The Great Deformation Read online

  Accordingly, his speeches portrayed an illusory world caught in a titanic struggle between the forces of freedom and the Kremlin’s purported quest for world domination. Faced by an apocalyptic threat, Citizen Reagan had found no trouble believing that a massive military establishment kept in a continuous state of readiness was imperative for national security.

  In fact, Reagan was an out-an-out statist in the realm of the military and national security. All the well-warranted skepticism he had about Big Government—the empire-building tendency of the bureaucracy, the inherent inefficiency and waste of public sector monopolies, the self-serving propensity of bureaucrats to hide the facts and twist the truth—did not apply on the Pentagon side of the Potomac.

  Nor did he have any sense that money spent on defense imposed the same burden on taxpayers and drain on the economy as did all other kinds of government spending. Instead, he would say over and over, “No, when it comes to national security you do not spend based on a budget, you spend based on what you need.”

  Needless to say, the Pentagon brass and the defense contractors could not have agreed more wholeheartedly. Nor could they have defined “need” more expansively. And so, ironically, the tribune of small government became the great enabler of the 1980s warfare state revival—a project of staggering waste and lamentable historical consequence.

  GENERAL EISENHOWER AND THE PATH NOT TAKEN

  There is no better way to illuminate the “path not taken” character of the Reagan defense buildup than by comparing its magnitude and spirit to the legacy of President Dwight D. Eisenhower. Ike was the one postwar president who had soberly assessed the dangers of both the Soviet adversary and also the warfare state which had been mobilized to contain it. In so doing, he had established two fundamental national security markers as pertinent to the 1980s as the 1950s.

  Firstly, Eisenhower sharply reduced the army and other elements of the conventional forces, believing that the academic concept of limited war favored by the liberal foreign policy establishment was an illusion in the nuclear age. He therefore rebuilt a much smaller and leaner defense budget on the predicate that the Soviet Union could ultimately be contained only by threat of massive nuclear retaliation.

  Secondly, he believed that a strong civilian economy and resolute fiscal discipline were as important to national security as military power. In this respect, Ike spent the entire eight years of his tenure in the White House personally engaged in a campaign to not only reduce the conventional force structure, but also to squeeze, scrimp, economize, and retrench wherever possible from programs which were needed.

  In so doing, he established what might be termed the “Eisenhower Minimum.” Described more fully in chapter 11, it was the level of defense spending that the only war general to occupy the White House in the twentieth century believed was adequate to contain the Soviets. Thus, when he left office the Department of Defense was one-third smaller in real terms than the war-bloated levels he inherited from President Harry Truman.

  Expressed in 2005 dollars of purchasing power, Ike’s final defense budget was $370 billion compared to $515 billion when he took office. The remarkable fact is that this Eisenhower Minimum reflected Ike’s assessment of national security requirements at the very peak of the post-Sputnik vigor of the Soviet industrial economy.

  By contrast, Reagan’s outgoing defense budget was $482 billion, measured in the same dollars of purchasing power. Not only was the Reagan defense spending level 30 percent larger in real terms than Ike’s last budget, but it came at a point in history when the Evil Empire was already descending into its final collapse.

  Moreover, the fact that the dead hand of the Soviet state had already asphyxiated its industrial economy was by no means a secret: there was plenty of open-source evidence of the looming Soviet breakdown. This historical development brought the possibility of relieving the American taxpayers of the three-decade-long financial burden of the Cold War. Accordingly, defense spending should have declined sharply below the Eisenhower Minimum to perhaps $200 billion by the end of the 1980s.

  Instead, it soared recklessly and unnecessarily above it toward the $500 billion mark. One reason for this untoward outcome is surely that in his inordinate deference to all things associated with the military, Ronald Reagan was entirely oblivious to the profound admonition that Eisenhower had issued twenty years earlier.

  In his farewell address, Ike famously warned the nation that “we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.”

