor at various universities, his early economic writings took note of the stultifying effects of high tax rates on incentives. Bruce Bartlett, in his supply-side chronicle, Reaganomics, notes that Roberts anticipated the "Laffer Curve" as early as 1971 in his book Alienation and the Soviet Economy.

In 1975 Roberts went to work as Rep. Jack Kemp's staff economist. Along with economist Norman Ture, he began a campaign to convince Treasury officials that the static view of tax-rate cuts is incorrect—that lower tax rates will stimulate economic activity and thus increase tax revenues.

In 1976 Roberts became minority staff economist for the House Budget Committee, where he proposed a permanent cut in tax rates as an alternative to Jimmy Carter's one-shot $50 rebate. It was the seed that led to the Kemp-Roth bill in 1977. Roberts had by then joined the staff of Sen. Orrin Hatch, where he played a key role in discrediting the Keynesian econometric models used by the Congressional Budget Office.

Roberts then became an editorial page writer for the Wall Street Journal and helped to solidify that paper's support for supply-side concepts.

In 1980 he took a position at Georgetown University's Center for Strategic and International Studies but was soon tapped by Ronald Reagan to become assistant treasury secretary for economic policy. He returned to Georgetown earlier this year as the first holder of the William E. Simon chair for political economy.

Roberts is no stranger to REASON's pages. His first of several articles over the years appeared in 1973. Thus, it was as an old friend of REASON's that senior editor Tibor Machan, accompanied by Washington-based contributing editor Joe Cobb, approached Roberts this spring for an interview.

REASON: The first question we have for you is a question that many people have asked you. Why did you resign from the administration?

ROBERTS: I was offered the William E. Simon chair in political economy, and it's a hard thing to turn down. It lets me carry on my three careers in one job. I can be academic, I can pursue my interest in public policy, and I can carry on with journalism.

REASON: But this seems to be a bit of an odd move for the following reason: if there has ever been an administration in which some of your ideals might have had a chance to flourish, why did it nevertheless seem to you so attractive to come back to the more theoretical domain as opposed to stressing the practical implementation of those ideals?

ROBERTS: Well, the center is public-policy-oriented. This is not a single-purpose, or only an ivory tower, academic environment. Most of the people here are academically qualified, but most of them have also held many positions in government, so you're not out of the policy process here. In fact, I'm still very much in the policy process. I just have a freedom to speak that you can't have as part of an administration.

REASON: Just to press it a little bit further, it has seemed to some of us who are in what you might call the libertarian wing of the political ethos, rather sad that Marty Anderson and you both "abandoned ship." It was our only hope that some of these ideals could at least be well articulated by intelligent people who have a basis for what they're saying as opposed to people who are pragmatists.

ROBERTS: I know what you mean. I would have to point out, though, that I did succeed in contributing to getting the tax cuts passed. I see that as a tremendous achievement for a year's time, capping a five- or six-year effort that I had been part of previous to the Reagan administration. So, when you look at the situation, it's definitely improved. But I think you should also not be surprised that people who are basically libertarians, like myself and Marty, don't expect all that much out of public policy. I think that's one of our messages, isn't it?—that you can't expect much from public policy, so that libertarians have got to be invariably frustrated if they try to stay in government for any long time and bring one great change after another. We got the great change, and now it's up to the president to hold on to it—and there, I think I'm a better advocate for him outside the administration.

REASON: Is his intention a sound intention thus far?

ROBERTS: Yes. The president's intention is sound. He has not had enough help from his administration or, recently, from his party.

REASON: Why is it that we aren't seeing the expected results from the dramatic changes in taxes and then budget policy made by Congress in 1981?

ROBERTS: That's no mystery at all. The changes are in principle, not practice. What taxes are lower? Congress did not cut taxes then; they cut them for a future period. The first significant cut in the personal income tax was pushed off to July of '82, and the rest of them are all for July of next year. So the tax program, on personal tax cuts, was shifted to the latter half of the Reagan administration. Some of the business tax cuts were made retroactive to January 1981, but they weren't passed until way in July or early August of that year. And no sooner were they passed than all kinds of doubts were raised about them by administration figures themselves. Senator Dole announced that, as far as he was concerned, the leasing provision of the business tax cut was finished. Anybody who entered into a leasing agreement was doing so at his own risk, because they intended to repeal that. You had, under the push of David Stockman, a minimum corporate tax submitted to Congress on the heels of the tax cuts. The minimum corporate tax is widely perceived—I think correctly—as an assault on the accelerated capital cost recovery provision of the business tax cut.

