Bush is practising bad Reaganonomics

There is world of difference between cutting high taxes and cutting taxes when they are already low

Reaganomics has a certain ring to it. By comparison neither Thatchernomics nor Bushonomics quite makes the cut. Maybe that is why the idea took hold that President Reagan should carry the responsibility for the new ideas that drove economic policies in the 1980s, policies that superficially at least seem similar to those of President Bush today.

Reaganomics has a certain ring to it. By comparison neither Thatchernomics nor Bushonomics quite makes the cut. Maybe that is why the idea took hold that President Reagan should carry the responsibility for the new ideas that drove economic policies in the 1980s, policies that superficially at least seem similar to those of President Bush today.

But what were they? Were they really the responsibility of a president who was not particularly interested in economics - despite being the only one ever to have a degree in the subject. And are they really the precursor to the policies of President Bush today?

It is quite hard to recall now what world economic conditions of 1980 felt like at the time. Inflation was in the high teens; there was an oil crisis, the second in less than a decade; unemployment was rising and there was a mood of despair. Here in Britain the new and inexperienced Thatcher government was also grappling with the legacy of the Wilson/Callaghan economic collapse. But actually the sense that nothing worked was pretty universal in the developed world. Everyone in the developed world knew inflation had to be curbed but there was less agreement as to how this should be done. Then along came Reagan.

There were three elements to his new economic policies. One was tax-cutting, the one that caught the headlines. Here the president did have a role. Legend holds that the Californian economist Art Laffer drew Reagan a diagram on a table napkin showing that if you cut income tax you would get more revenue, not less. The president bought the idea and what we now call the supply-side revolution was born.

The second element was a willingness to run budget deficits. Along with tax cuts, Reagan upped spending, particularly on the military. Eventually tax revenues did rise but in the short term the result was a swing into deficit, something that is again happening now.

To those of us outsiders this combination of tax cuts and increased spending looked hugely irresponsible, as indeed many people believe of the present President's policies. I remember saying this to Steve Forbes, owner of Forbes Magazine and subsequently a Republican presidential candidate himself.

"You don't understand," was the gist of his reply. "The purpose of the deficits, and the tax cuts, is to cut away the revenues and so reduce the size of the state. You cannot cut spending directly because there are too many interests against you. But voters will support tax cuts and eventually that will force discipline on spending."

I'm not sure that Reagan thought this policy through as explicitly as that but the US was rather more effective at containing the size of government through the 1980s than most others.

The third element was a tight monetary policy to squeeze out inflation. This should not be directly attributed to the president, for monetary policy was, and is, outside the role of the administration. But Reagan did support the tough policies of the early 1980s, including the strong dollar, which did indeed squeeze down inflation. So a key element of Reaganomics was this combination of a loose fiscal policy with a tight monetary policy.

And now? Looking back the extraordinary thing is the extent the policies of the early 1980s, both here and in the US, are received wisdom. Take tax. Art Laffer is rather sneered at these days as a folksy amateur. He was in London recently at a breakfast meeting and someone asked him how he felt about not getting the acclaim that other economists have received.

"Look," he said. "We won. No country in the world would go back to the 75 per cent top tax rate we had in America and whatever you had here in Britain."

Of course he is right: that most of Continental Europe now has top tax rates below 50 per cent and Germany is struggling to get down to just over 40 per cent is testimony to the power of those ideas a quarter century ago. Arguably the fact that Gordon Brown is urging on Continental Europe now the same sort of structural reforms that Reagan and Thatcher brought in during the 1980s is further evidence of the scale of their intellectual victory.

But there were costs in increased instability. The dollar shot up in the 1980s and then fell back. US unemployment soared (as did British) and it took a long time before US unemployment rates fell below those of Europe. In a nutshell, Reaganomics might have been a micro-economic success but in the short term at least, it was a macro-economic failure. And that leads to the troubling question of whether we should be worried about the parallels between those policies and that of the present Administration.

I think we should. Take tax cuts. There is a world of difference between cutting taxes that were outrageously high to something reasonable and cutting taxes that were already pretty low to something even lower. In the early 1980s tax rates were at levels that curbed enterprise and economic activity. But in 2001, when George Bush became president, they were not. There was no evidence of lack of entrepreneurial zeal in the late 1990s boom; if anything there was an excess of it. So why cut taxes further?

And why cut taxes on the rich, rather than the middle earners? There is a perfectly reasonable case for allowing the fiscal deficit to widen to offset a fall in demand but the way in which the Bush tax cuts are constructed are an inefficient way of boosting demand. You give money back to middle-income people who will spend it, not richer ones who are likely to save at least part of it.

And the deficit itself is reaching even higher levels now than during the Reagan years, despite the fact that, thanks to very low interest rates (big difference here from the 1980s), the US has had a particularly mild recession - much less serious than that of the early 1980s. You could say that if Reagan was fiscally irresponsible, thanks to good growth in the late 1980s he got away with it. By contrast the present Administration is committing the country to a long slog of deficit reduction that will take a decade or more.

And the final element of policy under Reagan, the tight monetary policy? Now we have precisely the reverse. As it happened, Alan Greenspan was appointed by Reagan in the final year of his presidency. But Dr Greenspan, in recent years, has been the arch-expansionist. Of course this is a period of low inflation, unlike the early 1980s, so the US does not need high rates. But it may need higher ones than it has at the moment.

The effect is that instead of having a loose fiscal policy offset by a tight monetary one, both policies are running with the loud pedal hard down. The result has been good growth but at the price of huge indebtedness at a national and a personal level. Under the present President, the US is sucking in savings from the rest of the world to maintain its living standards. No one knows how long that can continue.

I suppose that the US economy will grow through its present stresses. If you have growth most financial problems can be managed. In that sense the US is better placed than much of Continental Europe, which has Reaganesque fiscal deficits without the growth to support them. You can give two cheers, not three, to the economic policies of Reagan but be profoundly worried about similar policies being applied to an utterly different set of circumstances a generation later.