By Jude Wanniski
Memo To: SSU Students
From: Jude Wanniski
Re: Herb Stein, R.I.P.
I had planned to begin the fall semester this week, but the death of Herb Stein on Wednesday brought back all kinds of memories that I knew I had to share with SSU students -- and anyone else who has tuned in. It is a useful way to trace the development of the Supply-Side Revolution. Herb, who died at age 83 of heart failure, was my first economics teacher. This was in 1969 when I was the political columnist for the now extinct Dow Jones newsweekly The National Observer. At the time, he was a member of President Nixon's Council of Economic Advisors, with enough time on his hands to see me and take my calls every time I needed to learn some economics to keep up. I was eager enough to get an autographed copy of his most important book, The Fiscal Revolution in America, published in 1969 by the University of Chicago Press, that being the school that tendered him his Ph.D. in the 1940s. "Dr. Stein," as I addressed him back then, was also the inspiration of the term "Supply-Side Economics," which I coined in 1975 after he laughed off my apostasy as "supply-side fiscalism." I had broken away from his views, which were heavily influenced by the Keynesian demand-side revolution that had taken place while he was a student. At the same time, his book, which I have kept close at hand over all these years for its useful history of the period, was critical to my development of a supply-side political agenda for the Republican Party via Jack Kemp and Ronald Reagan.
It was Art Laffer, who I also met in 1969 when he was a 30-year-old chief economist for the Office of Management and Budget, who first introduced me to the idea that there were always two tax rates that would produce the same tax revenues, one coincident with a higher level of production, one with a lower level. This he did in a 1972 telephone call to me at The Wall Street Journal, to which I transferred that year, and after Laffer had returned to the University of Chicago. It was hard for me to grasp the concept, but in re-reading Herb Stein's book, I found this paragraph on page 9, which opened a whole new world of political and economic ideas for me:
More important for the subject of this book are two fiscal policy ideas of the 1920's, shared by Hoover and his contemporaries. One idea was that reduction of tax rates would raise the revenue. The other was that an increase of spending for public works could reduce unemployment in a depression. In order to yield its beneficial effect on the revenue, a tax reduction had to be of the right kind. It had to be a cut of the higher income tax rates, which would induce the saving classes to invest in productive United States enterprises rather than put their money in tax-exempt securities or foreign bonds or hoard it or consume it. The additional investment would raise the national income, and therefore the tax base, enough to yield enlarged revenues even at the lower tax rates. No explicit, comprehensive theory of national income determination went with this idea about revenue-raising tax reductions, which is not to deny that one could be constructed. But reductions of federal income taxes in 1924, 1926, and 1928 were each followed by an increase in federal revenues. To some, this seemed proof enough that a tax cut would or could raise the national income and thereby raise the revenue.
Instead of digging deeper into the proposition, Stein simply left it there as a note of historical curiosity. But it immediately propelled me to the Morristown, N.J. library, where I did the digging myself. If it had not been for that paragraph, I never would have been interested enough to pursue Art Laffer's telephone comments to me about two rates producing the same revenue. He had not pointed at the experience of the 1920s or mentioned the ideas of Andrew Mellon, the Treasury Secretary of the decade in the three successive GOP presidencies of Harding, Coolidge and Hoover. In reading back to the beginning of the century, I then learned that the cause of the high tax rates that were cut in 1924, 1926 and 1928 was the introduction of the federal income tax in 1913, which quickly became a steeply progressive system with America's entry into World War I.
It was not until I was in the midst of writing The Way the World Works in 1977 that I decided to name the "Laffer Curve" after Art's drawing of it on a cocktail napkin on December 4, 1974. By then, I understood the concept completely, as I'd had it explained to me in greater detail by Robert Mundell, the Canadian economist who had been exposed to it at the University of Chicago, where he professed after getting his Ph.D. at M.I.T., under Paul Samuelson. Mundell made it clear that the revenue increase need not necessarily occur in the first fiscal year following the tax cut, that the increase in production need only broaden the tax base to cover the interest on the bonds floated to finance the initiative. It was Laffer who gave me the propaganda weapon of the "Laffer Curve," which enabled ordinary citizens and politicians to immediately grasp what it had taken me many months to learn before I had seen the Curve.
When I wrote my book in 1977, I did so as a fellow of the American Enterprise Institute, on leave from the WSJournal. Herb Stein was then, and remained until his death this week, an AEI fellow. For the nine months of my fellowship, Herb and I dueled at the Tuesday lunch for the other AEI fellows, which then included Antonin Scalia, Jeanne Kirkpatrick, Irving Kristol, and a dozen other Republican intellectuals who were there, sitting out the Carter administration, awaiting the Reagan administration. At every step of the way, Herb fought my ideas, often in heated exchanges, but I could always get his goat by saying I would never have learned all I did if it weren't for the book he gave me back in 1969. At one point I remember him groaning that he had devoted several years of his life to researching and writing the book, and I had taken one little footnote out of it to concoct a whole new economic movement! I needled back that he would be remembered a thousand years from now for having provided Wanniski -- with that footnote -- the inspiration he need to revolutionize economic thinking! What Herb could never quite face was that he was one of the key advisors to Richard Nixon in that year 1969, having supported a doubling of the capital gains tax in an attempt to close the budget deficit! To accept my arguments meant that his advice to Nixon was the very worst he could have given him, and contributed to the failure of the Nixon presidency.