  Foremost among these potential abuses of political power was the obvious possibility that the military-industrial complex would extract unwarranted and excessive defense spending through the mobilization of fear and the enormous pork barrel dynamics inherent in the warfare state. And here Eisenhower distinguished himself from all of his successors during the Cold War era up to and including Ronald Reagan.

  All these presidents could be described as military Keynesians; that is, they believed that defense spending involves a “twofer”: the provision of national security and the creation of jobs and technological progress, as well.

  By contrast, Eisenhower held the old-fashioned view that military spending is inherently wasteful. It consumes resources that would otherwise be available to meet the needs of the civilian economy.

  Indeed, in a stunningly lyrical rife he had once insisted that “every gun that is made, every warship launched, every rocket fired signifies in the final sense, a theft from those who hunger and are not fed, those who are cold and not clothed. This world in arms is not spending money alone. It is spending the sweat of its laborers, the genius of its scientists, the hopes of its children … Under the cloud of war, it is humanity hanging from a cross of iron.”

  Needless to say, none of his successors, including left-wing community organizer Barack Obama, ever came close to such eloquence on the societal cost of military spending. In the Reagan White House, especially, cluelessness was the order of the day as the great defense surge gathered momentum, and the warfare state became its own reason for imperialism abroad and economic burdens at home.

  The legends of the Reagan era are legion, but the greatest legend is that the feckless Reagan defense buildup caused the collapse of the Soviet Union. As has been demonstrated, the $3.5 trillion (2005$) spent on defense during the Gipper’s term did not cause the Kremlin to raise the white flag of surrender. Virtually none of it was spent on programs which threatened Soviet security or undermined its strategic nuclear deterrent.

  In procuring new conventional tanks, planes, helicopters, missiles, and munitions, the United States did not launch an arms race that the Kremlin feared it could not survive. The 1980s race to rearm, in fact, resulted in the creation of a vast expeditionary force for no valid reason of state, and which got used for no redeeming purpose except that presidents could.

  If the Reagan defense buildup was not much related to its stated objective of thwarting the Evil Empire, it did fatally undermine any modest prospect for shrinking the domestic welfare state that existed in January 1981. Within a year, in fact, the juxtaposition of domestic versus defense budgetary regimens became so stark and untenable as to thoroughly poison the political well.

  The growing fat at the Pentagon generated acrid resentments throughout Washington’s civilian branches, even as favored constituencies harvested a bonanza of defense contracts and local economic stimulus. In time, this blowback extinguished even the modest initial quantum of support on Capitol Hill for the White House’s prescribed diet of domestic agency austerity.

  So when all was said and done, it was not an impecunious public purse, but the rampant fiscal profligacy and flagrant pork barrel excesses issuing from the Defense Department’s soaring top line that became the defining fiscal signature of the Reagan era. Indeed, in a supreme irony, Reagan’s short-lived challenge to the welfare stat
e in early 1981 was quickly supplanted by its opposite: a rapidly swelling warfare state that was both unnecessary at the time and destined to become an incubator of imperialist calamity in the decades ahead.

  CHAPTER 6

  TRIUMPH OF THE WELFARE STATE

  How the GOP Anti-Tax Religion Was Born

  THE REAGAN REVOLUTION’S TAX POLICY, TOO, WAS THE PRODUCT of error and confusion. These misfires eventually morphed into a GOP anti-tax doctrine that was stunning in its denial of reality. It literally stood on its head the fiscal orthodoxy that Republicans had uniformly embraced prior to 1980.

  Until then, conservatives had generally treated taxes as an element of balancing the expenditure and revenue accounts, not as an explicit tool of economic stimulus. All three postwar Republican presidents—Eisenhower, Nixon, and Ford—had even resorted to tax increases to eliminate red ink, albeit as a matter of last resort after spending-cut options had been exhausted.

  These Republican administrations also espoused an economic philosophy of lower taxes to encourage capital formation and private enterprise. But at the end of the day, the tax code stood first and foremost as an instrument of revenue collection, not an all-purpose elixir to promote economic growth.