So if you are a decisionmaker in the economy and are looking at the tax law, you don't know what it is. You just face massive uncertainty. You would not act on the basis of a law on the books that you see under assault before there's been time for the ink to dry. On the personal cuts, when you enact today a tax reduction that will take place in the future, you achieve the opposite of your goal, at least for the interim. Because what you do is, you tell everybody that their tax deductions are worth more now and to shift them all to the present, because the rates are higher, and that income will be worth more in the future, so shift it all to the future. That tends to cause income to drop and tends to cause tax collections to drop in the interim and on the whole produces worsening economic performance as people respond to the incentives of the delayed tax cuts. So you have to understand that, although in principle the policy's changed, in practice it really hasn't. Now we will reach these tax cuts in the future if they are not in the meantime further delayed, pushed off, or repealed.

REASON: What is the political prospect of their being tampered with again?

ROBERTS: I don't think they will be tampered with this year because it is an election year and there's a recession. It's very difficult to raise taxes in that kind of environment, even from a Keynesian perspective. What is happening does have some risk, because what we have is the resurrection of what was known as the British "treasury view." The treasury view, which was the focus of John Maynard Keynes's attack on economic policy, said that deficits drive the economy down because they impair confidence. And this led to a policy focus of trying to balance the budget in recession. According to Keynes, that produces a depression, because, by his account of a recession, demand is falling and cash flow is tightening; so if you take actions—for example, raising taxes—designed to recover the revenues you lose to recession, then you cause further reduction in demand and further restrictions on cash flow. You worsen the economy and, in the process, frustrate your effort to bring the budget into balance.

Well, the "treasury view" somehow has come back recently in Washington. It's elbowed aside the Keynesians, monetarists, and the few supply-siders and has the focus of everyone's attention. Congress and administration officials are speaking as if the whole goal of policy is to balance the budget. Now the original goal of Reagan's policy was to balance the budget—but through a process of economic growth, one that would improve incentives, improve the performance of the economy, and thereby bring the budget into balance by shifting the economy to a higher growth path. That seems to have fallen away, and people are focusing on deficits that are large, primarily because of the recession—recession always produces large deficits. And we do face some risk, if this old British treasury view of the '30s actually becomes policy, of further deflating a faltering economy. In that case it is not clear what would result.

REASON: You had some disputes with David Stockman. What did you find problematic about his stances?

ROBERTS: Well, let me address what went wrong with the Reagan program. Beginning really in December of 1980, the idea was to get on to this new policy of growth. But very early there was a move away from that, toward a policy of balancing the budget not through economic growth but through higher tax collections. That's the reason the tax cuts were first delayed from January of '81, '82, '83 to July of '81, '82, '83, and then the first installment delayed to October and cut in half. That was all in order to keep tax collections high, based on keeping the old rates as long as possible in order to balance the budget in 1984. Well, that obviously is already a subversion of the policy, because what it's saying is that high tax rates are better for the economy than lower ones, so let's keep them higher as long as we can.

REASON: You don't think that the motivation was political? Was it their conviction that this was necessary, or was it their belief that, if they didn't make these concessions of delay, however wrongheaded, they couldn't get anything whatsoever?

ROBERTS: It's hard to ever know that. But I doubt that the president couldn't have gotten his program, and I think that the reason he went along with the delay was that it was presented to him as a compromise that would let him achieve all the goals and also give him less trouble with Congress. But it didn't allow him to achieve the goals. Part of the trouble was a very tight monetary policy between April and October of last year, which is very deflationary, particularly after having very high money growth. In fact, in October of last year there was less money in the economy than there had been the previous April. Now that is a very contractionary policy. If you combine that with delayed tax cuts, you are almost assured of a recession. And if you get a recession, you are almost assured of large budget deficits. That's exactly what I said would happen. It's what's happened, and now the same people want to respond to the larger budget deficits by further delaying and rolling back the tax cuts—which is to treat the situation, which is a bad one, with the same medicine that produced it.

