Historical Sources of the Federal Budget Impasse

Eddie VanBogaert Monday, May 23, 2011

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Historical Sources of the Federal Budget Impasse
A budget in a lot of ways is like a checkbook. A checkbook tells us about an individual’s priorities. This is our national checkbook. It tells us where we are and where we want to go as a nation.
SENATOR JOHN THUNE (2007)

Most of the people here, you’ve got a family budget. If less money is coming in, you end up making cuts. Maybe you don’t go out to dinner as much. Maybe you put off buying a new car. That’s not what happens in Washington.
SENATOR BARACK OBAMA (2008)

Comparisons between household spending and the budget of the Federal Government are abundant. For decades, the analogy has been an effective rhetorical vehicle for connecting with voters on fiscal issues. Its widespread use is understandable: few Americans have backgrounds in budgetary policy, while most have had to manage personal finances. The checkbook comparison appears to make taxing and spending issues more accessible, even relatable. Unfortunately, this conceptualization oversimplifies the problem, misplacing political pressure through the false dichotomies of ideological purity. It is true that there is a structural deficit in the Federal budget that must be resolved. In time, the obligations of government debt can leech funding from public services and crowd out private investment. Unfortunately, recovery strategies for multi-trillion dollar economies are recent and without controlled testing. Accepting that the Federal Government ought to be involved in pursuing economic stability for the sake of public welfare, it remains understandably difficult to settle on a consistent macroeconomic approach when the historical precedents only loosely apply. In simplifying fiscal concepts for campaigns, partisan interests have not helped the public’s lack of understanding. There is no reason why Federal budgetary policy must be a zero-sum struggle between the two main economic philosophies. In a medium-term revenue framework, it should be possible for Congress to harness the benefits of both demand-side and supply-side strategies, albeit in separate circumstances, while being disciplined enough to meet the responsibilities of each. It does not seem to be presently appreciated that the strengths of these orientations are quite specific. The flat and continuous application of a single policy without respect to its historical record is not very informed decision-making. One source of the problem is a broken system of campaign finance. Special interests (corporations, large unions, industry groups) – often ones created or sustained by the public sector since the Second World War – have made their contributions so important to elected officials that reductions in spending are politically difficult. Tax issues have been won by the wealthy, a fraction of the population who have secured massive victories on income and estate taxes during the last thirty years. Combined, we have an irrational budgetary policy that has

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starved education in the name of the health care industry and ignored infrastructure for Big Oil. Too many candidates and voters are still talking about checkbooks, drawing microeconomic conclusions for macroeconomic questions. This essay examines the evolution of budgetary strategy in recent American history, beginning with the birth of demand-side orientation in the 1930s, and moving through the rise of an alternative strategy in the 1970s. Here in 2011, faced with operational impasses and ideological conflict, past budgetary policies are extremely relevant, but also deserving of careful scrutiny.

What is the deficit?
Consider broadly how the government operates. Incoming funds (mostly taxes) finance government operations (mostly public programs). The range of dynamics that affect both revenues and expenditures complicate what would ordinarily be considered a fairly simple exchange. This is the failure of the checkbook comparison: the character of the variables that affect personal incomes are often quite different than the economic systems that determine public tax receipts. Likewise, the government has a set of spending tools that are not comparable to those available for average consumers. The amount of revenue generated is primarily dependent upon the rate of taxation and the performance of the economy being taxed. The latter is demonstrated in a comparison of Federal receipts from 2008 and 2009 (see Figure 1). While tax rates remained largely the same across this period, the size of the American economy (measured by Gross Domestic Product) contracted by 3.7%.1 Figure 1.

Summary of Federal Tax Receipts, 2008-2009
in billions of dollars2
Revenue Sources 2008 Receipts 2009 Receipts Individual Income 1,146 972 Corporate Income 304 180 Payroll Taxes 901 898 Other Sources 173 165 Total Receipts 2,524 2,215 Source: Office of Management and Budget, 2010

                                                                                                                          1 Organisation for Economic Co-Operation and Development (OECD), Quarterly National Accounts: Quarterly Grow Rates of Real GDP, Change Over Previous Quarter, accessed on March 15, 2011 at: stats.oecd.org (National Accounts). 2 Office of Management and Budget, Budget of the Federal Government for Fiscal Year 2010 (Washington, D.C., 2010), 117 (Summary Tables). Table adapted from Table S-3.
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This highlights the contrast between the two main categories of deficits: structural and cyclical. A structural deficit occurs when public expenditures exceed the full potential of tax revenues, or what could be taxed from a fully performing economy. Cyclical deficits refer to revenue shortfalls that are products of economic decline.3 Federal budget deficits usually reflect a combination of both conditions. Because solutions to cyclical deficits incorporate disaggregated estimates (imperfect estimations of economic performance), the structural deficit is usually discovered first (from flat budget figures), and then used to calculate the portion of the deficit that is cyclical.4 Virtually all industrialized nations have medium-term expenditure frameworks that set taxing and spending targets for the decade ahead. These targets can be flexible (as they are in the United States, with annual appropriations by Congress) or set in place permanently (“fixed”). The overall framework is intended to foster stability through consistency in budgetary policy. In the last century, it has favored two strategies: demand-side orientation and supply-side orientation.5 Supply-side orientation attempts to stimulate economic growth through tax relief. Expenditure targets and the size of the structural deficit (if any) in the budgetary framework are dictated by the goal of lowering taxes. The hope of policymakers pursuing this strategy is that the money saved by taxpayers will be reinvested into the economy, yielding growth. Demand-side orientation tries to stimulate growth by putting money into the hands of consumers, often through public spending on government programs, but also by cutting tax rates for the consumer classes of the economy. In the United States, the popularity of these strategies is linked to successes of different political ideologies and has developed through the maturation of the American economy since the Great Depression.