The economy went into a shallow recession as capital formation dried up, and when Nixon asked his economic team how to pull out of the doldrums in time for his 1972 election campaign, Stein and the rest of his team advised that the Federal Reserve was causing the problem by not printing enough money. Policy shifted to easy money, with Nixon first getting rid of the Fed chairman he had inherited, William McChesney Martin, who was not about to follow the monetarist line. He replaced Martin with Arthur Burns, who did his best to increase the money supply as fast as possible. Because we were still on a gold standard, these efforts were constantly foiled. The "monetized dollars" would be transferred to Europe, where the central banks would gather them up and force the United States to "unmonetize" by the issuance of special Treasury bonds. The policy became circular, characterized by incredible turbulence in the currency markets in the spring of 1971. The Nixon advisors, including Laffer's boss at the OMB, George Shultz, decided to break the circle by closing the gold window. The Europeans would be stuck with the dollars, which did not pay interest, and they would have to be forced into an investment pattern that presumably would increase economic activity and win the 1972 election for Nixon! On August 15, 1971, the deed was done.
In the years that followed, as I learned why the failures were due to bad demand-side economics, I heckled Herb every chance I had. The fact that he was the sweetest and gentlest of men, who could never bear a grudge, permitted us to stay on good terms. As the above quote from his book indicates, Herb also refused to describe himself as a Keynesian or a Monetarist, but a member of the "Don't Know School of Economics." That is, he always maintained that since the dark science was evolving, anything was possible. But over the years, he was among the most persistent foes of the supply-siders and our arguments that the capital gains tax should be cut or eliminated.
We remained friendly enough that in 1974, while on the WSJ editorial page, I talked Bob Bartley, the editor, into bringing Herb on to the Board of Contributors which he had created. Herb was a fine writer and witty one, and I knew he would brighten up the page. Bob, brand new on the job, worried that of the four men he had chosen for the Board, two were Jewish intellectuals, Irving Kristol and Arthur Schlesinger Jr. and Herb would make it a third, a majority. I persuaded him nobody would notice, which was of course the case, and in the years since, a steady parade of Jewish intellectuals graced the page. (Kristol arranged for my fellowship at AEI, and ever since I address him as "Don Corleone," my intellectual godfather and godfather to dozens of other neo-conservatives.)
As I predicted, Herb was an enormous success on the Board, and continued his monthly column for 25 years, writing his last only a month ago. One other anecdote is worth telling. Herb called me at the Journal in 1972 and asked if I would do him a favor, telling me his bright young son Ben was bored to death working in the federal bureaucracy. In the Nixon years, Ben had worked as a speechwriter for the Nixon girls, Julie and Trish, but when that plum job ended, Ben was stuck with paper clips and paper shuffling. When I agreed to help, Ben called and I suggested he write something we could consider, and he wrote a review of a new movie, "The Godfather," which was incomprehensible in the first draft, but which was magnificent when re-written. I then coaxed Bartley into hiring Ben as our TV and movie critic. In a year or two, Ben made enough connections with Hollywood's elite to quit the paper and set up shop as a writer and actor in Tinseltown. Do you remember Professor Ben Stein as an economics teacher in "Ferris Bueller's Day Off?" He goes to the blackboard, picks up the chalk and draws: "THIS.... is the Laffer Curve." He also snuck me into the "Wall Street" movie with Michael Douglas, when Douglas plays a greedy shark who wonders about what "Wanniski would think of this," as he walks down a staircase with some deal in his hands. These days, of course, Ben is the host of a television quiz show and writes a regular column for The American Spectator, one of my favorite periodicals.
If I had time, I could pick out dozens of Herb's famous bon mots, which he sprinkled throughout his writings and in the days when he was chairman of Nixon's Council of Economic Advisors, 1972 to 1974. I have a few favorites that spring to mind. When asked by a reporter to explain why inflation was getting so high, when he had not predicted it, Herb put on a straight face and said: "If you take out all the things in the Consumer Price Index that have gone up, the index would actually go down." At another press conference, when he got irked with persistent questions on the same topic, he announced that "The Nixon Administration is against inflation and it is against deflation. We are for 'flation."
Rest in peace, old friend. You made a few mistakes along the way, but no more than any of the rest of us, and you did it without ever losing your temper, which I can't say about myself. And I wasn't kidding about your book -- the first important book on economics I read. It will hold up in the history of economic literature for at least the next millennium. I recommend our SSU students to get their hands on a copy, read it twice, and keep it close at hand.