Another fundamental flaw with the approach taken is that it conveyed to the markets two things: one, that the politicians may not have as much faith in those tax cuts as they say, because they shifted them off to the future; and two, that we run the risk we won't ever get them, because when they shift them off to the future, does this mean they are pessimistic about controlling the growth of spending? So I think that that itself brought up doubts that caused a lot of hesitation in the market.

REASON: Cutting taxes has been supported by this administration from within the framework of supply-side economics. Tax cuts were also pushed through by President Kennedy. What's distinctive about supply-side economics?

ROBERTS: I think that what supply-side economics was the first to realize, at least in our time, is that the incentives had gone badly and this was affecting the performance of the economy. Supply-side economics, as it's called, has two main points to make about policy, points based in economic theory but also based on observation of behavior. One is that it provides the broadest definition of the tax burden. Milton Friedman is correct that tax revenues collected are not a satisfactory measure of the total tax burden, and he offers instead total government spending, which includes the tax revenues collected plus all the government's borrowing. That's a better measure, but it's still not a general measure. The perspective that has been emphasized by the supply-side movement is that the total tax burden includes all the production that is lost to disincentives. So if you're looking at the cost of the tax system, you can't always see it. It includes things you never got, work never done, investments never made, risks never taken—and those costs can be extraordinary.

The other main policy message of supply-side economics comes from its theoretical perspective on how fiscal policy works. In the thinking of the past 20 years, fiscal policy has been deemed to work by the effects it has in raising or lowering disposable income, and thereby aggregate demand or total spending, such that fiscal policy affects the economy through changes in demand. Now, I think what supply-side has added to that is a very, very important part of policy. It's almost like the old argument, is price determined by the cost of production—that is, supply—or is it determined by what people are willing to pay for the product—that is, demand. That was an early argument between economists, and it was Alfred Marshall who said, it's like arguing which blade of the scissors cuts the paper. Well, I think running fiscal policy for 20 years on a demand basis has not been good for the economy. What the supply-siders point out is that fiscal policy works through relative price changes.

For example, if you change the marginal rate of taxation, you have affected not just incomes, disposable incomes, but you have affected two critical relative prices. One is the price that governs people's decisions about how they allocate their existing income between current consumption and savings or investment. The cost to the individual of allocating another unit of his income to current consumption is the forgone income stream—that is, the income he gives up, not having put that money into an investment or saved it. Well, what is the value of that forgone income stream? It is determined by the marginal tax rates, because the investment income will be an addition to your regular income and therefore is taxed at the highest rate that you face. Well, obviously, the higher that marginal tax rate, the less the value of that income stream and the cheaper is current consumption in terms of the forgone income.

The example that makes the point the clearest is the Englishman who until recently faced a 98 percent tax rate on investment income, and at relatively low levels. Suppose he's got $50,000 and he's deciding, should I buy a Rolls Royce or shall I put this money in an investment at a 17 percent rate of return? On a pretax basis, $50,000 at 17 percent would provide an income stream, in addition to his income, of $8,500 a year—in this year and all future years—which is a rather hefty price for a car. But after tax, the value of that income stream to him drops to $170 a year, which is an extraordinarily low price to pay for a Rolls Royce. In other words, the opportunity cost of the Rolls Royce is an income stream of $170 a year, so the car is practically free. That explains why there are so many Rolls Royces in England. People have been very confused about how England can be a declining economy, because we see Rolls Royces on every corner of London. But the Rolls Royces were not a sign of economic prosperity—they were a sign of a high tax rate on investment income.

REASON: Is there any comparable phenomenon that perhaps we can appreciate in the United States, although perhaps not as drastic as this example?