The Rise of Demand-Side
Those supporting Franklin Roosevelt’s New Deal proposals in 1932 had no idea that they were voting for the installation of demand-side orientation. The complete academic theory on how the government could become involved in stimulating aggregate demand was not formalized until John Maynard Keynes’ The General Theory of Employment, Interest, and Money in 1936.6 Additionally, the public was, as they are now, generally delayed in their reactions to the economic environment created by the Great Crash of 1929. Few had easy access to information about the
                                                                                                                          3 Organisation for Economic Co-Operation and Development (OECD), Reallocation: The Role of Budget Institutions (Paris, France: OECD Publications, 2005), 55. 4 Pierre-Richard Agénor, The Economics of Adjustment and Growth (Boston, MA: Harvard University Press, 2004), 88. 5 OECD, 56. 6 N. Gregory Mankiw, Principles of Economics (Mason, OH: South-Western Publishing, 2009), 770. Note: “Aggregate demand” refers to the total demand for goods and services within an economy.
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budgetary policymaking system.7 Public perception was limited to observable indicators like unemployment and the cost of consumer goods, which lag behind the overall performance of the economy. The debate in Congress was over whether the government should become involved at all, since it had not been responsible for the crash in the first place.8 After deferring to Congress for some time, the levels of unemployment necessitated that President Hoover act, or face electoral consequences.9 His response began with appeals to the business community, and eventually included encouragement to the Federal Reserve for loosened credit. Some demand-side tools were engaged – public spending was expanded with the Agriculture Relief Act – but the Hoover Administration did not demonstrate decisive command of any strategy.10 The Smoot-Hawley Act, an isolationist reaction that raised tariffs on imports, was countervailing to both supply-side and demand-side notions. It slowed foreign investment in many industries and created shortages of commodities, which raised prices.11 Hoover is often associated with supply-side theory because his economic platform in the election of 1928 was focused on tax relief, but this analysis seems incomplete because the platform also promoted the import tariffs that were unsuccessfully enacted in 1930.12 Again, these actions were more populist and patronizing of select constituencies than they were aligned with a particular strategy for budgetary maneuvering. Still, Hoover defended government passivity at several moments during his term, and such insistence became definitive of his presidency.13 President Roosevelt was elected in 1932 on the promise of more direct intervention. His campaign aimed to draw contrast between the alleged inaction of the Republican incumbents and the aggressive New Deal proposals. Said Roosevelt at the Democratic National Convention in July of 1932: Our Republican leaders tell us economic laws – sacred, inviolable, unchangeable – that these laws cause panics, which no one could prevent. But while they prate of economic laws, men and women are starving. We must lay hold of the fact that economic laws are not made by nature. They are made by human beings…

                                                                                                                          7 William Edward Leuchtenberg, The FDR Years: On Roosevelt and His Legacy (New York, NY: Columbia University Press, 1995), 43. 8 Matthew C. Price, Justice Between Generations: The Growing Power of the Elderly in America (Westport, CT: Greenwood Publishing Group, 1997), 23. 9 Ibid, 23. 10 Ibid, 24. 11 Bernard Beaudreau, Making Sense of Smoot-Hawley: Technology and Tariffs (Lincoln, NE: iUniverse, 2005), 79-85. 12 Ibid, 82-32. (Hoover’s platform: “The Kansas City Platform.”) 13 Price, Justice Between Generations, 25.
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Throughout the nation, men and women, forgotten in the political philosophy of the government of the last years look to us here for guidance and for more equitable distribution of national wealth. These appeals implied demand-side policy, but leaned more heavily on the social justice of redistribution than its approach for recovery. Regardless, the rhetoric was phenomenally successful. Roosevelt defeated President Hoover nearly 60/40 and ushered in a decade and a half of strong Democratic gains across the country.14 These victories were construed as a mandate for the expansion of the public sector, something that political realignment would echo for decades to come.15 The severity of the crisis demanded solutions that were further reaching than the public works projects that are emblematic of the New Deal. While public employment tactics like the Works Progress Administration had some effect on the staggering unemployment figures, instability in monetary policy was too great to permit full recovery during Roosevelt’s first term.16 To an extent, this was fated before he took office. A sharp rise in money supply in 1932, followed by a deep contraction between January and March of 1933, set off a liquidity crisis. Banks, uncertain about extreme volatility in the value of the Dollar, greatly reduced lending. Outstanding investments failed outright, forcing some banks to close, creating the public panic that led many Americans to withdraw the deposits that capitalized the lenders. Public infrastructure projects put some money into the economy, but did not restore the confidence in the banks that was necessary to energize private investment.17 Compounded by a 90% drop in stock prices that crushed household wealth, the US economy suffered the consequences of rapidly declining demand for goods and services.18 The utilization of public policy tools to catalyze resurgence in aggregate demand is a very inexact science. Because the effects of recovery measures cannot be tested in a controlled environment, the extent to which actions have succeeded is always
                                                                                                                          14 William C. Binning, Larry E. Esterly and Paul A. Sracic, Encyclopedia of American Parties, Campaigns, and Elections (Westport, CT: Greenwood Publishing Group, 1999), 136. 15 David W. Brady, Critical Elections and Congressional Policy Making (Stanford, CA: Stanford University Press, 1988), 84-105. 16 Jason Scott Smith, Building New Deal Liberalism: The Political Economy of Public Works, 1933-1956 (New York, NY: Cambridge University Press, 1970), 87-88. 17 Lawrence J. Christiano, Roberto Motto, Massimo Rostagno, National Bureau of Economic Research, The Great Depression and the Friedman-Schwartz Hypothesis (Washington, D.C., 2004), 9; Smith, Building New Deal Liberalism, 88-89; Harold G. Vatter and John F. Walker, “Real Public Sector Employment Growth, Wagner’s Law, and Economic Growth in the United States,” History of the U.S. Economy Since World War II (Armonk, NY: M.E. Sharpe, Inc., 1996), 269-273. 18 Christiano, The Great Depression and the Friedman-Schwartz Hypothesis, 1; Edwin Amenta and Bruce G. Carruthers, “The Formative Years of US Social Spending Policies: Theories of the Welfare State and the American States During the Great Depression,” American Sociological Review, vol. 53 (1988), 661; Mankiw, N. Gregory, Principles of Economics, 766.
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unclear. It may take years for results to be manifested, and the efficacy of approaches may be exaggerated or understated, because of interference from outside variables. Given this, and the multitude of factors that contributed to the scale and complexity of the Great Depression, there is a lot of disagreement among economists and historians about what actions were responsible for recovery.19 Public spending on infrastructure investment and World War II are primarily credited, albeit to differing degrees. Both approaches (and their respective drawbacks) are relevant to our contemporary budget debate.

