Today we celebrate the birthday of Milton Friedman, a man who had more great ideas than any other economist in my lifetime. Most people were exposed to Friedman’s ideas in the popular book that he wrote with his wife Rose, Free To Choose. That book led to a popular TV series in which Friedman debated his ideas with other prominent economists.
Friedman made the case for freedom of choice, and the absence of government coercion, in virtually every aspect of our lives, education, health care, jobs, work, consumption, investment, and provision for our retirement. I last hear him speak several years ago in Denver, supporting choice in education. He spoke with the same logic and passion that he did early in his career.
For me talking about Milton Friedman’s ideas is like a history of my intellectual journey as an economist. If you studied economics in the fifties, as I did, you probably read very little about Friedman and the monetary tradition in economics. The major confrontation of ideas in economics at that time was between the socialists based in Cambridge England, and the Keynesians in Cambridge Massachusetts. You might have read about Friedman and the monetarists in a history of economic thought course. But, for many mainstream economists the assumption was that money doesn’t matter, Keynesian fiscal policies could fine tune the economy to some desired level of income and employment. Friedman challenged the Keynesian model in his work in monetary theory, studies that would later earn him the Nobel Prize in economics.
For economic historians the major challenge was the path breaking study that Friedman wrote with Anna Schwartz, A Monetary History of the U.S. When I got around to writing a textbook in U.S. Economic History I used that study to trace the evolution of monetary and fiscal policy in the U.S.
The most important chapter in a Monetary History of the U.S. is that on the Great Depression, because it holds important lessons for us today. Friedman and Schwartz argued that government failures turned a business recession into a decade long depression. The Smoot Hawley Tariff was the most protectionist measure passed in a century. As other nations responded with their ownprotectionist measures, world trade and capital flows collapsed. As economic conditions deteriorated, banks contracted their lending. The Fed failed to respond to this contraction in the money supply, resulting in a collapse in the banking system, and the bank holiday of 1932. Indeed there is no time in the 1930s when the Fed pursued monetary policies that would have led to a more stable growth in the money supply and economic recovery. Nor is there anytime in that decade when fiscal policy contributed to economic recovery. The increased spending that accompanied the New Deal was offset by higher taxes.
The change in the rules of the game introduced in the New Deal, and sanctioned by the Supreme Court, essentially abandoned economic due process. Increased government regulation, government ownership of enterprises, and new entitlements programs created uncertainty for private investors and entrepreneurs. It was not until the end of World War II that the nation began to return to rules of the game that created incentives for private investment and economic growth. We would spend the next half century dismantling damaging regulations introduced during the New Deal, in banking and finance, agriculture, energy, transportation, etc.
It was during the 1970’s when Friedman’s approach to monetary and fiscal policies gained traction in the economics profession. As the economy experienced stagflation, the flaws in Keynesian theory became readily apparent. Expansionary fiscal policy and accommodating monetary policy were accompanied by higher inflation and unemployment, and retardation in economic growth.
Friedman maintained that government was too big, too expensive, and too intrusive in the lives of citizens. He argued that: if we want low inflation we must have a stable growth in the money supply; if we want economic growth we must have lower taxes and less government regulation; if we want to preserve capitalism and individual liberty we must decrease the size of government relative to the private sector.
As President, Ronald Reagan pursued Friedman’s vision for America. Under Reagan we had the first real test of Friedman’s monetary rule. The money supply, which had increased at double digit rates over the prior decade, was constrained to grow at roughly the long run rate of economic growth. Inflation, which had increase at double digit rates, was reduced over time to the target rate of 2-3%.
President Reagan’s greatest success was in reducing tax burdens, cutting the top marginal income tax rate more than half. President Reagan was more successful in reducing taxes than he was in constraining the growth in federal spending. However, he was one of the few post World War II Presidents to limit the growth in non-defense spending in order to allocate a larger share of the budget to defense. These more prudent monetary and fiscal policies set the stage for the most rapid economic expansion of the post World War II period.
At that time I was leading the quiet life of an academic in the ivory towers of Unversity of Colorado. I had written books and article supporting Friedman’s ideas, and introduced them into my courses. I got a call from John Andrews saying that he was organizing a new think tank, The Independence Institute, and since I was the only conservative economist he knew at CU I would be his first Senior Fellow. Since John didn’t give me a choice, I came on board and began writing issue papers and editorials for the Institute.
I was also invited to the Heritage Foundation to serve first as a Bradley Scholar, and then as Adjunct Scholar. That gave me an opportunity to study tax and spending limits and their impact on economic growth. Not many people know that Milton Friedman was the author of the first state tax and spending limit, Prop One, in California. Milton Friedman and then Governor Reagan toured the state in support of Prop One. While Prop One failed narrowly at the polls, it set a precedent for all of the tax and spending limits to follow, including Colorado’s TABOR Amendment. I helped design a model tax and spending limit, based on the TABOR Amendment, for the American Legislative Exchange Council.