ROBERTS: Well, here it's been a 70 percent marginal tax rate on investment income. It had the same effect. I can tell you from personal observation. Do you remember, it used to be that exotic cars, luxury cars, very quickly depreciated? One would come out and very quickly would lose its value. I can remember back in 1967, I think it was, I saw a road test of a new Ferrari, it was a 1967 model, in Road and Track, and the new car price was $14,500, which seemed like a substantial sum of money. But I said, clip that road test, because always previously prices of Ferraris dropped very rapidly, and you could buy one in several years at a relatively low price. So I clipped it and put it in my file, and I still have it. But that would seem to have been the turning point in, I suppose, the movement of people, with inflation, into higher tax brackets, because that car did not drop in price, and henceforth no Ferraris or Rolls Royces or any of those exotic cars dropped in price; they began rising. I don't mean the new-car price, I mean the used-car price began rising. The last I saw, the same Ferrari—the identical model, 1967—was $55,000. So I think there you have an illustration of the adverse effects of high marginal tax rates on savings and investment. It encourages people to move into consumption, and that has to affect the rate of economic growth and therefore economic progress.

The other critical relative price affected by fiscal policy, by tax policy, is the decision the individual makes about how to allocate his time between work and leisure, or earning current income and leisure, or between leisure and investing in his human capital—that is, upgrading his skills in order to raise his future income stream. Again, that decision is a function of marginal tax rates. The higher the marginal tax rate on additions to his income, the cheaper it is to engage in leisure. So a tax system of high marginal rates that affect very many people generally produces a rise in absenteeism, unwillingness to accept overtime, and a decline in human capital investments. Any additional effort comes on top of the existing work week; so the cost is high in terms of the disutility of the effort made, but the reward is low because of the high marginal tax rate.

These are the main contributions of supply-side thinking to economic policy: how you define the tax burden, and the awareness that fiscal policy affects relative prices that affect all kinds of production decisions—investments, savings, work; not just disposable income.

REASON: You are one of the few economists who has actually very closely studied Marxist economics, whereas most contemporary mainstream American economists don't bother with it a whole lot. What is interesting in the context of what you just said is that the Marxists maintain that separating leisure and work so drastically is ideological baggage. If we were just to drop this separation, we wouldn't have this problem with the economy—if people loved their work more and so on. Is there anything there that is fundamentally mistaken or that you have any comment about, because this Marxist criticism comes up frequently?

ROBERTS: I think that's a very silly utopian kind of view that everybody would just be simply working all the time. Even able people who find interesting jobs don't function that way. I think that what they are trying to do is to cloud up the fact that things have been neglected. Yes, this means a more individualist type of economic policy. There are also people who are committed to rather massive income redistribution and therefore are not in sympathy with lower marginal tax rates, because that will allow somewhat more individual success and somewhat more individual financial independence. And all of those things are not conducive to the collectivist, socialist kind of ideal where nobody really has any economic independence and people are all subject to this, that, and the other and you don't have a role left for differences in personality and interests and ambition and, therefore, income. I think that model, if anything, has succeeded in making the great mass of mankind miserable in their jobs. And so you find that people who once were happy being janitors, for example, doing necessary services that organizations and communities are dependent on, now feel somehow dissatisfied that they are not doing something "valuable" or "important." A whole hierarchy of jobs is what you have in the world, and you have it in the Soviet Union, too. And until there was the socialist assault on it, people could see each job as important, as contributing to success in a household or institution or firm. That sort of satisfaction in jobs has been destroyed by the socialist utopian propaganda.

REASON: We've talked about large budget deficits, which is a major political topic, but individual business owners are worried about interest rates. This brings up the other major sector of economic theory or economic policy—monetary policy. There is a somewhat esoteric and to many people confusing debate that has perhaps three or four sides. In one corner there are individuals like Henry Kaufman and James Tobin with a Keynesian point of view. In another corner are individuals like Beryl Sprinkel and Milton Friedman with a monetarist point of view. In the third corner there would be Jack Kemp and Lewis Lehrman with a gold advocacy. Can you shed a little light on this debate?

ROBERTS: Well, I'm not sure what Kaufman's point of view is. It seems to be the old "treasury view," which is the antithesis of Keynes. But to comment on your question about monetary policy, I have tried to bring the monetarists and gold people together by stressing what it is that they have in common, what they both want to achieve. One thing that they both seem to be in favor of is a fixed rule instead of a discretionary monetary policy. Another thing they both want is control over the monetary base. So I have tried to point out to them that they really have a great deal in common and they shouldn't overlook that in all their loggerheads, all the competition, and that they should focus on achieving these common goals.