Military-Industrial Complex
In Keynes’ establishment of demand-side orientation, he theorized that demand has four sources: individual domestic consumers, domestic businesses, exports, and public spending.20 Policymakers employing demand-side orientation use government spending to fortify aggregate demand against the decreases of private sources.21 Left unchecked, these decreases can devalue products and impact profitability. Reduced supply necessitates fewer workers, prompting layoffs.22 By supporting aggregate demand during recessions, demand-side orientation aims to restrain unemployment and shorten recovery time. Government spending on the military operations of World War II was the largest expansion of the public sector, by percentage of Gross Domestic Product, in the history of the United States.23 A disconnect between politics and economics (or simply political bias) seems evident in the public memory of this matter. For instance, one might expect a political liberal and Keynesian to embrace the evidence of World War II as a validation of the demand-side strategy. Strangely, though, in a zero-sum debate that pits the achievements of the New Deal against the stimulus of war, many modern progressives continue to downplay the consequences of 1940s military spending.24 Conversely, numerous conservatives and avowed supply-siders who reject demand-side orientation are quick to point out that World War II was
                                                                                                                          19 N. Gregory Mankiw, Principles of Economics, 769. 20 Peter Kennedy, Macroeconomic Essentials: Understanding Economics in the News (Boston, MA: Massachusetts Institute of Technology, 2000), 52. 21 Mankiw, Principles of Economics, 769; Kennedy, Macroeconomic Essentials, 52-53. 22 Kennedy, Macroeconomic Essentials, 52-53. 23 United States Census Bureau, United States Department of Commerce, “Chapter Y: Government Employment and Finances,” The Statistical Abstract of the United States (Washington, DC: United States Census Bureau, Government Printing Office, 2011), 11041114. Available online at: http://1.usa.gov/fy6j4K. 24 Smith, Building New Deal Liberalism: The Political Economy of Public Works, 1-10, 190192; Edward P. O’Connor, “DBQ Theme: The Great Depression and the New Deal,” Teaching and Using Document-Based Questions for Middle School (Portsmouth, NH: Reed Elsheiver, 2004), 119-122; Edward Sidlow and Beth Henschen, America at Odds (Belmont, CA: Cengage Learning, 2009), 59.
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more responsible for recovery than the New Deal.25 That appears to conflict with their contention that expansions of the public sector are not effective recovery measures.26 Liberals, meanwhile, discard or overlook one of the more convincing instances of their budgetary strategy in action. Figure 2.

Annual Defense Appropriations and GDP (1925-1950)
in billions of dollars27
350

300

250

200

150

100

GDP Incomes

50

Fed Receipts Fed Outlays Defense $ 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950

0

                                                                                                                          25 Glenn Beck, The Glenn Beck Show, (radio broadcast, July 10, 2010), transcript available online: http://bit.ly/a6OHd2. 26 Megan McArdle, “Did World War II End the Great Depression,” The Atlantic (February 2009), available online at: http://bit.ly/b0ZsoL; Lawrence White and David C. Rose (CATO Institute), “We Can’t Spend Our Way Out of This Quagmire,” St. Louis Post-Dispatch (January 21, 2009), available online at: http://bit.ly/bdMVC. 27 United States Census Bureau, The Statistical Abstract of the United States, 1104-1114.
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The data sets for this chart are adapted from tables in the United States Census Bureau’s “Statistical Abstract of the United States” (which adjusts for inflation) and rounded to the nearest hundred million dollars (see Appendix, Figure B). The hashed line marks the beginning of World War IIfocused policy. Defense spending, like many appropriations, is a figure often adjusted throughout the year to match the needs of government. The Departments of Army, Navy, and Air Force (following 1948 creation) are reflected above and below.

Figure 3.

