The Price of Civilization

by Jeffrey D. Sachs

  The Reagan Revolution

  The political coalition that put Reagan into office was determined to create a lasting legacy of a smaller federal government (“to curb the size and influence of the federal establishment”), and in this it partly succeeded. There were four main instruments of the Reagan Revolution: tax cuts on higher incomes, restraints on federal spending on civilian programs (at least relative to the growing economy), deregulation of key industries, and outsourcing of core government services. All four of these major policy changes took hold in the 1980s and are still in place today.

  At the aggregate level, the Reagan Revolution did not shrink the federal public administration, but it probably did stop it from expanding. The federal civilian bureaucracy had 2,109,000 full-time-equivalent civilian employees in 1981, the same in 1988, and nearly the same over the next twenty years, with an expected 2,101,000 full-time-equivalent civilian employees in 2011.14

  In terms of taxation, total federal revenues as a share of national income in 2007, before the financial panic, stood at 18.5 percent, virtually unchanged from the start of the Reagan administration. Total spending in 2007 stood at 19.6 percent of GDP, slightly lower than the 21.7 percent of GDP in 1980. Civilian spending was 13.9 percent of GDP in 2007, down slightly from 14.8 percent of GDP in 1980.

  The larger shift from Reagan onward was across the categories of domestic spending.15 As we saw in Figure 4.2, discretionary civilian spending declined from 5.2 percent of GDP in 1980 to around 3.6 percent of GDP in 2007 (before a temporary recession-related boost). Mandatory spending, mainly transfer programs to individuals such as Medicare, Medicaid, Social Security, and veterans’ benefits, grew slightly, from 9.6 percent of GDP in 1980 to around 10.4 percent of GDP in 2007. Thus the Reagan Revolution set into motion a squeeze on government investments in areas such as education, infrastructure, energy, science and technology, and other productivity-enhancing areas, while leaving mostly untouched the growth of transfers to individuals for health care and retirement.

  Demonizing Taxation

  The deepest political impact of the Reagan era was the demonization of taxes. Taxes are rarely popular, especially in the United States, a country that was founded on a tax revolt. Taxes not only take money out of pockets; they are widely seen by Americans as a denial of freedom itself. The standard libertarian line is that since government collects around a third of national income, it’s as if Americans are indentured to the government, even its slaves, during January through April of each year. Accurate or not, the anti-tax sentiment is ingrained in the American political discourse.

  Reagan’s main target was to reduce the top marginal tax rates on rich taxpayers. The history of the top marginal tax rates is shown in Figure 4.3. The federal income tax is a recent invention, just one century old. At the start, the highest marginal tax rate was a very modest 7 percent, but within a few years, and due to America’s entry into World War I, the top marginal tax rate soared to 77 percent in 1918. In the 1920s, the conservative administrations of Calvin Coolidge and Herbert Hoover brought the top rate back down to 25 percent, where it stood at the time of the Black Tuesday stock market crash on October 29, 1929, that marked the onset of the Great Depression.

  Figure 4.3: The Top Marginal Personal Income Tax Rate, 1913–2009

  Source: Data from Tax Policy Center (Urban Institute and Brookings Institution).

  With the New Deal, the top marginal tax rate rose to 63 percent, and then it rose further during World War II, to reach 94 percent by 1945. It remained near this stratospheric level until the 1960s, when tax cuts during the Johnson administration reduced it to 70 percent in 1965. It remained around that level until the Reagan Revolution. A series of tax cuts at the center of the Reagan agenda reduced it in steps to 28 percent by 1988. It is a mark of the lasting legacy of Reagan that the top marginal tax rate has not again reached even 40 percent since then. Obama entered office with the top rate at 35 percent.

  Reagan argued for tax cuts on three major grounds: that lower marginal tax rates would improve the incentives for innovation and entrepreneurship; that the increased growth following the tax cuts would mean higher rather than lower government revenues; and that lower tax rates would lead the way to a smaller government overall, on both the tax and spending sides. The message was contradictory. Would tax revenues go up or down? Would spending, even on popular programs, have to be cut? Reagan’s team had it both ways: that tax cuts would be self-financing through faster growth and that they would be the leading edge into politically difficult spending cuts. We’ll continue to return to the implications of the tax cuts in later chapters. Suffice it here to state that the tax cuts were not self-financing. They led to large budget deficits and to pressures to cut government spending on domestic discretionary programs, all the more because spending on the military rose.

  Cutting Civilian Outlays

  It was also an overt goal of Reagan and his supporters, almost as important as the tax cuts, to cut the size of civilian government outlays while simultaneously boosting military spending. Civilian programs were viewed as wasteful, unnecessary, and lavish transfers to the undeserving poor. One of Reagan’s lasting images was the “welfare queen,” a larger-than-life individual, always imagined as an African American woman, who bilked the federal welfare programs by registering for benefits under multiple aliases. Whether such a figure truly existed was much debated, but the wildly popular idea that welfare fraud was rampant led to a surge of public support for cutting or eliminating many income support programs. The War on Poverty thus became a war on the poor.

