The image that fires the Republican imagination these days has Ronald Reagan as Franklin Roosevelt. It's an understandable daydream; Reagan as a latter-day Roosevelt implies decades of GOP political domination. But the comparison may be accurate in a less flattering sense.
When he took office, Roosevelt had no workable idea of how to get the country out of the Depression. The New Deal consisted mostly of well intentioned fumblings which, in 1939, left the unemployment rate higher than in 1931. The Roosevelt experience in the 1980s would mean a decade of economic floundering.
That may indeed be Reagan's fate -- unless he's wiling to break sharply with the conventional wisdom and take actions that, initially at least, are bound to provoke a furor from the very people who elected him.
Voters with more than $15,000 income supported Reagan overwhelmingly, and the temptation will be to embrace a political and economic strategy -- tax cuts and spending reductions -- that appeals to this constituency. But no ecoomic program can hope to succeed unless it masters inflation; this approach probably won't but by concentrating spending cuts on the poor, it will make the government seem small and mean-spirited.
To be sure, countless federal programs (Amtrak, federal subsidies for the arts, pensions for government workers, child nutrition) need revising or eliminating. But pruning them will not radically affect overall spending levels, because there will be offsetting increases. The number of elderly will increase -- by 1990 the over-65 population is expected to rise about one-fifth -- and Reagan wants to boost defense spending.
Together, defense spending (about 25 percent), spending for the elderly (25 to 30 percent) and interest on the national debt (11 to 12 percent) account for more than 60 percent of government spending. With these parts increasing, other spending must be squeezed hard simply to keep things steady. The only way to change this is to eliminate massive programs, such as Medicare and Medicaid, that were enacted in the 1960s and have now become part of the social and political consensus.
The sobering message of this arithmetic is that, for all the political fistfighting that looms in the next year, the struggle will be over details, relatively speaking. Essential government obligations and spending levels will remain undisturbed. Today, government spending is approaching 23 percent of the nation's gross national product. In four years. Reagan would be extaordinarily successful if he cut that to 20 percent, which is higher than the average of the 1960s. Chances are he won't.
The same logic applies to taxes. Any tax "cut" will largely compensate for automatic tax increases that have occurred as a result of inflation kicking taxpayers into higher brackets. If Reagan and his advisers expect tax and spending changes to have dramatic effects on the economy, they're likely to be disappointed. In the same way, without repeal of major environmental laws -- which virtually nobody supports -- modifying regulations involves similar limitations.
What needs to be recognized is that the economy today is not simply running at high levels of inflation, but has developed an acute inflationary bias. Thousands of mechanisms -- tax provisions and indexed wage as well as government spending and regulatory programs -- nourish the bias and keep wages, prices and money incomes advancing.
This is a distinction with a difference. It means that inflation can't permanently be reduced by doses of recession because, once demand revives, the inflationary bias revives inflation. Thus has the country gone from 1 percent inflation to the curent 10 to 12 percent. Another swing in the cycle would presumably involve 12 to 16 percent rates.
Reagan needs to get at the bias. What makes the parallel with Roosevelt especially intriguing now is Reagan's urgent need to revise the political legacy of the New Deal which has, in fact, created the political and psychological realities that feed inflation.
If the New Deal willed a central idea to its successors, it was that the private economy, left to its own devices, could not be trusted to generate either prosperity or social justice. Government became the arbiter of economic change. But, as things turned out, government's well intentioned ambitions legitimized inflationary wage and price behavior. People came to expect rising living standards almost as a natural right.
Once government seemed to asure perpetual prosperity -- and the implicit promise became explicit with the "New Economics" of the Kennedy-Johnson years -- then workers logically became progressively less concerned with the security of their jobs and more concerned that living standards rise continually.
They assumed that any economic downturn would be brief. And anyone who felt left out of or abused by the prosperity could appeal to Washington for protection or compensation.
Reagan must somehow get at these inflationary assumptions, for they are obviously contradicted by experience. Providing economic "stimulus" to offset every recession adds to inflation later. Trying to shield Americans from higher world oil prices -- as the government attempted with controls on domestic oil -- simply promoted waste and postponed price increases. Rising living standards are not a preordained law of nature.
Any effective anti-inflation program must alter inflationary expectations. The suggestions below attack the wage-price spiral and inflationary tax provisions. More important, though, they move responsibilities away from government and, because inflation is broadly based, spread corrective measures over all classes. Together, the tax changes would raise substantial amounts of revenue -- between $60 billion and $100 billion -- that would allow Reagan to redeem his pledge for substantial cuts in tax rates without ballooning the federal deficit.
Eliminate the allowable tax deduction for mortgage interest payments on future home purchases. In fiscal 1981, this will cost the government about $15 billion in revenues.
