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Lawrence Kudlow
Lawrence Kudlow
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Reagan + Friedman + Keynes: We Need All the Help We Can Get.

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Back in early 1981, when I went to Washington to work for President Reagan, one of the architects of supply-side economics, Columbia University's Robert Mundell, visited my OMB budget-bureau office inside the White House complex. At the time, we were suffering from double-digit inflation, sky-high interest rates, a long economic downturn and a near 15-year bear market in stocks.

So I asked Prof. Mundell, who later won a Nobel Prize in economics, whether Reagan's supply-side tax cuts would be sufficient to cure the economy. The professor answered that during periods of crisis, sometimes you have to be a supply-sider (tax rates), sometimes a monetarist (Fed money supply) and sometimes a Keynesian (federal deficits).

I've never forgotten that advice. Mundell was saying: Choose the best policies as put forth by the great economic philosophers without being too rigid.

Of course, John Maynard Keynes was a deficit spender during the Depression. Milton Friedman warned of printing too much or too little money. And Mundell, along with Art Laffer, Jack Kemp and others, revived the importance of reducing high marginal tax rates to reward work, investment and risk. The idea was to make each of these activities pay more after tax, and in the process boost asset values across the board. This incentive model of economic growth was used effectively by President John F. Kennedy and the great 1920s Treasury man, Andrew Mellon.

During the 1980s, Reagan enacted Mundell's three-legged approach. He slashed tax rates on the supply-side and was not afraid to run budget deficits in the Keynesian mold. At the same time, Reagan gave Paul Volcker carte blanche to practice the tough-minded monetarism that curbed excess money and vanquished inflation. This eclectic policy mix reignited economic growth, and it ushered in a near three-decade prosperity boom that revived free-market capitalism.

Today, however, the economic naysayers are ignoring the advice of Mundell. Looking at our financial crisis, with its deflationary sweep from stock markets to home prices to energy, they want to lurch leftward to a big-government tax-and-spend regulatory approach. Instead, we need to put all three legs of the Mundell hypothesis in place. And we're already two-thirds of the way there.

Treasury man Henry Paulson is using a $700 billion rescue package to prop up banks with new capital, purchase distressed assets and backstop inter-bank lending.

Keynesian deficits will finance it. But it's working. While ankle biters on the left and right have dissed Paulson's plan, important credit-market spreads have declined significantly in the last two weeks.

Fed head Ben Bernanke, meanwhile, is combating deflation with a Friedmanite monetarist approach — the second leg of the Mundell mix. Over the past two months the Fed has doubled its balance sheet and spurred a major increase in the basic money supply in order to meet the enormous liquidity demands that always accompany deflation. The Fed should keep this up in the coming months until stocks, commodities and credit show life-signs of recovery.

But what's missing is Mundell's third policy leg: supply-side tax cuts. And here we find the partisan debate of the closing days of the presidential and congressional elections.

Democrats want to tax the rich, redistribute the wealth and spend our way out of the economic doldrums. It won't work. Sens. Barack Obama and Harry Reid, along with Speaker Nancy Pelosi, disdain supply-side tax incentives. But Sen. John McCain wants to reemploy them as a recovery tool.

McCain is right, and now is the time for the Republican Party to call for sweeping tax cuts that would reduce marginal rates by half for businesses, individuals and investors. Yes, it would be bold. But no bolder than Reagan in the 1980s, Kennedy in the 1960s or Mellon in the 1920s.

The corporate tax rate should be slashed from 35 percent to less than 25 percent, including capital gains. (Corporations, let's not forget, don't pay taxes. Only individuals do, since business costs are passed along to consumers.) The top individual rate should similarly be lowered, with fewer income brackets to clutter up the tax code. And investment taxes on capital gains and dividends should be cut from 15 percent to 7.5 percent to revive the dormant animal spirit of investors.

These tax cuts would mean all three legs of Mundell's pragmatic approach to policy are in place. Use the money supply to combat deflation (inflation is not the problem), employ deficits to rescue and stabilize the banking and credit system, and slash tax rates to reignite economic growth.

In effect, a successful rescue plan requires a drawdown of all the major economic schools of thought. Given the current economic emergency, we need all the help we can get. For a change, how about a little pragmatism in the policy mix? That just might do the trick.

To find out more about Lawrence Kudlow and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate web page at www.creators.com.

COPYRIGHT 2008 CREATORS SYNDICATE INC.



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Sir;... Do you know what I think??? If you want an economy to work you loan it money, and to pay it back the economy will work... If you want people to work, pay them.... If you want them to work harder, pay them less... And if you want to work them hardest; make them pay the bulk of taxes... It is possible to get a single man to pay his own wages, and pay taxes, and make profit; and all for at third of what he produces... If you push people hard enough they will sell you everything they own at a loss... They will sell you their future to pay interest, and the capital built up by generations... All you have to worry about is sucking too much money and wealth out of the poor too fast because if you do, your class will choke on what you can't swallow while workers find they can afford nothing without collateral to borrow against... ..You have the ideal system there old buddy... How did it ever work before the government stepped up to transfuse wealth into its open veins every few years... How do you sell such a lame idea of an economy to people??? Is it with Chinese Arithmatic??? Doesn't it ever appear that nothing adds up??? If you count the cost of infrastructure, crime, war, poverty, pollution, education, and medication doesn't it seem like some numbers are missing from the balance sheet??? I think you rich folks have a problem with book keeping, and you count on government to cover your shorts... The thing is, that government can hardly cover our shorts if it is covering yours... So figure it out brightlight... If the price of a teaspoon of rich is a boatload of poverty how can you call your economy a success??? We have to get something out of the deal too... It isn't all about me, and it isn't all about you... If we can't all make it to a happy place together, my bet is that the rich will go over board first... Who knows what will happen if things don't improve??? I would like to point out all the people of this world that found at the end that they had too much money and too few friends... Make friends with the people of America...Quit taking money we haven't made yet to mark your bills paid... Let's all be friends... Let's all be Americans...Thanks...Sweeney
Comment: #1
Posted by: James A, Sweeney
Sat Oct 25, 2008 8:02 PM
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