August 16, 2018
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Republicans, deficits and the two-Santa theory

J. Scott Applewhite | AP
J. Scott Applewhite | AP
Senate Majority Leader Mitch McConnell, R-Kentucky, leaves the chamber after announcing an agreement in the Senate on a two-year, almost $400 billion budget deal that would provide Pentagon and domestic programs with huge spending increases, at the Capitol in Washington, Feb. 7, 2018.
By Karl W. Smith, Bloomberg View

With his signing of a budget deal Friday morning, a Republican president has now joined forces with a Republican-controlled Congress to increase the projected 2019 deficit from $710 billion to $1.15 trillion. And that’s in just two months, the time it took to add spending increases to the effect of the $1.5 trillion tax overhaul enacted in January.

It’s hard to miss the contrast to the Republican fiscal hawkishness that was on display in 2010, when House Speaker John Boehner negotiated a series of budget compromises with President Barack Obama. For today’s Republicans, the appeal of tax cuts and military spending trumps everything. In Boehner’s day, Republicans argued that the deficit was an existential threat, and that shutting down the government was a painful necessity if it meant preventing the deficit from spiraling out of control.

Naturally, the change of tune has produced accusations of hypocrisy. Sen. Rand Paul, the libertarian-minded Kentucky Republican, took to the Senate floor to complain that his party keeps faith with its conservative identity only when it’s out of power. He wasn’t completely wrong. But the whole truth is more complicated. The Republican rift over austerity runs deep.

In March of 1976, The National Observer published an article by the conservative thinker Jude Wanniski entitled, “Taxes and the Two-Santa Theory” that argued that Republican fiscal policy had gone dangerously astray.

The GOP had committed itself to a program of permanent austerity, Wanniski observed, meaning that in good times Republicans wanted to raise taxes to ward off inflation while in bad times Republicans wanted to cut spending to balance the budget. In contrast, he argued, Democrats had the political sense to play Santa, offering the economy increased spending whenever they could and paying for it with higher taxes when the bill came due.

Wanniski thought that a triumph of the Democratic Santa would harm the economy, as rising taxes dampened incentives for entrepreneurship and choked off the capital that businesses need to expand.

What the economy required, he wrote, was two Santas: a Democratic one to deliver the gift of government spending, and a Republican one to hand out tax cuts. The addition of the tax-cutting Santa would unleash private enterprise, expand the business sector and dampen the demand for social services, Wanniski thought.

Notice that Wanniski wasn’t especially fearful of deficits. He hinted that it was the absence of the tax-cutting Santa that tended to push deficits higher anyway. First, the permanent austerity demanded by the GOP meant that Americans could only receive a bit of succor from the spending delivered by the Democrats. So naturally, they demanded ever more of it. Second, the resulting high tax rates constrained business formation so much that revenues were actually lower than they would be if rates were cut.

The two-Santa theory became the political complement to supply-side economics, a phrase also popularized by Wanniski, and formed the basis of the fiscal policies of the Ronald Reagan presidency, when taxes were cut and spending was increased. Contrary to Wanniski’s predictions, the budget deficit surged. The economy, however, turned a corner. It went from low growth and high inflation in 1980 to high growth and low inflation by 1987.

Reagan’s popularity elevated the status of the supply-siders and their two-Santa theory. For two decades, the Republican austerity impulse was contained. The financial crisis in 2008 and popular rage over the accompanying bailouts revived it. The tea party seemed to be the hope for the Republican future, and the party leadership was swept away by calls for fiscal restraint.

Their hearts, though, were never really in it. After all, this was the party that, under President George W. Bush, cut taxes during a time of war and expanded benefits under Medicare, the largest U.S. entitlement program.

Deep down, they still believed in Reaganomics. Now that a Republican is in the White House and the tea party has faded from prominence, the two-Santa theory prevails again.

Karl Smith is director of economic research at the Niskanen Center and founder of the blog Modeled Behavior.

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