Now, so far the Federal Reserve has shown either an unwillingness or an inability to abide by a quantity rule—controlling the value of the dollar by controlling the amount of money in circulation. The money supply has not been following any steady, predictable growth and in fact has been extraordinarily volatile. By quarters of last year it was like 12 percent, zero, zero, 12 percent. And in January of this year it was hitting roughly 20 percent. So there's no sign of complying with any target—they cross it going up and down, but they're never on the road. So I think that should tell you either that we will have a hard time getting a quantity rule or maybe that they can't deliver for some operational reason, maybe some conceptual ones. But we cannot continue year after year with the kind of monetary volatility that we have had in the past two years. I don't think we will ever see low interest rates with such an uncertain monetary policy, unless people eventually get used to it, which is always a possibility too. But it seems to me that what the monetarists and the gold people need to do is to agree on the need for monetary stability and very quickly find a way to get those conditions incorporated into policy. I have found that one of the greatest barriers to good economic policy is the competitiveness, personal competitiveness, of the policymakers. It's very difficult to get enough fellowship and a group to hold it together to get a policy this country desperately needs.

REASON: What about F.A. Hayek's proposal to actually make the entire monetary system wide open and not have anything like a central bank philosophy any longer in this country, not even a Fed? Hayek proposes that we just allow competition in currencies. Now it's a very remote possibility, but perhaps that is the answer, and maybe people who are concerned should start beating the drums on behalf of something like that.

ROBERTS: Well, I think that there's never anything wrong with getting far out on the issues. I think, however, given the desire for some certainty about monetary things, which I think is very strong among people in the markets, that to tell them now that we just kind of turn the whole thing wide open—that's likely to make people anxious. They are experiencing extreme uncertainty already, and I think what they really want is to have the dollar in some way defined so that it has a given value. The government says this is the value of the dollar. This is what it is, and then the government commences in some way to defend that value.

REASON: But why should anyone believe the government, one administration after the next, when the power to change the definition will still reside in the hands of the government? You yourself note that the volatility is enormous these days.

ROBERTS: But that's the volatility that results from the dollar that is undefined. You see, the whole trouble with the quantity rule of money, from the standpoint of the gold people, is that it does not define the currency. You try to control its value by not making so many dollars available.

REASON: Isn't the gold standard proposed as kind of a stand-in measure for a contractual solidity of money? I mean, even if you threw the money system into the private domain, there would still be stability induced through contractual commitments. The gold people would tie it to the gold standard, but in a private system, you would have to tie it to contract.

ROBERTS: You mean you would have a gold standard in the private money?

REASON: Something like that, or some sort of standard.

ROBERTS: That might well happen. I don't want to say that I'm against privatizing money or having people advocate privatizing money. I'm trying to say, though, that, given the problems that we have right now to survive—we always have to survive with what we are faced with—we would not solve them by trying to establish private money, because I don't think that push would succeed right now.

REASON: Milton Friedman and Hayek had an exchange at Hong Kong in 1978 at the Mont Pelerin Society meeting precisely on this. Friedman made your point about the political feasibility of a private money system, and Hayek's answer was: Well, the political feasibility is determined by the people like you, Milton. If you suppress the idea and don't go out in your Newsweek columns and say it, then of course it's not going to be politically feasible. It's only going to be politically feasible if we educate people. Feasibility doesn't just exist there, it is created.

ROBERTS: There's certainly truth to that, but there's still truth to my point, too, which is that at this time, given the anxiety of the markets and people about money—which is one of the reasons I think interest rates are so high—I don't think you would reduce that anxiety by saying, "Look, it's all going to be up to individual banks. Some will have a greenback standard, some will have a gold standard, and we're going to see what falls out." People aren't ready for that. I don't mind having people educated to the advantages of competing currencies and so on, but the immediate problem is that we can't go on year after year with this kind of volatility, this kind of uncertainty—it's destroying long-term contracts, it's destroying long-term bonds, it's affecting long-term investment decisions. And I don't think we should live with that volatility over the next decade or however long it takes to bring in this other view of money. You've got to deal with the problems now in the best way that you can now.

REASON: And that's where we'll have to end it. Thank you very much.