Blending Economic Theories Risky

F. Scott Fitzgerald wrote that "the true test of a first-rate mind is the ability to hold two contradictory ideas at the same time." By that standard, our president, whose intelligence opponents have long underestimated, may be an economic genius.

In a recent White House meeting, aiming to define the economic policy reaction to the events of Sept. 11, President Bush reportedly said: "We are both supply-siders and Keynesians."

Now, that's a little like saying you're both a Red Sox fan and a Yankees fan. Supply-siders and Keynesians stand at opposite ends of the ideological spectrum.

Bush's apparent contradiction is part of the larger fog that has enveloped economic and fiscal policy-making since the terrorist attacks.

Republicans have uncharacteristically signed off on vast new spending bills for the reconstruction of New York City and the Pentagon, and for a new domestic security agency. The new spending is regarded as both a necessary response to aggression and a means of getting our listing economy back on its feet.

Meanwhile, Democrats have departed from their scripts and joined Republicans in calling for further tax reductions. Proposals have been floated to reduce capital gains taxes, payroll taxes and corporate income taxes. Keeping more money in the private sector where it can be deployed effectively, it is argued, would kick-start the idling economy.

These two approaches to economic slowdowns -- raising spending and cutting taxes -- underscore the fundamental differences between the followers of John Maynard Keynes and the supply-side devotees of economist Robert Mundell.

Keynes believed effective fiscal policy should stimulate consumer spending through government spending. His ideas were ascendant during the New Deal and World War II, the first great eras of intentional deficit spending, when Washington created a host of new agencies to deal with social ills and prosecute the war.

Supply-siders, by contrast, hold that supply creates its own demands. The policy upshot? Rein in government spending and slash taxes to keep more capital in the private sector, especially during economic downturns. That will generate massive new economic activity.

Supply-siders are identified with the presidency of Ronald Reagan. Although his father dubbed supply-side theories "voodoo economics," President Bush entered office intent on governing more like Reagan than Roosevelt. Declaring the projected surplus the property of the people, not the government, he pushed through a massive tax cut. One of its goals was to leave fewer funds available for government spending.

But with the nation now on a war footing, things have changed. And even as our near-term surpluses evaporate, Bush and his Washington colleagues on both sides of the aisle want to increase spending and reduce taxes at the same time.

This strategy may be dangerous -- politically and fiscally.

By embracing Keynesianism, Bush has undermined his rationale for opposing new government programs. Let's say the economy continues to struggle for another year. Once the furor over the terrorist attacks fades, politicians will hasten to raise new crises -- the lack of health insurance, the state of public schools, the flagging steel industry -- that demand prompt and expensive government responses.

The other potential danger is a return to the slow growth and rapidly rising deficits of the early 1990s. After the tax cuts in the 1980s, it will be recalled, government revenue failed to rise at anywhere near the rate of government spending.

Already, there are hints that the bond market is less than pleased with the emerging combination of economic orthodoxies. Even after the Federal Reserve interest rate cuts, long-term rates haven't fallen much.

Finally, the government response to the last recession stands as a refutation of both Keynesians and supply-siders. In early 1993, President Clinton proposed a stimulus package for infrastructure, and new spending on programs like a service corps. But Congress quickly halted Clinton's Keynesian efforts. And once Republicans took control of Congress in 1994, they pushed for a balanced budget and spending reductions.

In 1993, rather than reduce taxes at a time of slow economic growth, as the supply-siders called for, the Clinton administration and Congress raised marginal rates on the wealthy. Supply-siders predicted endless recessions. What followed turned out to be the longest expansion in American history.

Both supply-siders and Keynesians were wrong about the treatment for America's ailing economy in the early 1990s. Now that President Bush has embraced both approaches simultaneously, we can only hope that's not the case today.