  The broadest indicator of the post-1980 change is the share of national income devoted to the provision of public goods and services in several categories. Figure 4.1 showed the overall civilian budget of the federal government relative to GDP. We can see that the Reagan Revolution achieved one of the first things it set out to accomplish: an end to the rising trend of civilian outlays as a share of GDP. The civilian budget rose from around 5 percent in 1955 to a peak of 14.9 percent of GDP in 1981. Then the increases stopped. Total civilian spending remained in the range of 13 to 15 percent of GDP thereafter, settling at 13.9 percent of GDP in 2007, the year before the financial crash and the rise in stimulus spending.

  Spending on “physical resources,” mainly infrastructure, was sharply curtailed, falling by half, from around 2 percent of GDP to around 1 percent of GDP.16 The accumulated backlog of unmet infrastructure needs has soared as a result, to more than $2 trillion (roughly 15 percent of GDP), according to the American Society of Civil Engineers, which keeps track of America’s infrastructure performance and needs.

  Another area that was sharply cut was education, job training, and employment programs, all vital areas of investment in human capital, especially in the context of globalization. Most education spending is at the state level, but the federal role is extremely important to preschool, higher education, and job training and placement. The federal education programs were curtailed in the 1980s, and overall public spending in this area fell from 0.85 percent of GDP in 1981 to 0.50 percent of GDP in 1988 and then rose very slightly to 0.53 percent of GDP in 2007, the year before the crisis.17

  One of the most consequential decisions of the Reagan administration was to dismantle the research and development program on alternative energy supplies begun by Jimmy Carter. When Americans wonder why we are far more dependent on oil in 2010 than in 1973, at the time of the first oil embargo, and why we are drilling in dangerous deep-sea reserves, they should look first at Figure 4.4, showing the outlays on energy R&D. Jimmy Carter declared the energy crisis the “moral equivalent of war.” The free-market Right mocked Carter’s call for a national energy strategy and cleverly and unfortunately repackaged Carter’s call to arms with its acronym, MEOW.

  Carter substantially boosted R&D on solar energy, biofuels, coal-to-liquid-gas, and other technologies. R&D spending roughly tripled from 1974 to 1980, rising from $2.9 billion to $9 billion (expressed in constant 200
9 dollars).18 When Reagan came to office, he dismantled what he found, driving R&D back to around $3 billion, with much of that really directed at dual-use military technologies of nuclear power. Symbolically, he ultimately removed the solar panels that Carter had installed on the White House roof, vividly indicating the end of the drive for renewable energy. We are now paying the price, a quarter century later, for Reagan’s actions.

  Figure 4.4: Federal Energy Research and Development as a Percentage of GDP

  Source: Data from International Energy Agency Data Services.

  The Great Deregulation

  The free-market ideologists of the Reagan Revolution despised regulation as an intrusion on private property and more pragmatically saw government regulation as an obstacle to short-run profitability. Bureaucrats were seen as meddling in the genius of the market and standing between business and a gusher of profits. Since the early 1980s, the underlying conceptual reasons for the regulation—including externalities, asymmetric information, principal-agent problems, outright fraud, and risks of self-fulfilling market panics—have been downplayed as unimportant or unworthy of attention compared with the benefits of granting more entrepreneurial discretion as soon as possible.

  The biggest deregulation blunders were in financial markets and environmental regulation, both areas in which markets do not function efficiently on their own. The Great Depression had taught the country of the need for thorough financial regulation to curb fraud and excessive leveraging of risk. Yet the Reagan administration unleashed a process of dismantling that regulation. The first step was the Garn—St. Germain Depository Institutions Act of 1982, which deregulated savings and loan institutions and set the course for the massive savings and loan crisis a few years later. From the 1980s onward, financial deregulation became a bipartisan political gift to Wall Street, which amply rewarded politicians with jobs and generous campaign funds. Some of the key measures included the dismantling of barriers between commercial banking and investment banking and the decision at the end of the Clinton administration to keep derivatives unregulated. The disdain for regulation led Alan Greenspan to believe that financial institutions would police their own risks, a blunder that ended up costing the world economy trillions of dollars.

  Tough environmental regulations on air and water pollution introduced in the 1960s and 1970s were also partially rolled back after 1980. James Watt, Reagan’s secretary of the interior, slashed funding for regulatory agencies within the Interior Department and championed mining and oil production on federal wilderness lands. Environmental regulations certainly did not disappear after 1980, but their application has remained inconsistent, conflict-ridden, and limited by aggressive claims of private property rights asserted by libertarian groups within the Republican Party.

  Another aspect of deregulation, which has had profound but underrecognized consequences, was the deregulation of the media, especially TV. Until the 1980s, television networks had a mandate to serve the public good through public-interest programming, a fair balance in reporting, and access to the airwaves through the so-called Fairness Doctrine. This mandate was completely eliminated in the wave of deregulation. TV station owners became interested in one overriding goal: making profits through advertising and mass viewership. The fragile ability to promote public education and awareness was abandoned. The arrival of our media-saturated age was given a major boost.

