A tax Scheme to Deindustrialize America
The Treasury Department's tax-reform proposal is a retreat from the supply-side principles put in place by President Reagan during his first term. Enactment of the proposal would reduce the profitability of investment and reinstate the declining productivity growth and the stagnation in the standard of living that characterized the economy during the 1970s -- with little or no offsetting gain in simplicity or fairness.</br></br>During the 1970s, the capital-labor ratio and U.S. labor productivity growth collapsed under the impact of Keynesian demand management, bad tax law and increased labor-force growth. As a result, high-wage U.S. labor became increasingly uncompetitive in markets at home and abroad, and protectionist pressures rose. Despite its pro-free-trade stance, the Reagan administration has been unable to resist these pressures and has established quotas on Japanese cars and foreign steel products.</br></br>The threat to free trade posed by the decline in U.S. labor productivity growth has serious implications for the future of the Western alliance. This alliance depends on European and Japanese access to U.S. markets. The alliance was easy to maintain during the 1948-68 period when the growth in the U.S. capital-labor ratio was more than three times higher, and productivity growth more than five times higher, than during 1973-80. Our allies' continued access to our markets is seriously threatened by the long-term deterioration in U.S. labor productivity. Only a sustained rise in productivity can prevent the unraveling of free trade and the Western alliance.</br></br>Supply-side economics rose in response to these fundamental economic and strategic challenges. When I went to work for Rep. Jack Kemp in 1975, we understood exactly what was at stake. Despite the enormous stakes, it took years to move policy in the direction of the problem. An important step was finally taken in 1981 with the Reagan administration's Economic Recovery Tax Act, which reduced the cost of capital and increased the after-tax rate of return on U.S. investment. This fundamental change was possible only because the Reagan administration brought its tax policy to office with it (along with policy officials to enforce it) and did not permit the bureaucracy in the Treasury's Office of Tax Policy to determine policy or to design the 1981 legislation. If the permanent government had controlled the policy, it would have substituted its own agenda and never permitted the drop in the cost of capital that constituted the fundamental achievement of the 1981 bill.</br></br>But bureaucracies recover quickly from defeats. As soon as the Reagan administration was knocked off balance by the Federal Reserve's recession and lost its policy vision in the general hysteria over the budget deficit, the permanent government seized the opportunity to reassert control. President Reagan was promised that the 1982 tax increase (Tax Equity and Fiscal Responsibility Act) would reduce the five-year deficit projections by one-third. Instead, the deficits doubled. But more important, and less remarked, TEFRA repealed a substantial part of the reduction in the cost of capital equipment enacted in 1981.