Wealth of a Nation
How the Keynesians went off the road at the Laffer Curve.
Apr 5, 2010, Vol. 15, No. 28 • By EMILY ESFAHANI SMITH
EconoclastsThe Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity
by Brian Domitrovic
The only history of supply-side economics written by a professional historian to date, this entertaining account should be required reading not only for staffers on Capitol Hill and the economic do-gooders in the White House, but also for anyone interested in “the most significant development in American—arguably world—economic history” in recent times. Brian Domitrovic tells the story of how a few renegades patched together the supply-side revolution.
The scene is Michael 1, a restaurant just footfalls away from the American Stock Exchange in New York. Michael 1
A first-rate storyteller as well as historian, Domitrovic skillfully unfolds the events that ignited the supply-side revolution and breathes life into the colorful characters behind the scenes. We learn, for example, that the 42-year-old Mundell, founding father of the revolution, wore his hair below his shoulders in 1974 and spoke “in a low slur, glided over syllables, sprinkled in wry remarks, and had a Canadian accent to boot”—forcing his dining interlocutors to lean in to their table to hear what he had to say. Then in 1999, with his hair cut, a triumphant Mundell shed his mumbling speech when he started bellowing Frank Sinatra’s “My Way” during his address accepting the Nobel Prize for economics.
Jude Wanniski showed up for his first reporting gig “in a Buick Riviera convertible and lamé outfit, with a leggy Vegas showgirl (his wife) riding shotgun” and did as much as anyone to spread the gospel. It was Wanniski who presided over a famous encounter between Dick Cheney, deputy to Gerald Ford’s chief of staff Donald Rumsfeld, and Arthur Laffer, at which meeting the Laffer curve was born. Laffer was making the case for cutting tax rates, and Cheney was worried that such cuts would diminish government revenues. Laffer argued that cutting rates could actually bring in more revenues, and to elucidate the point, grabbed a napkin and pen and drew a graph showing the relationship between tax rates and revenue. It looked like a “McDonald’s arch lying on its side,” Robert Bartley would later testify, but Cheney was unconvinced. Right then, the Laffer Curve would have been relegated to the ash heap of economic history had Wanniski not made it the focal point of a bestselling book four years later, The Way the World Works.
As for Bartley, the reticent Midwestern editorial page editor of the Wall Street Journal, he was ever skeptical of the Establishment and once wrote that the heroes of the 1980s economic boom were “college dropouts, breakaway engineers, and illegal immigrants.” It’s not clear where the supply-siders fit into that scheme; but in 1974, and still doubtful, he began attending the Michael 1 dinners, where he pressed and challenged the aloof Mundell on a number of points. Mundell gave rambling answers, quoting poets and speaking allusively, but Wanniski stepped in as translator, and eventually Bartley came around, penning a 1977 Journal editorial, “Keynes Is Dead.”
To “demand-side” economists, Keynes’s acolytes, spending was the solution to the woes of an economy. In power, they printed money to spur spending, and the price of food and oil skyrocketed, unemployment hit 8 percent, and growth degenerated to levels not seen since the Depression. To make matters worse, Washington routinely boosted taxes, which, combined with inflation, produced the ignoble phenomenon known as “bracket creep.”
To supply-siders, the solution was simplicity itself: Enact the exact opposite policy mix. Stabilize the dollar and cut tax rates. Loosen fiscal policy, and strong monetary policy would create jobs and capital. Jobs and capital would spur economic growth. When Laffer and company took these ideas public, they were considered radical. And even today, criticism of supply-side economics can be remarkably juvenile: Paul Krugman characterizes it as an African virus, DailyKos says it was the “Greatest Lie Ever Told,” and Slate calls it “the classic Republican phony theory.”
But while the nattering nabobs chatter away, history tells another story. Ronald Reagan’s landslide victory over Jimmy Carter elevated supply-siders to the levers of power, and Reagan instituted a 30 percent cut in the marginal income tax rates, echoing the 1977 Kemp-Roth legislative proposal. In 1981 the Reagan tax cuts were enacted, supply-side economics became law, and “the seven fat years” followed. Between 1982 and 2007 the United States experienced the greatest period of stable economic growth in its history.
Which leaves one question: If the supply-side theory discredited Keynesianism and brought prosperity, can it do the same in the present dismal economic climate?
Emily Esfahani Smith is an editorial assistant at The Weekly Standard.