ARTHUR Okun, who sat on the Council of Economic Advisers and was its chairman in the Johnson years, wrote in 1969 of “the agonizing balance between growth and price stability.” The Great Inflation began on Okun’s watch and its birth can be pinpointed to President Johnson’s decision to commit American forces to Vietnam in July 1965. It would continue for 17 distressing years. “The initial impact of the Vietnam escalation in the second half of 1965,” Okun wrote, “both directly and through its stimulus to business investment, generated a disruptive boom.” Real output leapt from 5.5 percent in the first half of 1965 to 8.5 percent in the following three quarters. “Our price performance was unhinged. … The economy had especial difficulty adapting to the breakneck advance.”
The writing of history viewed as a path is strewn with pitfalls. Perhaps the most common may be called the hindsight syndrome. Every policy maker who has blown his assignment, or his apologist, hastens to point to the obvious, that it is easier to make a sound decision after the event than before it. A large number of those who write about the past ignore this truism. Another common pitfall is that, because a mistake was made, it must have been deliberate. This is the devil theory of history. The writer, therefore, must identify Satan and condemn him. While inflation has some beneficiaries, it has no friends. Johnson’s failure to confront inflation immediately, particularly with higher taxes to pay for the war, has drawn a number of hindsight authorities, and they have identified two devils—LBJ and McNamara.
During his years reporting from Saigon David Halberstam helped to invent the credibility gap and was pleasantly surprised whenever he discovered Lyndon Johnson telling the truth. Thus, he had no trouble identifying the devil.
Johnson, according to Halberstam, treated the cost of the war as a “public relations problem.” The true numbers were “kept partially secret from the press and the Congress and the allies.” The Joint Chiefs knew those costs and at the outset asked that the nation be put on a wartime footing with the necessary higher taxes. “Lyndon Johnson would not give accurate economic projections, would not ask for a necessary tax raise, and would in fact have his own military planners be less than candid with his own economic advisers.” The President’s reasons for this duplicity, Halberstam wrote, were familiar:
He was hoping that the worst would not come true, that it would remain a short war, and he feared that if the true economic cost of the war became visible to the naked eye, he would lose his Great Society programs. The result was that his economic planning was a living lie, and his Administration took us into economic chaos: the Great Society programs were passed but never funded on any large scale; the war itself ran into severe budgetary problems …; and the most important, the failure to finance the war honestly, would inspire a virulent inflationary spiral.
Wilbur Mills made the same point another way. He told the President that it was impossible to have both guns and butter. “I talked to him about it, but it didn’t appear to make a lot of difference to him. Lyndon Johnson always was a spender.”
The President waited two critical years before he asked Congress for a tax increase to pay for the war. When his economic advisers urged him to move, he refused. The reason he gave was that the public would not stand for it and Congress would not enact it. While his economic advisers had no choice but to defer to his political judgment, they questioned it. CEA chairman Gardner Ackley said he did not know how much the war was going to cost, but that did not matter. “What it was doing to the economy now was about all we needed to know, and it was clear that what it was doing to the economy at the end of 1965 already spelled trouble, and that it was time for policies to adjust to it.”
Charles Schultze, the Director of the Budget, favored a tax boost at the end of 1965, but, he later recalled, “I feel much more strongly about this from hindsight than I did from foresight.” Schultze observed that “deep down inside and intuitively, Johnson recognized the problem of fighting a limited war.” It would have been as “easy as the devil to sell an all-out war.” Play on hate, wave the flag, nothing too good for our boys. But it was very hard to “fight a limited war for limited objectives with limited means.” If he had wanted to go all-out, he could have whipped up the American people and slapped on a war economy, even wage and price controls. But that ran the risk of letting the hawks take over and that would be the end of the Great Society.
Deborah Shapley, his biographer, pointed her finger at McNamara for doing Johnson’s bidding. The secretary promised that the war would be financed by open and honest accounting and that it would be the “most economically fought war in history.” Both proved false. At the outset Westmoreland demanded an immense build-up of men and arms and McNamara and Johnson gave him everything he asked for.
