Speaking with the editorial board of the Reno Gazette-Journal in January 2008, Barack Obama set the cat among the pigeons by likening his presidential candidacy to that of Ronald Reagan. In 1980, Obama said, Americans were prepared for their country to head down “a fundamentally different path.” Reagan sensed this, and as president he “changed the trajectory of America in a way that Richard Nixon did not, and in a way that Bill Clinton did not.” Obama suggested that, while Republicans had been “the party of ideas” for an extended period, the public was once again ready to embrace a new direction. These comments, which sparked a media frenzy and drew a caustic reply from Hillary Clinton, fueled the notion that Obama was intent on becoming “the liberal Reagan.”
Today, with the president’s health-care initiative stalled and his approval ratings battered, many Democrats and pro-Obama pundits are taking comfort in the Reagan analogy. Didn’t the Gipper’s popularity plummet amid the 1981–82 recession? Didn’t Republicans get hammered in the 1982 elections? And didn’t the economy rebound strongly, helping Reagan win a 49-state landslide in 1984? The lesson for Obama, they say, can be summed up in three words: Stay the course. Just as Reagan never wavered from his agenda despite high unemployment levels and growing public dissatisfaction, Obama should reject a move to the right and remain doggedly committed to his early policies.
While this argument may appeal to frustrated liberals, it paints a misleading picture of Reagan’s first term and fails to address the core problems with Obama’s economic-stimulus efforts. Reagan did not govern as a rigid ideologue. Dealing with a sizable Democratic House majority and facing the worst economic slump since World War II, he made plenty of compromises, even on hot-button issues such as taxes and Social Security.
Roughly seven months after his inauguration, Reagan signed the Economic Recovery Tax Act of 1981, which slashed individual income taxes and lowered the top marginal rate from 70 percent to 50 percent. A year later, however, with government revenues depleted by the recession, he signed the Tax Equity and Fiscal Responsibility Act of 1982. Both in constant dollars and as a share of GDP, it was the largest tax increase enacted between 1968 and 2006, according to a study by Treasury Department economist Jerry Tempalski. (Indeed, it was even bigger — by those measurements — than President Clinton’s 1993 tax hike.)
More tax increases followed. In January 1983, hoping to generate new funds for transportation projects, Reagan approved legislation to boost the federal gasoline tax, a measure that had been filibustered the previous month by GOP senators Jesse Helms, Don Nickles, and others. The landmark Social Security amendments of 1983 contained tax hikes, as did the Deficit Reduction Act of 1984.
Which brings us to another area where Reagan pivoted. In 1981, the new president took a stab at reducing Social Security benefits. His proposal collapsed even faster than George W. Bush’s Social Security gambit did in 2005. Members of both parties ripped the idea: No less a pro-Reagan conservative than Rep. Carroll Campbell, the future South Carolina governor, complained to White House budget director David Stockman, “You absolutely blindsided us with this Social Security plan.” By reaching for the “third rail,” the Gipper risked alienating legions of Reagan Democrats. As the late historian John Patrick Diggins put it, “Reagan’s hand grazed the rail and recoiled from the voltage just in time.”
Fast-forward to 1983. Reagan had tapped the Greenspan Commission to investigate Social Security’s dodgy finances. This yielded a bipartisan reform bill that raised taxes significantly, lifted the retirement age, and pushed federal employees into the program. Reagan was disappointed with the legislation but signed it anyway, trumpeting “our nation’s ironclad commitment to Social Security.” In a 2003 Washington Monthly article, journalist Joshua Green called this “one of the greatest ideological about-faces in the history of the presidency.”
Reagan had aimed to shrink entitlements and wound up doing just the opposite. While he could claim a slew of initial budget victories, his first-term spending cuts were less dramatic than conservatives had hoped. For example, his quixotic attempt to shutter the Department of Education had no chance of succeeding, especially after April 1983, when the National Commission on Excellence in Education released its famous report (“ANation at Risk”) on America’s academic decline.