There's increasing evidence taht the tax deduction, combined with high nominal tax rates, has prompted Americans to overinvest in housing as a way of reducing their actual tax rates. This means that some people who would normally be renters haved purchased and that other people have bought homes larger than they otherwise would have. In the 1970s, for example, the size of the average new home increased about 15 percent.
All this creates additional demand for land, lumber and building materials and helps account for the steep inflation in real estate values. At the same time, it has whipped up the demand for mortgage credit and probably diverted investment funds from industry. Removing the tax preference from home ownership would tend to reverse these trends. It would have a depressing effect on housing prices (and, thus, the inflation indexes) because people would simply be able to afford less. New homes would be slightly smaller, and downward pressures would develop on prices for existing homes.
Old buyers and new would both gain and lose under this proposal. The former, to be sure, would have enjoyed the tax advantage, but the latter would purchase at relatively lower prices. Health
Reduce the favorable tax treatment for medical expenses and employer contributions to health insurance plans. Workers are not now taxed on the contributions their employees make to such insurance plans, though the contributions are obviously income. In fiscal 1981, this exemption will cost the Treasury an additional $15 billion.
Health care is one of the most stubbornly inflationary sectors for the economy and yet, as the nation gets older, we will be needing more it it, not less. Between 1967 and 1978, for example, health costs as measured by the consumer price index rose about 120 percent -- slightly faster than the increase in the overall index. No one is really certain how much of this reflects genuine inflation -- higher fees for the same services -- and how much reflects new medical services. But virtually all analysts agree that the health sector's inflationary tendencies are encouraged by a pervasive sense of irresponsibility. Doctors and hospitals know that either insurance companies or the government pays most bills; the same knowledge makes patients less cost-conscious.
Can the system be made more responsible? Maybe. Patients, doctors and hospitals all need to be brought closer to the discipline of the payment process.
If workers were taxed on the contributions made by their employers, they -- or their unions -- would surely begin to shop around for the most effective form of medical care, whether prepaid plans (such as health maintenance organizations) or simply the most attractive insurance policies. The tax-exempt status of these contributions represents a gross inequity for workers who must buy their own health insurance; they generally receive only a minimum tax deduction up to a ceiling of $150.
Along with these changes, most remaining out-of-pocket medical expenses should not be tax deductible, as they now often are. Current laws allows most medical bills above 3 percent of income to be deducted. Many medical expenses are a standard part of a family's budget, just like food, fuel or education. They shouldn't receive special tax treatment. No one wants families bankrupted by medical catastrophe, but a much higher limit -- say 10 percent -- would respond to that concern. Wages
Freeze the minimum wage (it rose to $3.35 an hour on Jan. 1). Eliminate the Davis-Bacon Act. Don't give companies favors without insisting upon stringent wage restrictions.
It's myth to think that only poor people receive the minimum wage. Studies show that many people from middle-class families -- teenagers, working wives -- have minimum-wage jobs. Automatic increases in the minimum tend to give a large upward shove to the whole bottom part of the wage structure and probably eliminate some low-paying jobs. Likewise, the Davis-Bacon Act, which requires that contractors on government construction projects pay "prevailing" wages, tends to prop up building costs: "prevailing" wages are usually interpreted to be union wages.
The greatest opportunity to influence wage-setting patterns may involve the auto industry. A condition of any additional help for the Chrysler Corp. ought to be a wage freeze or, possibly, a rollback to levels prevailing at the start of the current contract. Moreover, the Chrysler case ought to be used as an opportunity to explain to the public that above-average labor cost increases have contributed heavily to distress in steel, auto and other heavy industries. What steel and autos need to do now is get their sales volumes, employment and profits up by keeping prices down. Spiraling labor costs make this difficult. Indexed programs
Eliminate the automatic adjustments for increases in inflation.
Most major government transfer programs (an exception is traditional "welfare" -- aid to families with dependent children) are adjusted annually or semiannually for changes in the consumer price index. When consumer prices are advancing more rapidly than wages, this means that recipients of governments payments receive special protection. In 1980, for example, Social Security payments increased 14.3 percent against a 10 percent rise in average labor compensation.
And the effects are cumulative; increases in one year build a higher base for the next and, in periods of high inflation, this tends to bloat federal spending. Programs ought to be indexed, but the formula should be much less generous. Benefits ought to be increased by the rise in consumer prices or the average increase in labor compensation, whichever is less. If Congress thinks that the elderly or other government recipients deserve special protection, extra increases ought to be voted explicitly. They ought to compete against all the government's other difficult spending and taxing choices. Taxing government benefits
Taxing benefits such as Social Security and unemployment benefits. In fiscal 1981, favorable tax treatment for two major categories of government transfers -- Social Security and unemployment insurance -- will cost the government an estimated $14 billion.
