Reagan's the Wrong Scapegoat for Market Crisis

July 17 (Bloomberg) — Is this the end of Republicans and their Reaganite philosophy? That's how many Americans are subtitling the financial drama unfolding before their eyes.

A typical analysis came from an op-ed writer in the Springfield, Missouri, News-Leader: "The present economic crisis with its multifaceted negatives originated from Reagan's 'trickle-down economics,' also known as 'supply side economics."'

The Fannie Mae and Freddie Mac story is huge. The losses in the mortgage-finance system are already worse than those of the savings-and-loan crisis. Fannie and Freddie will doubtless cost taxpayers as well. But to assign responsibility to Reaganomics, or Republicans alone, is worse than crisis revisionism. It is absurd.

The reality is that Reaganism is a broad, common-sense movement in which Democrats have also long participated. What's more, Reaganism hasn't always delivered what it promises. You can even argue that the current challenges are a result of not too much Reaganism, but too little.

Recall the period this one is coming to resemble, the 1970s. Oil-price spikes, rising inflation, stubborn unemployment. Economists, including Reagan advisers, talked about it all in macroeconomic terms — aggregates, demand, and yes, supply.

But a lot of the trouble then was at the individual level. Sometimes that individual had no job. Sometimes the job wasn't rewarding enough: The top income tax rate was 70 percent.

Even people with taxable income of $50,000 paid in the 50 percent range. While that money translates to $168,000 today, even people at that income level now don't pay the top tax rate of 35 percent.

Reaganism to Rescue

Universities and their professors didn't feel like innovating since it wasn't clear who owned their ideas. Inventions stayed in scientists' heads or collected dust on lab shelves. Access to capital? Too often only government, or New Yorkers, had that.

The response was Reaganism — a movement that studied aggregates but also concentrated on restoring rights to the individual, including property rights. The combo — macro and micro — mattered.

Some of that Reaganism came before Reagan. In the 1970s, scholars began to talk about how the Great Society didn't work and entitlements had to be scaled back. President Jimmy Carter put a man who had the courage to stop inflation at the Federal Reserve — Paul Volcker.

Brutal Steps

It was in 1978, well before David Stockman or Art Laffer made it to the West Wing, that lawmakers passed the crucial, Reaganite, supply side 1978 capital-gains rate cut, the Steiger Amendment. Senators Robert Dole and Birch Bayh got their colleagues, including Strom Thurmond and Ted Kennedy, to sign on to an intellectual property law that made it possible for professors, universities and individual firms to keep the fruits of their own research. Implementation came in 1980, not 1986.

Reagan's own moves mattered mightily, of course. Some of the steps he took on behalf of the private sector were brutal. To this day, the families of air-traffic controllers recall the way he sacrificed those men's careers when he fired striking union members in the name of curtailing public-sector unionism.

Reagan went after tax breaks and slashed the top income-tax rate. Democrat Dan Rostenkowski led the House in helping Reagan write that law. And somehow tax cuts cost less in reality than they did on paper.

Growth Is Good

Here Laffer, one of the economists being attacked today, was correct. But less important than the precise amount of revenue the cuts drew was the general signal they sent: Growth is good. People got to keep their money. Tax cuts weren't just about stimulating growth, they were also about property.

Reaganism's achievements made its shortcomings seem unimportant. One of those was the president's failure to spend political capital to thoroughly overhaul Social Security or Medicare. Reagan also failed to control federal spending, but then the Democrats wouldn't let him.

What about the Clinton 1990s? Some of the credit for that growth goes to the Reaganites. After all, while both Presidents George H.W. Bush and Bill Clinton raised the top tax rate from Reagan's 28 percent, they didn't take it back anywhere near the old 70 percent.

Clinton ended welfare, which Reagan had not, and declared that "the era of big government is over." Republicans in the House and the Clinton Treasury together executed textbook Lafferism with the capital-gains rate cut of the late-1990s. The Clinton Treasury's "strong dollar" rule is also the rule of a supply sider given the Nobel Prize in the Clinton years, Robert Mundell.

Faster Than Sagebrush

Fannie Mae and Freddie Mac? Their portfolios went from billions to trillions between 1990 and 2003.

That's faster than sagebrush growing on a presidential ranch. It was about twice as fast as the mortgage market, notes Alex Pollock of the American Enterprise Institute. Yet neither party had the stomach to prune like the Gipper.

Reaganites were so in love with homeownership — those property rights — that they ignored the Fannie-Freddie duopoly. Democrats also told themselves that they were doing only good.

What about President George W. Bush? His Reaganite, Clinton-like, capital gains cut helped the economy post Sept. 11. But Bush has ignored the Mundellian strong-dollar rule.

Bush has laid on a new entitlement, Medicare Part D, which bestows a prescription-drug benefit to the elderly. And both Bush and the Democrats have been too eager to let Washington assume responsibility for the mortgage market.

Harsh times generate harsh criticism. The economy's deepening troubles mean that Democrats, especially, are angling hard for a snapshot that allows them to depict every misfortune of 2008 as the work of Reagan's old team.

They can do that, but it should be recognized as the political ploy that it is. And when it comes to blame, there's enough of it to go around.

(Amity Shlaes, a senior fellow in economic history at the Council on Foreign Relations and author of "The Forgotten Man: A New History of the Great Depression," is a Bloomberg News columnist. The opinions expressed are her own.)

© Copyright 2008 Bloomberg

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