Data Table of GDP, Federal Revenues/Expenditures, Defense Appropriations, and Individual Incomes (1925-1950)
in billions of dollars
Year GDP Total Federal Receipts Total Federal Outlays Total Defense Appropriations Adjusted Gross Income (Individuals)

1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950

90.6 97.0 95.5 97.4 103.6 91.2 76.5 58.7 56.4 66.0 73.3 83.8 91.9 86.1 92.2 101.4 126.7 161.9 198.6 219.8 223.0 222.2 244.1 269.1 262.2 293.7

3.6 3.8 4.0 3.9 3.9 4.1 3.1 1.9 2.0 3.0 3.7 4.0 5.0 5.6 5.0 6.9 9.2 15.1 25.1 47.8 50.2 43.5 43.5 45.4 41.6 40.9

2.9 2.9 2.9 3.0 3.1 3.3 3.6 4.7 4.6 6.6 6.5 8.4 7.7 6.8 8.8 9.6 14.0 34.5 79.0 94.0 95.2 61.7 36.9 36.5 40.6 43.1

0.7 0.7 0.7 0.7 0.8 0.8 0.8 0.8 0.8 0.7 0.7 0.9 1.2 1.2 1.4 1.8 6.3 22.9 63.4 76.0 80.5 43.2 14.8 12.0 13.9 13.4

25.3 25.5 26.2 29.0 22.8 22.3 17.3 14.4 13.4 15.1 17.3 21.9 23.9 21.6 25.8 40.3 63.8 85.9 106.6 116.7 120.3 134.3 150.3 164.2 161.4 179.9

Consider annual estimations of Gross Domestic Product from 1925 to 1950, contrasted against the Federal Government’s revenues and expenditures (see Figures 2 and 3, above). GDP, a leading indicator, hits its floor in 1930. Two years later, tax revenues bottom out at less than half of their 1927 levels. The adjusted

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gross income of individuals (aggregate “take-home” incomes) falls last in 1934.28 The personal incomes figure reflects long-term unemployment and a 300% increase in the top marginal tax rate.29 A budget surplus of 20% of total outlays in 1930 became a deficit of almost 60% during the same term, as the public earned less taxable income and recovery-focused spending programs launched. This comparison turns in the run-up to World War II. Even before formal American involvement, new allied exports began driving demand for military products.30 Between the spring of 1940 and Pearl Harbor in 1941, non-farm employment and wages increased by about 20%.31 The full commencement of combat operations in early 1942 expanded defense appropriations to two-thirds of all federal spending in that year.32 This was a staggering 84.5% of all expenses by the end of the war in 1945.33 By leveraging a significant amount of money raised through higher taxes and bond sales, the Federal Government was producing a third of all economic activity by 1943.34 Demand-side orientation is dependent upon the eventual stimulation of private demand. Spending by individuals, businesses, and foreign sources within an economy must replace temporary, deficit-funded efforts to relieve the continued issuance of public debt. Otherwise, the interest obligations would restrain a public government’s capacity in the longer term, for services or stimulative measures. Competing for increasingly scarce debt purchasers, bonds have to offer higher rates of return, which is more expensive for the government. Even if these buyers are found, public issuers risk slowing growth by “crowding out” private industry in the market for investors.35

