The economist Robert Mundell died on April 4. Although known primarily for his work on international economics—he’s popularly known in economic circles as the “father of the euro”—he played a vital role in the creation of what came to be known as supply-side economics: the idea that big tax cuts will so stimulate economic growth that revenues will not fall. Important supply-siders such as Arthur Laffer and Jude Wanniski credited Mundell as the originator of their ideas. And while these ideas have engendered decades of hotly contested debate, Mundell’s foundational work is still very vital today, even to the pandemic recovery that America has embarked upon in the early days of the Biden administration.
Mundell’s primary interest was international macroeconomics, which he developed while working at the International Monetary Fund in the 1960s. His work was pioneering because most economists tended to ignore the international sector in their macroeconomic analyses. But after the abandonment of fixed exchange rates and the adoption of floating rates in 1971, the basic macroeconomic equation fundamentally changed. As the financial journalist David Warsh explains, the new international monetary regime greatly empowered monetary policy, which had been viewed as a macroeconomic sideshow previously, while de-emphasizing fiscal policy, which had been viewed as the primary economic lever.
I hadn’t yet met Mundell in the mid-1970s when I was doing work for Congressman Jack Kemp that involved helping him develop what would eventually become the 1981 tax cut. Mundell was an important, if unseen, presence even then. Jack and Jude talked about him all the time as the ultimate guru to whom we all owed a debt. It took me a long time to understand why his work was so important, mainly because the works of his that I had read at that time weren’t especially insightful. I remember asking Jude what work of Mundell’s I should read, and he told me Man and Economics. I did as he suggested, but it failed to enlighten me much on the subject of tax policy.
In May 1974, what would turn out to be an extremely important conference, sponsored by the American Enterprise Institute, took place in Washington. Organized by Laffer and the monetary economist David Meiselman—a close associate of Milton Friedman—its focus was primarily on bringing together divergent strains of monetarist thought on the problem of inflation, which at the time was growing in importance. The conference proceedings were published as The Phenomenon of Worldwide Inflation in 1975.
A key point made by Mundell in his paper for the conference was that inflation had important real effects on the tax system: It pushed workers into higher tax brackets when they got cost-of-living pay raises, it forced investors to pay taxes on illusory capital gains, and it diminished the value of depreciation allowances for corporations. Thus taxes were rising sharply in the 1970s, slowing economic growth and, ironically, making inflation worse, Mundell said.