Washington: The New Voodoo


President Bush's weak finish in successive primaries may finally make clear to him what has been obvious to most observers for months: Voters are dissatisfied with his handling of the economy. When Bush was elected in 1988, most people thought they were getting Ronald Reagan II and that the record peacetime economic expansion that started under Reagan would continue. But the country is now midway through the second year of a recession. What happened? Have Reagan's economic policies stopped working?

No. Bush has abandoned them. Reagan's economic program, even if imperfectly implemented, was clear: Cut taxes, restrain government spending, and roll back government regulations. It did not take Bush long to reverse course. Bush's budget agreement gave us the largest tax increase in U.S. history; federal spending has grown faster under Bush than under any president since Franklin Roosevelt; and his cabinet appointees have enacted thousands of new and expensive regulations. The American people have been saddled with Richard Nixon II, a president who talks conservative economics but enacts leftist programs.

Bush's proposed fiscal 1993 budget completes his abandonment of the Reagan economic program by resuscitating the ideas of economist John Maynard Keynes from the graveyard of discarded theories. Interwoven throughout Bush's 1993 budget are proposals based upon the discredited Keynesian theory that stimulating aggregate demand by boosting government and consumer spending will restore economic growth.

Keynesian theory was the driving force in economic policy for much of the post-WWII era. Democrats, in particular, liked the theory because it gave them a reason to expand government programs.

Republicans never challenged the prevailing Keynesian orthodoxy. They were content to complain about budget deficits and make speeches about big government. Lacking an alternative economic theory, however, their efforts to reduce government spending were stymied by Keynesian counterattacks that lower government outlays would reduce aggregate demand and retard economic growth. And since old-fashioned Republicans were deficit-phobes, the idea of tax cuts not matched by spending cuts was unthinkable. Indeed, Republicans opposed the tax-rate reductions proposed by President Kennedy.

But in the 1970s, cracks began to appear in the Keynesian foundation. Inflation and unemployment rose in unison, violating the Keynesian theorem that the two variables should travel in opposite directions and undermining Keynesian policy, which was based upon adjusting fiscal and monetary policies to bring down unemployment by increasing inflation and vice versa. Failure of this "Phillips Curve" trade-off opened the door to new economic approaches.

The Republican brainlock was broken by a small band of free-market-oriented congressional staffers who junked the Keynesian approach and explained how tax cuts would increase incentives to work, save, and invest, thus expanding the economy. Popularized by then-Rep. Jack Kemp of New York, this new approach (supply-side economics) eventually became the cornerstone of Reagan's economic-growth package.

Yet Bush has repudiated that legacy. His own "progrowth" package marks a dramatic return to '70s-style economics.

Explicitly Keynesian policies include administration actions to accelerate federal spending so it occurs earlier in the year. Along similar lines, the White House has proposed changes in tax withholding schedules to put more cash in consumers' pockets today at the expense of lower refunds next year. There is nothing wrong with this idea; taxpayers should not be making interest-free loans to Uncle Sam. But the claim that this change somehow will lead to greater economic activity is ludicrous.

The White House also has called for increased spending for domestic programs in future years, adopting the statist and Keynesian strategy of calling these outlays "investments" that will boost future growth. Taxpayers are supposed to believe that higher spending on education programs, Head Start, migrant health centers, family planning, foster care, the superconducting supercollider, the space station, mass-transit subsidies, public housing, and homelessness will promote economic growth. The White House rather conveniently neglected to provide any analysis explaining how these programs, which in the past have not even solved the problems for which they were allegedly created, much less stimulated the economy, are now supposed to encourage economic growth.

White House tax policies are almost as bad. Bush proposes, as a growth measure, increasing the personal exemption for children by $500 annually. Anything that allows taxpayers to keep more of their money is a good thing, and the tax burden on families is particularly devastating, but raising the exemption will do nothing for economic growth, since incentives to work, save, and invest remain unchanged. There is no real difference between this proposal and the openly Keynesian $50 tax rebate proposals floated in the '70s.

The administration's proposed investment tax allowance also fails the growth test. Under current law, a large amount of the money businesses spend on new investment is treated as taxable profit. The White House seems to realize this bizarre taxation of investment is bad for the economy and has proposed to increase the amount of investment spending a business can deduct from income. Unfortunately, Bush has reduced a sound idea to a fine-tuning budget gimmick by restricting the proposal to investments occurring this year. As a result, the long-term incentive to invest remains unchanged.

Bush's economic policy has been a disaster. Budget decisions are driven by Richard Darman, Bush's budget director and a career bureaucrat. Darman has turned back the clock for Republican economic policy, reducing the GOP to insincere speeches about big government, opposition to substantive tax cuts, and endless back-room dealing with congressional power barons.

The net result: Government has gotten bigger and will continue growing. Unfortunately, it appears that free-market supporters will have to re-invent the wheel, going through the same process that occurred 15 years ago to make Republicans, and some Democrats, realize that Keynesianism is an economic and political disaster. The 1980s showed that tax policies based upon increasing incentives work. There is no reason why similar policies won't work today.

Daniel J. Mitchell is the John M. Olin Senior Fellow in Political Economy at the Heritage Foundation.