                                                                                                                          28 United States Census Bureau, The Statistical Abstract of the United States, 1104-1114. 29 William F. Shughart, II, and Robert D. Tollison, eds., Policy Challenges and Political Responses: Public Choice Perspectives on the Post-9/11 World (The Netherlands: Springer, 2005), 100. 30 Nathan Grundstein, Presidential Delegation of Authority in Wartime (Pittsburgh, PA: University of Pittsburgh Press, 1961), 91, note 5. Note: This increase even prompted President Roosevelt to begin regulating who could become trading partners of the rapidlygrowing defense industry. 31 James B. Atleson, “The Mobilizing Period: Dress Rehearsal for Wartime,” Labor and the Wartime State: Labor Relations and Law During World War II (Champaign, IL: University of Illinois Press, 1995), 20-22. 32 Bureau of National Affairs, Doing Business Under the Defense Program: A Handbook of the Laws Governing Business Practices During Rearmament (Washington, DC: Bureau of National Affairs, Inc., 1940); National War Labor Board, War Labor Reports: Salary and Wage Stabilization (Washington, DC: National War Labor Board, 1943). 33 United States Census Bureau, The Statistical Abstract of the United States, 1104-1114. 34 Ibid. 35 Marcus Miller, Robert Skidelsky, and Paul Weller, “Fear of Deficit Financing: Is It Rational?” Public Debt Management: Theory and History (New York, NY: Cambridge University Press, 1990), 296-197.
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The nature of World War II, a personnel-heavy overseas military operation, worked to the favor of the public investment.36 Active servicemen saved more of their earnings, unable to spend much of it while deployed. Rationing and resource scarcity forced many Americans to postpone capital purchases. An influx of women into the workforce increased national productivity.37 Increased savings and pent-up demand replaced and surpassed the public sector contraction caused by the postwar spending drawdown.38 There is also some limited evidence that favorable trade conditions benefitted the American economy in the wake of the Second World War’s destruction, which (mostly) spared the United States.39 Whether it had intended to or not, the United States was poised to complete the demand-side scheme as theorized. It may be impossible to separate the merits of the strategy from the advantageous postwar economic conditions, but the position of the United States would have undoubtedly been worse without the marked expansion of military appropriations. Manufacturing for allied forces might have provided sufficient private growth to end the 15% unemployment of 1940, but the rate of increase was a fraction of the eventual government-led demand.40 There might not have even been a choice if security vulnerabilities necessitated a greater national defense. Subsequent foreign attacks were expected after Pearl Harbor, and would have demanded a response at some point, confronted with the prospects of incredible collateral cost.41 Still, this range in function is more a feature of demand-side orientation than a dilution of this evidence: the subject of public sector spending in the pursuit of economic stimulus can serve alternative policy objectives if applied correctly. Accepting that dynamic, the sustainment of the postwar military-industrial complex remains a reminder that economic strategy is not the sole political motivator in budgetary policy. Public demands, pushing in the late 1940s and early 1950s for interests related to the Cold War, kept military spending elevated through the immediate postwar decade.42 Defense appropriations in 1950 were at 250% of their 1940 levels (as a percentage of GDP), bolstered by a war in Korea that interrupted the defense cool-down. Technologies refined in World War II, especially
                                                                                                                          36 John W. Kendrick, Productivity Trends in the United States (New York: National Bureau of Economic Research, Princeton University Press, 1961), Xxxvii-xxxviii, 61-76. 37 Clair Brown, and Joseph A. Pechman, eds., “Consumption, Work, and Growth,” Gender in the Workplace (Washington, DC: The Brookings Institution, 1987), 71-72, 172, 254, 297. 38 Earl A. Thompson and Charles Robert Hickson, Ideology and the Evolution of Vital Economic Institutions: Guilds, the Gold Standard, and Modern International Cooperation (Norwell, MA: Kluwer Academic Publishers, 200), 347. 39 RM Auty, ed., Resource Abundance and Economic Development (Oxford, UK: Oxford University Press, 2001), 5-9. 40 United States Census Bureau, The Statistical Abstract of the United States, 1104-1114. 41 Donald M. Goldstein and Katherine V. Dillon, The Pearl Harbor Papers: Inside the Japanese Plans (Dulles, VA: Brassey’s Publishing, 1993), 157. 42 Tony Shaw, Hollywood’s Cold War (United Kingdom: Edinburgh University Press, 2007), 202-203.
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in aviation, were more expensive to service, but were perceived as necessary to compete with the Soviet Union in the new international paradigm.43 In discussing these budgetary consequences, it is important to separate disagreements about the wisdom of defense investments from their sheer quantitative impact. Military spending pursuits may have been foolish, irrelevant, or necessary from the standpoint of foreign or social policy, but inasmuch as the institution affects economic strategies, consistency is more vital than the purpose of the funding. If public revenues cover the outlays, new debt obligations do not pose risks to the functions of government. The higher taxes necessary to support larger defense operations take money out of the private sector (from the taxed) and bring the productive capacities of that wealth under the public umbrella. Certain diversifications in demand sources are arguably more ideal, but a shift within the scope of the Cold War’s military investments (5-7% of GDP, versus 1-3% in the 1930s) is not really a radical policy alteration as long as the expenses are addressed.44 The fulcrum of the policy debate – and the rhetorical challenge to strategic consistency – surrounds an argument about where wealth is best advanced within an economy. Upon leaving office in January of 1961, President Eisenhower cautioned against the sustained expansion of defense industries.45 The income taxes supporting the military-industrial complex, he said, were diverting too much money away from investment in private development, where greater productivity could be achieved.46 This supply-side perspective became politically prominent immediately upon demand-side’s time of weakness.

The Rise of Supply-Side
Despite being strongly associated with the 1980s and the policies of President Ronald Reagan, events of the 1970s are actually the origins of supply-side dominance. By the 1960s, recovery from the Great Depression had installed Keynesianism as the favored strategy, but 1973 brought a new recession fueled by rising energy prices and increased global competition.47 Demand-side no longer seemed unassailable, and conservative economists like Milton Friedman framed a counter-movement. Some Republican politicians, in response to President Lyndon Johnson’s expansion of social entitlement programs, championed the approach.

                                                                                                                          43 Charles J. Gross, American Military Aviation: The Indispensible Arm (College Station, TX: Texas A&M Press, 2002), 183-186. 44 United States Census Bureau, The Statistical Abstract of the United States, 1104-1114. 45 Sterling Michael Pavelec, The Military-Industrial Complex and American Society (Santa Barbara, CA: ABC-CLIO, 2010), 95. 46 Ibid, 95-96. 47 Rhona Free, 21st Century Economics: A Reference Handbook, Volume 1 (Thousand Oaks, CA: SAGE Publications, 2010), 351.
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These advances were not largely demonstrated until the Eighties because of political setbacks for Republicans.48 Central to the momentum shift were a few critical public sector errors. Steep military deficits from the war in Vietnam were not balanced in the medium-term window as the debts from World War II and Korea had been.49 A strong consumer market had pushed the 1950s economy to raise the tax dollars needed to cover costs. The same was not true in the Seventies. Stagflation, a term coined in the decade’s early half, described a combination of side-by-side currency devaluation and high unemployment.50 The condition made goods more expensive for households that were making less income. Oil prices rose in October of 1973, halfway through a twoyear market sell-off that shed more than 40% of the Dow Jones Industrial Average.51 President Richard Nixon was elected in 1968 as a supply-side supporter. Backed by Friedman, William F. Buckley, and others, Nixon sought free-market answers to the economic contractions caused by withdrawals of service personnel from Vietnam.52 Inflation and unemployment overwhelmed any “peace dividend” from returning members of the military.53 Nixon’s “New Economic Policy” (1971) was aggressive, freezing wages for 90 days, raising tariffs on imports, and ending the Gold Standard for currency valuation. The first two were short-lived, but the latter brought down the existing system for monetary policy.54 Early in his first term, Nixon argued that late-Sixties cyclical deficits were the products of high unemployment and that the structural deficits were results of balance-to-payment shortfalls from creditor nations calling in aggressive dollar-togold guarantees.55 Under the Bretton-Woods system of international finance, U.S. Dollars were promised for gold, which had been set by international accord at $35 per ounce in 1944. Some flexible controls were featured, but interest was largely