There was, however, one major domestic issue on which the Gipper proved heroically firm and unbending: He allowed Federal Reserve chairman Paul Volcker to squeeze the money supply and crush inflation, at the cost of a painful economic downturn. Syndicated columnist Robert Samuelson tells the story in his 2008 book, The Great Inflation and Its Aftermath. Volcker’s monetary tightening attracted harsh criticism from liberal Democrats, but also from GOP supply-siders such as Rep. Jack Kemp, and from senior Reagan administration officials, including Treasury Secretary Donald Regan and White House chief of staff James Baker. As unemployment climbed steadily upward (it peaked at 10.8 percent in late 1982), Reagan was under enormous pressure to break with Volcker, but he refused to budge. Indeed, as his biographer Lou Cannon recently noted, the president chose to “campaign for Volcker’s policies, which he had made his own.”
The result was a monumental economic triumph. Inflation dropped from 13.6 percent in 1980 to 3.2 percent in 1983.Just how remarkable and crucial was Reagan’s support for Volcker? “It is doubtful that, aside from Reagan, any other potential president would have let the Fed proceed unchallenged,” writes Samuelson. “Without Reagan and Volcker, the assault on inflation would have been less concerted and less successful.” Reagan knew that robust and resilient GDP growth would be possible only when inflation had been squashed. He understood that Volcker’s tight-money crusade, which finally ended in the summer of 1982, was laying the groundwork for a durable economic expansion.
If Obama’s policies were clearing the way for a similar expansion, the Reagan analogy would be more appropriate. Unfortunately, the Obama administration has already repeated at least one of Tokyo’s mistakes from the 1990s, and it may soon repeat another. During its “lost decade” of post-bubble stagnation, Japan did not force banks to sort out their nonperforming loans, and it raised taxes amid a nascent economic recovery, thereby sparking a new recession. Likewise, after the 2008 Wall Street meltdown, neither President Bush nor President Obama aggressively cleaned up the toxic assets plaguing U.S. financial institutions. Now, with the economy showing tentative signs of revival, Obama is planning to let some of the Bush tax cuts expire and jack up the tax burden on U.S.-based multinational corporations. He is also advocating health-care and energy policies that include a bevy of new taxes, regulations, and price controls.
As Council on Foreign Relations economist Benn Steil has pointed out, the Bush-Obama-Fed bank bailouts have exacerbated the “credit misallocation” that triggered the crisis. Steil fears the U.S. could be headed for “the second dip of a W-shaped recession.” What about the gigantic fiscal-stimulus package enacted last February? American Enterprise Institute economist John Makin reckons that it helped prevent negative real GDP growth in the second half of 2009, but he cautions that it “will fade rapidly by mid-2010.”
There is good reason to be skeptical of the vaunted Keynesian “multiplier.” According to research by Harvard economist Robert Barro, decades of U.S. macroeconomic data indicate that reductions in marginal tax rates are generally a better stimulus tool than government spending. (Prior to joining the Obama White House as chair of the Council of Economic Advisers, Berkeley economist Christina Romer co-authored a paper arguing that “tax cuts have very large and persistent positive output effects.”)
But even from a Keynesian perspective, the Obama stimulus bill was badly designed. Economist Martin Feldstein, Barro’s Harvard colleague, has noted that only around a quarter of the stimulus funds “will be used for government spending that adds directly to GDP.” True, brutal recessions have traditionally been followed by vigorous recoveries, but economists Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard observe that, throughout the world, post-financial-crisis recoveries have tended to be slower and weaker. The current economic rebound is being hampered by the threat of looming tax hikes and regulatory changes, along with soaring budget deficits and uncertainty over the Fed’s “exit strategy” from its massive liquidity injections.
Back to Reagan: The real lesson of his first term is that all presidents must adjust to practical realities, and that “staying the course” on economic policy pays dividends only if the policy in question is working. Reagan was willing to sacrifice popularity in order to let Volcker fix America’s central economic problem. His decision was vindicated by the subsequent low-inflation boom.
While Obama can take partial credit for temporarily stabilizing the financial system, he has not resolved the toxic-loan mess or properly tackled the “too big to fail” dilemma. “It is hard to see how any of the fundamental problems in the system have been addressed to date,” concludes a new report by the inspector general of the Troubled Asset Relief Program (TARP). Indeed, whatever its short-term impact, stimulus and TARP spending has not built a solid foundation for muscular and sustainable GDP growth. If Obama wants to be the liberal Reagan, he needs a Plan B.