  The story of how this tradition of sound fiscal policy was lost after 1980 is crucial to understanding the economic deformations plaguing the present era. This is especially so because the GOP’s extended sojourn in the realm of fiscal know-nothingism has not been so much purposeful and explicit as it has been convoluted and accidental in its origin and institutionalization.

  ORIGIN OF THE REAGAN TAX CUTS: KEYNESIAN INFLATION

  Although the facts have been obscured by partisan revisionism from both sides, the Reagan tax cuts were initially grounded in this earlier conservative tradition. It was only much later that glib revisionist theories like “starve the beast” emerged. Similarly, the bastardized supply-side notion that tax-rate reductions would not result in revenue loss owing to the Laffer curve had few adherents beyond Laffer himself.

  In fact, while the Reagan White House and practical Republican politicians alike believed lower tax rates would stimulate economic growth and some revenue feedback, none believed these cuts would be 100 percent self-financing. The latter became incorporated into GOP catechism only much later—egged on by the rank sophistry of Laffer, Jude Wanniski, and one or two other charlatans who constituted the entirety of the supply-side coterie.

  The fact is, when the Reagan administration took office it was confronted by an immense tax roadblock to economic expansion. The pernicious interaction of the 1970’s double-digit inflation and the progressive rate structure of the individual income tax code were causing tax rates to rise rapidly due to bracket creep.

  Based on the early 1981 outlook for continued high inflation, the existing tax law, owing to bracket creep, would have drastically and automatically raised the federal tax burden on the economy. From a level of about 19 percent of GDP in 1980 the revenue claim on national income would have risen to an unprecedented 24 percent by 1986.

  A tax increase equal to 5 percentage points of GDP is no small matter, and would amount to $750 billion annually in today’s economy. So what the Reagan administration had inherited was a huge prospective enlargement of the tax burden.

  What it also inherited was the legacy of Keynesian fiscal policy activism and the resulting chronic deficits which became institutionalized in the late 1960s and had led to inflationary money printing by the Fed. Paul Volcker was aggressively attacking the latter, but it would take time to subdue.

  In these circumstances, it did not require any belief in the finer points of supply-side doctrine to see the need for income tax reductions. If left on automatic pilot, the “bracket creep” then raging would quash the economy’s capacity for recovery and growth.

  Moreover, this looming, unlegislated escalation of the tax burden was something entirely new under the fiscal sun. To be sure, if the old right had long fulminated against the “abomination of 1913” which saw enactment of both the income tax and the Federal Reserve. But during peacetime, anyway, this potential witches’ brew of inflationary money and confiscatory taxation had never really materialized.

  During the Roaring Twenties era, for example, consumer prices had averaged a zero rate of change. Thus, there was no bracket creep during the income tax’s first peacetime decade, just deep legislated cuts in the high wartime tax rates engineered by the incomparable Andrew Mellon.

  Likewise, after plunging by 20 percent during the initial four years of the Great Depression, consumer prices had drifted up only tepidly until the onset of the Second World War. So there had been no bracket creep in the 1930s, just Franklin D. Roosevelt’s deliberate legislative enactments aimed at soaking the rich.

  When economic normalcy again returned after the Korean War, the consumer inflation rate settled into a peacetime crawl, rising by an average of 1.6 percent annually during 1953–1967. So again, significant bracket creep had still not emerged, while discretionary legislative action had functioned to modestly reduce income tax rates.

  As it happened, President Lyndon Johnson’s misbegotten “guns and butter” crusade eventually did uncork the evil genie of 1913. During the years subsequent to 1967, a pusillanimous Fed, shorn after 1971 of its last link to the fixed financial anchor of gold, unleashed a runaway inflation for the first time in peacetime history.