                                                                                                                          48 Edwin C. Sims, Capitalism: In Spite of It All (Amsterdam, The Netherlands: OPA, Gordon and Breach Science Publishers, 1989), 101. 49 Anthony S. Campagna, The Economic Consequences of the Vietnam War (New York, NY: Praeger Publishers, 1991), 141-145; Gardner, Lloyd C., and Ted Gittinger, eds., The Search for Peace in Vietnam: 1964-1968 (United States: Lloyd C. Gardner and Ted Gittinger, Lyndon B. Johnson Foundation, 2004), 102-104. 50 Free, 21st Century Economics, 351. 51 Council of Economic Advisors, Economic Report for the President (Washington, DC, 1975), 20, 128. 52 Lynn Turgeon, Bastard Keynesianism: The Evolution of Economic Thinking and PolicyMaking Since World War II (Westport, CT: Greenwood Publishing Group, 1997), 24; William F. Buckley, “Op Ed: The Watergate Moment,” The New York Times, Letters (August 8, 1994), available online at: http://nyti.ms/kNDsVN. 53 Turgeon, Bastard Keynesianism, 24-25. 54 Ibid, 25. 55 Catherine R. Schenk, The Decline of Sterling: Managing the Retreat of an International Currency (New York, NY: Cambridge University Press, 2010), 317.
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fixed.56 This structure collapsed with the “Nixon Shock” in 1971, when on August 16, the administration announced that the Federal Government would no longer be honoring gold transactions.57 The politics of the Gold Standard aside, the sharp devaluation increased inflation on all fronts. A dollar that was worth less eroded domestic purchasing power and the Organization of Petroleum Exporting Countries (OPEC) raised prices to repair a trade position that was lost in August 1971. The run-up in energy prices that was borne from the new trade and currency dynamics had a commanding impact on the use of domestic budgetary tools, since fuel costs weakened consumers and made government services more expensive to provide.58 Nixon pushed forward with considerable deficits, declaring famously in 1971, “I am now a Keynesian.”59 The statement referred more to the cemented overall role of demand management in the practice of macroeconomic analysis, but still demonstrated the President’s fragile allegiance to a single strategy. Nixon rode publicly driven demand-side expansion into a friendly re-election year economy.60 A deficit struggle that emerged in 1975 as growth began to wane. This debate also publicly acknowledged the convergence of economy strategies. Alan Greenspan, the new Chairman of the Council of Economic Advisors under President Gerald Ford (replacing one of many advisors who left with Nixon), argued that government spending (as a significant portion of aggregate expenditures) “outstripped the sustainable growth of the supply of real goods and services.” He endorsed the tax cut plan proposed by President Ford in the Economic Report for the President (1975):61 The tax cut will not prevent a decline in real output from 1974 to 1975 but it will reduce the extent of the year-over-year decline—perhaps by one-half of 1 percent to 1 percent in terms of real [Gross National Product]—and will contribute to the recovery in the second half of 1975. The support was tempered by the acknowledgement that a “number of factors” were complicating an assessment of the stimulus program’s economic effects, mainly that the tax cut “will be saved rather than spent.”
                                                                                                                          56 National Bureau of Economic Research, Michael D. Bordo, and Barry Eichengreen, eds., A Retrospective on the Bretton-Woods System: Lessons for International Monetary Reform (Chicago, IL: University of Chicago Press, 1993), 125-128. 57 Robert Charles Angel, Explaining Economic Policy Failure: Japan in the 1969-1971 International Monetary Crisis (New York, NY: Columbia University Press, 1991), 115-119; Schenk, The Decline of Sterling, 317. 58 Turgeon, Bastard Keynesianism, 24-25. 59 Bradley Bateman, Toshiaki Hirai, and Maria Christina Marcuzzo, The Return to Keynes (Boston, MA: Harvard University Press, 2010), 12-15. 60 Ibid. 61 Council of Economic Advisors, Economic Report for the President (Washington, DC, 1975), 20, 128.
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The year that followed rewarded the Ford Administration’s actions, if only in the short run. Production capacity and consumer spending power were both expanded in late 1975, presenting a modest decline in inflation but not relieving “distressing” levels of unemployment. The President and Chairman Greenspan both stressed that this relief was likely still years away. This did not assist Ford in the 1976 Presidential Election, already dogged by associations with Watergate and the disgraced Nixon White House. Former California Governor Ronald Reagan, President Ford’s opponent in the 1976 Republican primaries, did not adopt supply-side orientation as a central platform component until the following cycle. Those involved in the 1980 election for Reagan have cited the development of this rhetoric as a key difference between the preparedness of his race against Ford and the campaign that won him the presidency.62 One particularly damning instance for the failed effort came in October of 1975, prior to the campaign’s formal announcement. A Reagan speech entitled “Let the People Rule” was seized upon by the Ford Campaign and used to discredit Reagan’s economic credentials. The remarks, scripted by campaign staffer Jeffrey Bell, proposed that local and state governments be given more fiscal autonomy.63 These themes were borrowed from Reagan’s gubernatorial rhetoric that advocated for considerable dismantling of national bureaucracy and a dilution of federal budgetary controls. The gaffe was an overstatement of the proposal’s cost saving potential. This “Ninety Billion Dollar Speech” was teachable moment for the Reagan Camp, as they were forced to strengthen the former governor’s policy image before the race against President Jimmy Carter.64 For supply-side orientation, tax cuts won the middle, claiming independents and “Reagan Democrats” in the Election of 1980.65 The prospect of paying fewer taxes in exchange for cutting waste was in concert with political reactions to declining real incomes (from inflation) and distrust of the post-Watergate Federal Government. Kneecapped by foreign policy, Carter was unable to reign in the energy costs that were eroding purchasing power. The domestic economy saw higher prices from industries struggling to match greater operating costs and wage earners’ demands, which were themselves products of devalued incomes. The Carter Administration, internally torn on a preferred remedy, unsuccessfully appealed to industry leaders to hold back price increases.66 Disagreements among advisors reflected broader discord among the interest groups that President Carter needed for cooperative agreement supporting price
                                                                                                                          62 Craig Shirley, Reagan’s Revolution: The Untold Story of the Campaign That Started It All (Nashville, TN: Nelson Current, 2005), 342; Amos Kiewe, Davis W. Huock, and Davis T. Huock, “From Federalism to Supply-Side,” A Shining City on a Hill: Reagan’s Economic Rhetoric, 1951-1989 (New York, NY: Greenwood Publishing Group, 1991), 115-116. 63 Kiewe, A Shining City on a Hill, 116-118. 64 Shirley, Craig, Reagan’s Revolution, 342. 65 Ibid, 342-344. 66 W. Carl Biven, Jimmy Carter’s Economy: Policy in an Age of Limits (Charlotte, NC: University of North Carolina Press, 2002), 190-191.
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stability. An anti-inflation initiative in October 1978 was rebuked by business and labor alike. When a major sanction of the measure was declared unconstitutional in early 1979, much of the plan fell apart.67 With lingering debt from Vietnam and unfunded entitlement expansions early in the decade, demand-side stimulus tools were difficult for the Carter Administration to engage politically. Support for expansion of the public sector was at a historical low.68 Recovery options were effectively limited to monetary tinkering and pleading with private institutions.