I joined the Americans Prosperity Foundation as distinguished Scholar, to help promote tax and spending limits in the states. In Wisconsin we were within a few votes of getting a tax and spending limit through the legislature; but, a few legislators were arguing for a less stringent limit than inflation and population growth. We arranged for a conference call with these legislators and Milton Friedman. When I explained what these legislators were proposing Friedman’s response was, “Don’t do that, set the limit at inflation and population growth”. We were not successful in getting this tax and spending limit through the Wisconsin Legislature. But we all learned that Milton Friedman wasjust as passionate about stringent tax and spending limits then as he was in the 1970s.
I am also indebted to Friedman’s ideas on tax policy. Friedman’s proposal for low flat rate income taxes was a major influence on President Reagan’s tax reforms. When Reagan’s second tax cut was enacted in 1986 it created a windfall in tax revenue for states such as Colorado that linked their income tax to the federal income tax. At the Independence Institute we argued that Colorado citizens should not pay higher income taxes simply because the federal government broadened the base of the federal income tax. We argued for a flat rate income tax to replace Colorado’s graduated income tax. The Republican leadership in the Colorado Legislature asked us to estimate a revenue neutral flat rate income tax. My estimate was 4.25%, which has proven to be spot on. We got a flat rate income tax, but the Republican leadership chose to set the rate at 5%, and asked us to support that tax policy. I take my hat off to John Andrews who chose the high road, arguing that the Institute would not support a tax increase.
Today we are facing an economic crises. As Milton Friedman predicted, these are times when governments are most likely to abandon prudent policies. Indeed, it appears that we are about to repeat the mistakes of the Great Depression. The fed should be held accountable for the instability in monetary growth that led to first a housing bubble and then to collapse in the housing market. The Fed should be held accountable for failed oversight of financial markets to prevent overextension of credit and abuse of leveraged financial instruments. Instead we have observed an unprecedented expansion of the money supply over the past year. President Obama proposes even greater concentration of power in the Fed to control the money supply and regulate financial markets.
Over the past decade fiscal discipline has been eroded by unconstrained growth in federal spending. Under current law entitlement spending will absorb larger shares of the federal budget, and federal spending will reach 40-50% of GDP over the next few decades. President Obama proposes even greater entitlement spending. His stimulus spending and financial market bailout will increase federal deficits and debtto levels not seen since World War II. The Fed has promised to expand the money supply by whatever amount is needed to finance these expansionary fiscal policies The Congressional Budget Office projects that these fiscal policies will result in retardation and stagnation in economic growth within a few decades. There is no way that we can increase taxes, borrow, or print money to finance these deficits without causing economic stagnation.
We are on a path that will Europeanize the American economy. Over much of the post World War II period the European countries pursued socialist policies that resulted in retardation and stagnation in economic growth. Only in recent decades have European countries rescinded some of these policies, and pursued more prudent monetary and fiscal policies conducive the economic growth. We don’t have to sit back and watch the Europeanization of our society. We don’t have to wait for imprudent monetary and fiscal policies to bring economic stagnation before we act.
The great advantage that we have over the European countries is that we have a Constitution that limits the federal government to specific enumerated powers and reserves all other powers to the states and citizens. The founding fathers incorporated the Tenth Amendment in the Constitution for precisely these times. It is not just a matter of preserving states rights and state sovereignty, the federal government is violating the rights of citizens under the Tenth Amendment. Seven states have enacted, and thirty states have introduced resolutions challenging the violation of the tenth Amendment by the federal government.
Citizens must use this opportunity to impose an economic constitution on the federal government, one of the original ideas advanced by Milton Friedman. If we can’t impose monetary rules on the Fed, then we should break up this monopoly control of the money supply and of the financial system.
After decades of irresponsible fiscal policy we can no longer wait for Congress to impose fiscal discipline. We must incorporate fiscal rules in the U.S. Constitution similar to those incorporated in our state constitutions. Every state constitution includes a balanced budget provision and a limit on debt. Most state constitutions incorporate a tax and spending limit, and a prohibition on unfunded mandates.
The founding fathers incorporated Article V in the Constitution for precisely these times. In the 1990s we came within one state of enacting a balanced budget amendment to the U.S. Constitution under Article V. A resolution to incorporate an amendment, under Article V, to prohibit unfunded mandates by the federal government on the states has also been enacted in a number of states.
The criticism of attempting to incorporate fiscal rules in the U.S. Constitution under Article V is the fear of a runaway convention. But safeguards can be put into place to limit a call for a constitutional convention to the issue of fiscal discipline. Further, what we have observed in recent decades is a runaway federal government. These violations of the tenth Amendment have been sanctioned by the Supreme Court.
I encourage you to join in these efforts to support capitalism and individual liberty, a tradition which owes much to the work of Milton and Rose Friedman. You can do this by supporting their Foundation and the Independence Institute, sponsors of this event. I also encourage you to support our efforts to incorporate fiscal rules in the U.S. Constitution. You can find us on our web site Voteontaxes.org.
Remarks Prepared for the Milton Friedman Birthday celebration, sponsored by the Friedman Foundation and the Independence Institute, Denver, Colorado, July 31, 2009.