  This unique outbreak of peacetime inflation is now forgotten, but its importance cannot by overemphasized. Consumer prices rose at an average rate of nearly 7.5 percent annually over the next decade and a half, including four years of double-digit gains. The resulting relentless push of inflation-swollen incomes into higher tax brackets clearly did stifle entrepreneurial energies and erode business investment incentives, thereby contributing to the abrupt slowdown of real GDP growth.

  So it was the stagflationary breakdown of the national economy resulting from Nixon’s abandonment of sound money in August 1971 which ultimately triggered the Reagan Revolution. Real growth faltered badly for the better part of a decade, averaging just 2.5 percent per annum in the eight inflation-racked years ending in 1981, compared to 3.8 percent during the two decades prior to 1969.

  It was these threats to the middle-class living standard which set the stage for the 1980 campaign referendum on the “are you better off” question. Believing that it was worse off and fearing even further decline in the future, the public sent Ronald Reagan to the White House to fix the underlying problem Nixon had bequeathed.

  THE REAGAN 10-10-10 TAX CUT WAS DE FACTO INDEXING—NOT LAFFER CURVE MAGIC

  The long forgotten truth is that the original Reagan tax cuts essentially amounted to preventative indexing; that is, insulation of the tax code from further bracket creep before the anticipated inflation of incomes actually happened. At the time, Alan Greenspan explicitly argued for the Reagan cuts on this basis. It was also the practical justification embraced by old guard congressional Republicans—few of whom put any stock in the Laffer Napkin and the free lunch theories of its author and purported economist, Arthur Laffer.

  De facto tax indexing was in theory fully compatible with the older tradition of Republican fiscal orthodoxy. From the perspective of early 1981, at least, it did not appear to open up an insuperable fiscal gap: moderate tax cuts would simply forestall the bracket creep-driven rise of the tax burden.

  In that context, the original Reagan tax plan—the Kemp-Roth rate cuts of 10 percent annually for three years and the business depreciation incentive known as 10-5-3—was not inordinately radical. In fact, while the revenue loss was large and measured out to 4.5 percent of GDP when fully implemented, it merely offset the projected bracket creep over the five-year fiscal horizon at issue.

  Thus, the math of the Reagan tax plan brought the projected 1986 tax burden back down to 19.5 percent of GDP, exactly equal to the tax extraction from the American economy that had been embodied in Jimmy Carter’s last budget (fiscal year 1981). Contr
ary to legend, then, the original Reagan tax package did not actually aim to reduce the inherited tax burden at all. Based on projections at the time, it penciled out as merely a reversion to the Carter status quo ante.

  THE FISCAL MATH OF HOWARD BAKER’S LIBRARY—IT BARELY WORKED AND SOON CRASHED

  The spending side of the final Carter budget had come in at about 22 percent of GDP. After the planned tax rollback there remained a 2.5 percent of GDP deficit, which was viewed in those days as dangerously large. Yet the Reagan Revolution was about shrinking the girth of the state—so a 2–3 percent retrenchment on the spending side seemed entirely appropriate and achievable.

  Indeed, balancing the budget at 19.5 percent of GDP did not require especially radical spending cuts relative to recent norms: total federal outlays averaged 20 percent of GDP during the decade of the 1970s, and had been 20.2 percent as late as 1979. What made the Reagan fiscal plan seem radical was the mere fact that domestic spending was to be cut at all, especially after the massive increases of the Nixon-Ford era.

  When the Republican leadership gathered in Majority Leader Howard Baker’s library to plot fiscal strategy on the eve of the inauguration, the task of balancing Ronald Reagan’s conflicting campaign promises was not yet insuperable. With taxes pinned at 19.5 percent of GDP—still high by all prior peacetime history—and the defense build-up still unquantified, rolling back total Federal spending by a few percentage points of GDP was seen by the seasoned Republican leaders gathered there as a daunting but achievable goal.

  But not long after the inauguration, the unraveling began. It never stopped. To this day its legacy hangs over the nation’s battered financial accounts like a fiscal sword of Damocles.