Contemporary Applications
Somewhat similarly to Carter, President Obama is now in a situation where few demand-side tools are viable. This was recently not the case. Possessing more political capital in the 111th Congress (2009-2010) than Carter had in the 96th (19791980), Obama was able to use public sector expansion as a recovery tool repeated times during 2009.69 While time will yield greater perspective, there is a strong case that the administration’s stimulus program, in coordination with the capitalization efforts of the late Bush presidency (TARP), prevented greater catastrophe. This is a remarkable development, given how deliberate Keynesian policy had been dormant since the Johnson Administration.70 Complete recovery has proven to be more elusive. The Federal Government is limited in its ability to engage demand-side tools because of the entrenched nature of existing spending items, like the military-industrial complex. Shrinking these items would have the effect of shrinking the whole economy, if they were not immediately replaced with other things. Because transitioning this spending is not politically viable with the Republican-controlled House, the Obama Administration can (A) embrace the Republican’s supply-side agenda, (B) fight for existing (but problematic) spending items, or (C) do something in the middle. None of these approaches seem very ideal for the President’s situation. Embracing a supply-side strategy of stimulating growth through additional tax cuts would, at best, not produce a net increase in jobs for at least a few years. The public sector layoffs from spending cuts would take time to be reabsorbed into the private labor force. The historical evidence for the effects of 1980s tax reform is obscured by the onset of tremendous growth in the tech sector, questioning the extent to which the readjustment was effective. Conversely, continuing the status quo, a budget that is more than 40% composed of defense spending, is not sustainable with current revenues. Raising taxes is very unpopular politically, so the government is at the mercy of new growth to raise necessary funds under the current formulation. Nearly one-tenth of Federal
                                                                                                                          67 Biven, Jimmy Carter’s Economy, 186-187. 68 Dean Baker, The United States Since 1980 (New York: Cambridge University Press, 2007), 2-5. 69 David Wessel, In Fed We Trust (New York, NY: Three Rivers Press, Random House, 2010), 278-279. 70 Bateman, The Return to Keynes, 182-183.
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spending currently goes toward interest payments on existing debt, and international creditors are threatening to make new outlays more expensive. Borrowing from the Social Security trust, a popular financing source over the last three decades, has largely been exhausted, raising new concerns about the risks of paying entitlements on an annual basis, after having surpluses in the fund as recently as 1990.71 Attempts to stimulate the economy outside of budgetary policy have produced less than stellar results. The Federal Reserve can no longer lower interest rates to encourage lending, having already cut the Federal funds rate to zero.72 Quantitative easing, a program designed to have the Federal Reserve purchase government bonds, failed to meet expectations.73 Inflation, the hallmark economic problem of the Carter presidency, is becoming the primary point of contrast between the recession of the late 1970s and that of the last few years. The Consumer Price Index (CPI), an estimation of the adjusted rise in prices for consumer products, year over year, is a respected inflationary measure. This score has shown that even when energy prices are included, devaluation and the associated erosion of purchasing power are not the risks that they were in 1980.74 Thus, the advancement of new public spending, at least as it relates to inflationary fears, is probably not as dangerous: Figure 4.

