In the early 1970s, Richard Nixon— scratch that; Milton Friedman—said, "We are all Keynesians now." It was more or less an accurate statement.
But the perverse simultaneity of inflation and unemployment (giving us a fancy-sounding portmanteau word, "stagflation," that every noneconomist can love) throughout the 1970s shattered this fiscal consensus.
The election of Ronald Reagan and the subsequent sharp reduction in marginal tax rates was supposed to have ushered in the era of supply-side economics. The Keynesians were demand-siders; the supply-siders said that supply could create its own demand—you just had to unleash the suppliers' potential via tax and regulatory relief.
After a nasty recession, a recovery followed. The supply-siders declared victory, and still do to this day.
The Keynesians said, "Nonsense." What do you call a fiscal policy that cuts taxes and increases spending to stimulate the economy? Keynesianism!
Economists Wallace C. Peterson and Paul S. Estenson argued in the Journal of Post Keynesian Economics that the Reagan administration's combination of income tax cuts and aggressive increases in military spending was classic Keynesianism in everything but name.
There's also a significant monetary side to this. Paul Krugman argued last year that the 1981-82 recession was "deliberately created by the Fed to bring down inflation":
The Fed raised interest rates sky-high, causing a plunge in home construction, which was the main driver of the slump. When Paul Volcker believed that we had suffered enough, he cut rates, housing sprang back—and it was housing that mainly drove the recovery. Reaganomics was basically irrelevant.
But let's get back to the fiscal stuff. James K. Galbraith contended in 2009 that closet Keynesianism continued into the 21st-century, well after the theory was supposedly abandoned and discredited:
The political instinct remains to react to recessions with a "stimulus package." Under Republican presidents, at least until this year, this policy was usually called "supply-side economics"—Reagan was a great practitioner of it, as was George W. Bush in 2001–04. This is short-term Keynesianism in disguise, always accompanied by professions of budget piety and promises that "fiscal responsibility" will return as soon as normal conditions are restored. But it is Keynesianism nonetheless. It is government intervention to support total spending, and especially the use of public spending power, in the military or elsewhere, to bring the economy out of a ditch.
I find the narrative of persistent Keynesianism, in practice if not in theory, hard to dispute. What I'd like to challenge here is the widespread notion that even if we do the easy part—deficit-financed stimulus in the lean years—we never do the hard part of Keynesianism—that is, raise taxes and control spending during the fat ones. We only get, as Galbraith noted, cynical "professions of budget piety and promises that 'fiscal responsibility' will return."
Is that really true?
I think there's a plausible argument to be made that Reagan did attempt the hard part of Keynesianism: He raised taxes.
As Bruce Bartlett observed, "Back in 1982, Ronald Reagan was persuaded that the deficit was such a severe impediment to growth that a tax increase to reduce it would be economically beneficial."
There is a supply-side accounting for the walk-back of roughly one-third of the '81 tax cuts. It has to do with the incremental timing of the cuts as well as the structure of the overall code. The Cato Institute's Daniel J. Mitchell says it's "hard to pinpoint" when the Reagan tax cuts actually kicked in:
The tax burden may have actually increased in 1981, since the parts of the Reagan tax cuts that took effect that year were offset by the impact of bracket creep (the tax code was not indexed to protect against inflation until the mid-1980s). There was a bigger tax rate reduction in 1982, but there was still bracket creep, as well as previously-legislated payroll tax increases (enacted during the Carter years). TEFRA also was enacted in 1982, which largely focused on undoing some of the business tax relief in Reagan's 1981 plan. People have argued whether the repeal of promised tax relief is the same as a tax increase, but that's not terribly important for this analysis. What does matter is that the tax burden did not fall much (if at all) in Reagan's first year and might not have changed too much in 1982.
In 1983, by contrast, it's fairly safe to say the next stage of tax rate reductions was substantially larger than any concomitant tax increases.
The problem with this analysis, it seems to me, is that it fails to account for the Reagan tax increases that were enacted after 1983, right up to 1987's Omnibus Budget Reconciliation Act. This is to say nothing of the notorious tax hikes that occurred in 1990 under the first President Bush and in 1993 under President Clinton, who had paired his deficit reduction efforts with economic stimulus.
All of this is to suggest that, if you look at fiscal policy as a single narrative rather than through prism of partisanship, it's possible we're better at Keynesianism than we realize.
- See an opinion slide show of 10 wasteful stimulus projects.
- Read 10 Things You Didn’t Know About the Bush Tax Cuts.
- See a slide show of how Mitt Romney and Rick Perry differ on the economy.