McNamara hid and falsified the costs from the Council of Economic Advisers, the Treasury, the Congress, and the public. He ordered the Defense Department controller, Robert N. Anthony, to assume that the war would end on June 30, 1967. He raided other parts of his budget to pay for the war. In early September 1965 there were rumors of 500,000 troops and $10 billion. Ackley, who was making a speech on September 9, checked the cost with McNamara. He said that the figure was not even close to $10 billion. Ackley made the wrong speech and soon was told that the real number was $12 billion! Even this was not correct. At a meeting at the Johnson Ranch on November 22, 1966, McNamara admitted that the actual cost was $20 billion. The federal deficit, instead of being $1.8 billion, was $9 billion. Shapley summed it up this way:
Through 1966 McNamara was the President’s hard nosed servant. He deflected questions and speculation about the future scale of the war and its cost. He displayed an amazing ignorance of whether the war would get larger or smaller, whether it was likely to end sooner or later. Since he didn’t know, it would be “irresponsible” to name a figure. He answered questions on future troop numbers artfully, steering clear of any hint of a wider war. He avoided lending any credence to those who suspected—rightly—that Johnson was in deeper than he said and was going deeper still.1
The Kennedy administration had adopted a loose incomes policy to deal with mild peacetime inflation. The January 1962 Economic Report in the Council’s section, not the President’s, contained this sentence: “The general guide for noninflationary wage behavior is that the rate of increase in wage rates (including fringe benefits) in each industry be equal to the trend rate of over-all productivity increase.” Since man-hour output had been rising at approximately 3.2 percent annually, that number became the “guidepost” for wage advance. If the employer kept his wage increases within that figure, he would have little reason to raise his prices. Since there were no sanctions to enforce the guidepost, this was wage-price restraint by exhortation, or, as it was popularly known, “jawboning.” In 1965 the Council, consisting of Chairman Ackley and members Okun and Otto Eckstein, was generally responsible for informal administration of the system. But after the troops went to Vietnam they received extraordinary help from the President. The early problems arose in the metals—steel, aluminum, and copper.
In 1965 the Steelworkers insisted on a handsome wage increase. They had not had one since 1961 and during the spring I. W. Abel had defeated the high-living David McDonald for the presidency of the union. He wanted to show his members that they had made the right choice. USW had historically compared itself to the UAW and Walter Reuther had negotiated guidepost busting settlements with the auto companies in 1964. The steel industry was losing its export markets and imports were now pouring in. It insisted that profit margins were too low. The steel contracts had opened on January 1 and the ensuing bargaining had been fruitless. The deadline was pushed forward to August 1 for notice and September 1 for a strike.
On August 17 the President met with Abel, who demanded a big boost. Califano checked it with Eckstein, who specialized in the guideposts, and he said the demands were way out of line and would cause a big increase in prices. Johnson rejected the union’s demand. LBJ’s formula: no strike, a wage increase of not more than 3.2 percent, and no increase in prices.
The President distrusted Secretary of Commerce Jack Connor and Secretary of Labor Willard Wirtz because, he thought, they were prejudiced in favor of their constituents. He informed each of the deal he insisted upon. He then bypassed them by naming a mediation team consisting of LeRoy Collins, the conciliator of racial disputes, and Wayne Morse, an expert on labor relations. While the senator had bitterly opposed the President on Tonkin Gulf, he was a professional who did not hesitate to support him on wages and prices. But the team failed to produce an agreement.
On August 30 Johnson gave the negotiators an ultimatum: accept his deal or postpone the strike. He sent them to Room 275 in the Executive Office Building, which he had occupied as Vice President. He then named a new team, which he kept secret from Connor and Wirtz: Arthur Goldberg, who had long represented the Steelworkers, and Clark Clifford, who presently represented Republic Steel. “He indicated … ,” Califano wrote, “that he had no confidence in Connor and Wirtz, and at the same time told the secretaries that he was depending solely on them to settle the strike on his terms.” The parties extended the deadline for eight days.
After intense negotiations Clifford reported that the companies would improve the wage offer if LBJ would permit price increases in products that had no Japanese competition; Wirtz said the union believed it could get a better deal if the President “winked” at modest price increases. Johnson: “None. Zero.”
Connor and Wirtz then got into an argument over the cost of the fringe benefits. Johnson insisted that they agree and ordered Califano to mediate a settlement. After a number of exhausting sessions Connor and Wirtz on behalf of their constituents signed an agreement. Johnson, triumphant, called the negotiators into the Oval Office, congratulated them, and announced the agreement on national television. He sent word “to our soldiers out tonight in the jungles of Viet-Nam [that] it means a continued uninterrupted flow of the goods that are so essential to freedom and to his life, and even more, the assurance that those at home will never forget his sacrifice in the pursuit of their selfish ends.” CEA costed out the wage and fringe benefits at 3.2 percent, right on the nose.