Contrasted Consumer Price Indexes (CPI), 1979, 1980 and 2011
Average of annualized percentage change for all items, seasonally adjusted75

Affected Period Jun/1979 – Dec/1979 Dec/1979 – Jun/1980 Jun/1980 – Dec/1980 Jan/2011 – Apr/2011

CPI 12.5% 16.3% 8.9% 3.2%

                                                                                                                          71 Carolyn L. Weaver, Social Security’s Looming Surpluses: Prospects and Implications (Lanham, MD: University Press of America, 1990), 114; John Attarian, Social Security: False Consciousness and Crisis (New Brunswick, NJ: Transaction Publishers, 2003), 284285; David John, “Trustees Show Permanent Deficits for Social Security,” The Wall Street Journal, Federation Feature (May 18, 2011), available online at: http://on.wsj.com/jCxkYZ. 72 Howard Packowitz, “Fed’s Evans Sees No Feds Fund Rate Increase by Year’s End,” NASDAQ, Dow Jones Newswires (May 23, 2011), available online at: http://bit.ly/jQkehf. 73 The Associated Press, “Top Economist Warns of Dangers in U.S. Debt Fight” (May 16, 2011), available online at: http://bit.ly/jQkehf. 74 Becky Yerak, “Top C.D. Rates Outpaced by Inflation,” The Chicago Tribune (May 23, 2011), available online at: http://bit.ly/mGTGNM.   75 Norman Frumkin, Recession Prevention Handbook: Eleven Case Studies, 1948-2007 (Armonk, NY: M.E. Sharpe, 2010), 223; Bureau of Labor Statistics, “News Release: Consumer Price Index: April 2011,” (Washington, DC: United States Department of Labor, 2011), available online at: http://1.usa.gov/1Vgpf.
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These sorts of differences are why the blanket application of a one-size-fits-all approach for budgetary policy is not justified when the proper historical considerations are made. In 1980, when rapidly declining purchasing power challenged private sector recovery, continued expansion of the public sector through demand-side tools was risky. Artificial support of aggregate demand raises prices by design. This “demand-side inflation” would have compounded the primary problem in the late Seventies economy. Today’s scenario appears closer to the deflationary climate of the late 1930s. Both then and now, energizing the lending market is a higher priority than tamping inflation. This is more suited to demand-side stimulus. Again, these comparisons should be applied carefully. In his essay “The Great Slump of 1930,” John Maynard Keynes wrote about the lack of real control policymakers are able to exert over macroeconomic trends, even with budgetary strategies: “We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the workings of which we do not understand. The result is that our possibilities of wealth may run to waste for a time – perhaps for a long time.” Seventy-five years removed, popular fiscal orientations are still exceptionally humbled by a lack of controlled testing. Replication of strategic precedent is often prevented by differing conditions. The inability of these policies to be generally applied and proven is a disturbing strike to these theories’ credibility, especially considering how faithfully they are followed by ideologues. Voters do not appear to consistently align electoral decisions with support for a budgetary approach on its merits, so these strategies, bound to the political fortunes of partisan figures, haphazardly wax and wane with unrelated political victories. Consider again the climate of the previous two sessions of Congress. Much in the way that weaknesses in the 1970s economy reflected poorly on demand-side installations, the late-2000s recession brought forward an unexpected Keynesian resurgence as a backlash to recent economic uncertainly.76 A return to demand-side orientation in fiscal stimulus was not likely the motivation of many of Obama’s supporters (though he did acknowledge the distinction during the campaign), but his election marked the first turn back to pure demand-side since the theory’s setbacks in the Seventies.77 Unlike the setting for Carter, Democratic waves in 2006
                                                                                                                          76 E. Phillip Davis, “Comparing Bear Markets: 1973 and 2000,” National Institute Economic Review, vol. 183, no. 1 (January 2003), 78-89; Kent Gilbreath, Business and the Environment: Toward Common Ground (Washington, DC: The Conservative Foundation, 1984). 77 Farrokh Langdana, Macroeconomic Policy: Demystifying Monetary and Fiscal Policy (New York: Springer, 2009), 227-228; Joseph E. Stiglitz, Freefall: America, Free Markets, and the Sinking of the World Economy (New York: W.W. Norton, 2010), 70-71.
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and 2008 afforded the Obama Administration sufficient goodwill to push through recovery measures like the stimulus package in early 2009. That political capital soon vanished. Republicans seized on a small government, libertarian revival that rode a large enthusiasm gap over Democrats into significant midterm gains in 2010. Fierce debates over the state of the public workforce have pushed back from this somewhat. In each case, the political coalitions necessary to achieve legislative control make it difficult for partisan platforms to be intellectually parallel to budgetary strategies. Congressional Republicans, for instance, entertain interests that support for a sustained or expanded militaryindustrial complex, but also lower taxes. The Democratic President proposed a stimulus program in the ARRA that was over 6.5% of GDP, but signed a renewal of the Bush tax cuts less than two years later. These are not creative methods of using strategies to complement each other. These are policy conflicts that pose real dangers to the government’s future operational abilities. Unfinanced tax cuts or unsupported spending expand interest obligations that limit the future utility of both tools. Unfortunately, retracting these measures in the months and years ahead could shrink the economy and disturb special interests that compose fragile political coalitions. Until the disincentives of inaction – namely those that play roles in the re-election of public officials – are great enough to overcome the discomfort of these short run obstacles, little seems ready to change.

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