When most families had only one wage earner -- and when benefits were truly aimed at people in distress -- tax-exempt status may have made sense. It no longer does. With more and more two-earner families, one member can be receiving a substantial salary, while the other is receiving a sizable government check. For unemployment benefits, Congress partially corrected this problem by imposing a light tax on benefits to workers with more than $20,000 of taxable income ($25,000 for couples); but that threshold is still above median family income levels.
A more general principle is involved here. Government ought to distribute benefits either because people "earned" them (as in Social Security) or because they "need" them (as in umemployment insurance or food stamps). But benefit payments have now become such a large part of total personal income that exempting them from taxes simply exaggerates the bias against workers and in favor of nonworkers. Those recipients who are truly needy will generally not pay taxes on their benefits, because their incomes won't be high enough. Otherwise, a dollar of private income and a dollar of government "transfer" income ought to be treated the same. Energy
Impose a 30-cent to 60-cent-a-gallon tax on gasoline. This would raise $30 billion to $60 billion. Remove price controls from natural gas.
There is no way the United States can soon end its dependence on imported oil or the potential insecurity of those supplies. The best that can be done is to reduce our dependence. A gasoline tax would immediately reduce consumption slightly (perhaps 250,000 to 500,000 barrels a day), but, more importantly, would push people more quickly toward fuel-efficient cars.
Foreign policy considerations also recommend such a move. Although not widely appreciated, European nations generally have not raised their gasoline taxes in line with oil price increases. If they could be persuaded to do so now, the effect on world oil demand would be still more sizable. Although initially inflationary, such measures could promote long-term price stability. Should Iran and Iraq resume oil production, a large surplus of production capacity would exist; this would make repetition of the hugh price increases of the 1970s unlikely. The same logic applies to ending today's artifically low natural gas prices.
Any practical politician is bound to regard these proposals as hopelessly dreamy; the larger the affected constituency, the more dreamy. Eliminate the mortgage interest rate deduction? Is this a sick joke?
It may be sick, but it is no joke.
Much of today's opposition to inflation is so cosmetic and hypocritical because, inconveniences and uncertainties aside, most people manage to cope with it quite adequately. Reagan will soon discover that the middle-class constituency which condemns inflation in principle is composed of individual constituencies, most of whom have strong vested interests in highly inflationary practices.
By satisfying all the individuals constituencies, Reagan may leave in place the one problem -- inflation -- that causes the mass constituency to rebel. Jimmy Carter fell victim to this contradiction. He became so enthralled with the intracacies of interest-group politics that he forgot that the ultimate political test is whether the mass constituency is satisfied.
Economists have no simple formula to resolve this contradiction.
Time has discredited liberal schemes for wage-price guidelines or controls. They tend to bog down in detail, and the most politically powerful worker groups -- most recently the auto and steel workers -- usually win the largest wage increases when they merit the smallest.
Nor do the so-called supply-side economists, who argue that oppressive tax rates have discouraged work and investment, have panacea. Their pet proposal -- the 30 percent Kemp-Roth cut in personal tax rates -- would probably be inflationary rather than the reverse. Most people work because they need to eat. Alone, Kemp-Roth would pump up demand without doing much for supply.
Inflation is, in the end, too much money chasing too few goods, and no policy can succeed without a determined tightening of the money supply. But unless accompanied by measures that suppress the wage-price spiral and inflationary pshchology, such tightening produces mostly high interest rates and only a gradual reduction in inflation -- perhaps 0.5 to 1 percentage point annually. That's too slow. Political pressures soon build to pump up the economy.
If Reagan is to avoid this stop-go suicide, he will somehow have to create a genuine anti-inflation constituency willing to accept tougher measures. But inflation mocks politics, because fighting inflation inevitably involves discipline and restraint. The trick is to find something to make the discipline attractive -- or at least palatable.
Massive reductions in tax rates, financed by eliminating inflationary tax provisions, could be the trick. If the supply-siders are right, lower tax rates on personal and investment income ought to promote noninflationary expansions. But, mostly, people have to be convinced that the government is determined to exercise the economy's inflationary mechanisms. Otherwise, private wage and price practices won't change, and the economy will remain stagnant.
This is that old intangible, leadership.
Reagan needs to change the terms of political debate. He needs to develop a new rationale of limited government. Government can no longer effectively intervene in the economy at every minor stumble or accede to every interest group that appeals to Washington for help.
Precisely because it needs the strength to shoulder the basic obligations undertaken since Roosevelt -- caring for the truly needy, providing support for the elderly, protecting the environment -- government must repudiate the illusion that it can control all economic change.
This is a job that ought to engage the instincts and energies of a conservative, but it's not clear whether it engages Reagan's. Like Roosevelt, he seems determined to be decisive without quite knowing what to be decisive about.