Carter Out, Reagan In -- Star Wars, Tax Cuts, Supply Side Economics, and Growing Budget Deficits
In 1982 Ronald Reagan became 40th President of the United States. I had been the Senior and for most my seven years in the Office of the Secretary of Defense, only economist since returning from Switzerland and the UN in 1978. During the Carter Administration I had been working on a plan to introduce Nato Bonds, debt issued by individual governments within the alliance to fund purchases of weapon systems in order to quickly and rapidly beef up the defense of our allies in face of the growing, on paper at least, Soviet threat. Funding bonds in individual currencies under the NATO umbrella would have presented the Soviets with an economic challenge that might bring down the failing government in the East. I had even hired a researcher to write a paper and the conclusions were the same -- challenge the Russians to a financial race and you will destroy the Soviet Union economically. When Carter lost the election and Reagan won, promising a massive increase in defense spending and "supply-side" tax cuts, it was like the United States was going on a spree of unfunded debt on the US borrowers tab rather than jointly with the other countries of NATO.
As part of the reorganization of the Office of the Secretary of Defense and to meet the letter, if not the spirit of the Republican platform that Reagan had run on, the Office of the Assistant Secretary of Defense for Systems Analysis, the McNamara era whiz kids who had managed to get the United States embroiled in Vietnam, the "best and the brightest" as they were characterized (and people I had worked with when I was just a Summer intern during the halcyon days of the Johnson build-up, 1966-69) were to be disbanded. Of course you couldn't run an organization spending 1/3rd of the US budget without smart people, so they did what governments do, our office was renamed and the Assistant Secretary position disbanded, turned into a Director, reporting directly to the Secretary of Defense, and given a new name Program Analysis and Evaluation. But within my little fiefdom, until the new office was established, there was fear. We went so far to hire a company that had good political connections to do a special study in hopes remaining in our plum status jobs (everyone was either SES or GS-15). My office was responsible for putting together the DoD budget that Carter had presented and was DOA as Reagan planned to spend more money than we had on Star Wars and other efforts to as they put it -- drive the Soviets into the tank.
The DoD budget is a massive document, thousands of lines of requests, covering everything from paying the troops, operations and maintenance, and new equipment. We gathered in my boss's office and we had a copy of the budget and everyone got a few pages of printed text and we started to cut them into strips, one strip for each appropriation category, and then we had to reassemble them to that the original Carter budget was now going to be the completely redesigned Reagan budget ready for the new requests -- huge increases. When I had had in October my seminar, reported elsewhere, where I had had six major economic forecasting firms and their Chief Economists, including Larry Klein (who had just won the Nobel Prize, so it turned into a bigger deal than it originally was to be), Otto Eckstein, and Michael Evans, to name three of the six, the only economist who had turned down the request, was Alan Greenspan. Greenspan was mad that I had not spent the $ 10K he charged to buy his services), I had proposed two budget levels -- the standard 3% growth that we had been doing under Carter, and what I had billed as a wartime budget of 10% increase each year. So when Reagan came in, he bumped the 3% Carter budget up to 10%. So our exercise with the slicked printed budget and the new urgency to spend the Soviets into oblivion.
Who's Afraid of the Deficit --Reagan took the Deficit from $ 70 billion to $ 170 billion, Bush to $300 billion, Clinton to $0, Bush to $ 1.2 trillion, Obama to $600 billion, and Trump to a Trillion and Counting, So Who Says Republicans are anything but Keynesian's at heart
The only problem, aside from the fact that David Stockman and his supply side thinking, didn't fit with the earlier exercise that I had run showing a 10% increase in spending with taxes unchanged (not cut deeply) led to a growing budget deficit that Reagan had also promised, like Donald Trump, to eliminate through his magical manipulation of the economy, i.e. Voodoo economics, In all, but one case, the higher defense spending, no changes in tax rates, showed bigger deficits (only one of my six was able to get the 10% figure to balance, i.e. spend more on defense and you get a few more dollars in revenues enough to cover the higher spending, only Merrill-Lynch's model managed to get this result). Aside from the Reagan increase in defense, there were the Reagan supply side deep cuts in taxes. The net result was a growing budget deficit and a growing trade deficit. Much of the new money flowing into American peoples paychecks went overseas as foreign goods flooded in and the US dollar appreciated in value. Of course we were in a deep recession in 1982 and I as the Pentagon's economist was dispatched to talk to companies about what the Pentagon's growing budget would do for them to help out Congress men. I had the right stuff to do this having build the Defense Economic Impact Modelling System (DEIMS, still being used today but with a new name) at the end of the Carter Administration. But honestly I knew from all the work I had been doing on measuring how defense spending affected the industrial economy that spending more money in a collapsed (and it was collapsed in 1982) US industrial base was not inflationary, it didn't cause higher rates, it didn't crowd out, in fact it was rather benign, less than 6% of the US GDP in total.
Enter the Story -- Dr. Murray Weidenbaum of Washington University in St. Louis, distinguished Professor, and long time critique of defense spending. How he became Reagan's first Chairman of the Council of Economic Advisors I will never know. He had written extensively on how damaging to the economy spending on national defense was and how it caused inflation. A nicer man you couldn't find, but not one easily convinced by anyone such as myself, so Reagan brought in someone who might just convince Dr. Weidenbaum that spending billions more on defense and cutting taxes n the rich and the poor didn't cause inflation or that government deficits just only matter when there is a Democrat in the White House.
Ushered into the office, I was alone with Alan Greenspan, who I had only spoken to on the phone and Murray.
To make a long story shorter, I failed. Murray was unconvinced. Alan tried his best, i tried my best, but he was determined to tell Ronald Reagan he could not have his cake and eat it too -- no big bump in defense, no Star Wars, no driving the Soviets into the tank, no tax cuts, no extra desert, just deficits, Republican deficits, but dangerous waters all the same, and so I went back to New York, saw Dream Girls on Broadway with my wife, had a nice meal, and a few months or days, not sure later, Alan Greenspan became famous -- first at Reagans next Chairman of the CEA, and later the second longest serving Chairman of the Federal Reserve.
I've been working this problem for many, many years and the longer I think about things, the more I'm convinced that budget deficits really don't matter so long as there is excess supply. The complexity of the economy and the tendency for most products to have more people welling than buying, makes the idea of inflation being caused by sudden demand for hoopla hoops or F-15 parts as causing inflation is nonsensical. We are in a point where people are crying out for help, where helping people to spend money is more important than some number with lots of zeros on the page after it. My best guess for 2030 in nominal dollars is that the world economy measured in gross output or production will be over 400 trillion dollars but in 1995 dollars just half this amount. Its just numbers, less meaningful than if I said its food in Sudan and diamonds in New York. So when Republicans talk about deficits and the dangers I think of my grand effort to convince Dr. Weidenbaum that spending on defense wasn't more inflationary than giving a tax cut to Warran Buffett or Jeff Bezos -- as I used to say all the time -- its just a bit of aggregate demand. So what, in the worlds of the immortal Alfred E Neumann "What Me Worry!!!"