  The Privatization of Public Services

  The general belief of the Reagan administration, sustained through several administrations till now, was that private providers of services should replace direct government provision, even when the government is financing the services. Thus, the government has massively stepped up the contracting of military services such as base operations, judicial services such as management of federal prisons, and social services, including health care, education, and income support. In each of these areas, private companies on contract to the government now provide the services that were once provided directly by the government. As with deregulation, tax cuts, and limits on government spending, the outsourcing phenomenon has been a bipartisan strategy since it was unleashed in the Reagan administration.

  As the public has discovered during the course of the Iraq and Afghanistan wars, private contractors now implement an astounding array of military activities. This form of contracting is treacherous, as it is highly vulnerable to abuse: favoritism in allocating contracts, kickbacks, nonperformance of contracted services, over-invoicing, and more.

  The notion that the private provision of public services will automatically deliver more value for money than the direct government provision of services is built on a series of confusions. Most of the services in question are public goods, so that private competition is inherently lacking. Government outsourcing is therefore tantamount to converting a public monopoly to a private monopoly, with no competition regarding the quality of services. Nor does the free-market ideology acknowledge the pervasive abuses of the contracting process. Contractors are often selected fraudulently as the result of bribes or on political grounds in return for campaign contributions. Congress routinely pays for expensive weapons systems that are opposed by the Pentagon, because local military contractors win the political backing of their congressional delegations.

  The End of Government as National Problem Solver

  The final legacy of the Reagan Revolution is the most important of all. Since the early 1980s, Washington has stopped serving as a national economic problem solver. From the 1930s to the 1970s, when a major national problem presented itself, the federal government tried to solve it. That included reducing unemployment in the 1930s, winning the war in the 1940s, building the national infrastructure in the 1950s, fighting poverty in the 1960s, and confronting environmental and energy threats in the 1970s. It was taken for granted that major economic problems required policy leadership and federal engagement.

  How different our national life has been during the past thirty years. By declaring government to be the problem and not the solution to America’s economic ills, Reagan inaugurated a new mind-set as well as a new set of policies. If you are an average citizen, don’t expect Washington to address your concerns. If you are a special interest, however, come take a seat at the regulatory table; the regulations will be expunged or rewritten to suit your needs. As new challenges—including globalization, climate change, financial instability, and soaring health care costs—have come along, special interests rather than the national interest have been at the political center stage.

  Reagan’s Bad Diagnosis and the Meager Results

  The proof of a bold diagnosis is whether it leads to a useful prescription. Reagan’s diagnosis that the federal government needed to be reined in led to sharp cuts in marginal tax rates, widespread deregulation and privatization of government services, and essentially a ceiling on tax revenues at around 18 percent of GDP. On all relevant indicators, the period from 1981 to 2010 proved to be no better, and was generally much worse, than the period from, say, 1955 to 1970, before the onset of the terrible decade of the 1970s. (The same conclusion applies if we limit the third interval to 2008, on the eve of the Obama administration.) As we see in Table 4.1, economic conditions deteriorated in the 1970s on many fronts: the unemployment rate, growth of earnings, budget deficit, and inflation.

  Table 4.1: Economic Performance, 1955–2010

  Source: Tax Policy Center; Office of Management and Budget Historical Tables; U.S. Census Bureau; Saez and Piketty Data Set on Income Inequality; U.S. Bureau of Economic Analysis.19

  The Reagan prescription aimed to reverse the trends of the 1970s. In this, it mostly failed. The period from 1981 to 2010 had much lower top marginal tax rates, but that prescription had little overall benefit for the economy. Economic growth declined, as did employment growth. The unemployment rate averaged more than 6 percent. Inequality soared, with the share of household income accruing to the top 1 percent rising from 10 percent in 1980 to 21 percent in 2009.20 Earnings
stagnated. The deficit widened. Only inflation showed a marked improvement compared with the 1970s. The conclusion is really unmistakable: the Reagan Revolution failed to put America back on its previous path of growth, high employment, and shared prosperity.

  CHAPTER 5.

  The Divided Nation

  The retreat of government after 1980 partly reflected Reagan’s incorrect diagnosis that “big government” had caused the economic crises of the 1970s. Another cause was globalization, as I will explain in the next chapter. A third factor was the rise of social tensions in America that made it more difficult to acknowledge, and act upon, shared principles and values. From the 1980s till now, America has seen itself as a tensely divided society, and we’ve dissipated tremendous national energies on our social divisions rather than focusing on the important values that unite most Americans and that can and should be the basis of economic policies.

  Our era’s social cleavages are well known to any American: red states versus blue states; suburbs versus urban centers; rural versus urban; whites versus minorities; fundamentalist versus mainline religious denominations; conservatives versus liberals; and Sunbelt versus Snowbelt.1 These divisions are real. Americans have very diverse views about many important matters, from their religious preferences to cultural standards to attitudes about social justice. And as with most things in life, “Where you stand depends on where you sit” (or reside, to be more accurate). Being a white suburban southerner creates a different reality from that of an urban African American northerner, with a different set of cultural attitudes, social norms, and political views.