“Johnson’s decision to hold off a tax increase,” Califano wrote, “… set us on a scavenger hunt to find money for the federal treasury.” A prime source was the sale of government stockpiles of strategic materials built up after World War II. “The big bucks were in aluminum: 1.4 million tons of excess aluminum could be sold for close to $700 million.”
In November 1964 the price was set at 24.5 cents per pound. While there were eight firms which produced aluminum, the Big Three—Alcoa, Reynolds, and Kaiser—dominated ingot output and in mid-1965 were operating at 100 percent of capacity. Fabrication was more competitive. On October 29 Ormet, a small firm, raised the ingot price half a cent. Reynolds and Kaiser followed immediately and Alcoa was studying the action. Eckstein informed the President that the increase was unjustified, that the industry should reduce prices.
If Eckstein was upset, Johnson was enraged. In fact, he was in a dreadful mood, recovering slowly from gall bladder surgery, publicly ridiculed for exposing his big scar to news photographers, on a tight diet restricting his huge appetite. Califano found him almost impossible to deal with:
What I didn’t know at the time was that this had been a terrible day for LBJ: as a result of a map-plotting error two American pilots had destroyed a friendly village of Vietnamese civilians; his daughter, Luci, who was eighteen, had told him she was going to marry Patrick Nugent and the President and Mrs. Johnson thought their youngest daughter was too young to get married and was making a serious mistake; and Johnson had seen Peter Hurd’s portrait of himself, which he hated. He called it “the ugliest thing I ever saw.” Mrs. Johnson said afterward that she didn’t expect to endure an encounter so grim if she “lived to be a thousand.”
To top it all, the New York Times reported that he was “sputtering mad.” He roared at Califano, “Do you hear me? I am not now, never in my life have been, and never will be ‘sputtering mad!’ “ Califano had to bite his hand to restrain his laughter. The poor aluminum industry did not have a chance.
When Alcoa also raised its price, McNamara on November 6 released 200,000 tons of virgin aluminum from the stockpile. It was not enough. Johnson told him to add another 100,000. On November 10 Alcoa rescinded its action and within hours the rest of the industry followed.
At that moment Anaconda, the leading copper firm, raised its price. But U.S. copper, unlike aluminum, followed the world price and Chile was the price leader. Johnson sent Averell Harriman to Santiago to demand that President Eduardo Frei roll back his price, and 200,000 tons of copper were marketed from the government stockpile. Anaconda surrendered.
Lyndon Johnson’s virtuoso performance in the metals in the latter part of 1965 made him the world’s greatest guideposter. Ackley was a witness to what he described as an “awesome” performance when he brought Roger Blough, the chairman of U.S. Steel, to the Oval Office to discuss steel prices.
Roger started to explain what it was that he wanted to do and why it was a reasonable thing to do. And the President just started working him over. … I have never seen a human being reduced to such a quivering lump of flesh. Roger was unable to speak at the end of that interview. LBJ just took him apart, spread him out on the rug, and when he left, Roger was just shaking his head.
But the massive force of the Great Inflation would soon wipe out Johnson’s role and the guideposts themselves.2
In mid-1965 the Keynesian economists at the Council of Economic Advisers could look on the nation’s economy with great satisfaction. They had guided the country, particularly with the 1964 tax cut, into an extraordinary controlled boom. This was the fifth consecutive year of economic growth. The Industrial Production Index (1957–59 = 100) had stood at 109.7 in 1961. In June 1965 it reached 143.1. The Council had persuaded Kennedy to fix an “interim” unemployment goal of 4 percent. In 1961 the rate had been 6.7. In June 1965 it had fallen to 4.7 percent. In fact, it would break the 4 percent barrier at 3.7 in February 1966. And, mirabile dictu, there was virtually no inflation. In June 1965 on the base of 1957–59 = 100 the Consumer Price Index stood at 102.8.
Walter Heller later reflected on this triumph, of which he had been the main architect. There was “very little price inflation” and that was almost entirely due to farm prices which have a “certain life of their own” unrelated to aggregate demand. “So … there was no real inflation.” He had not anticipated both full employment and stable prices. No industrial economy had ever achieved that utopia. But “the Vietnam escalation just knocked things into a cocked hat.”
For most of the rest of 1965 the economists were led astray because the impact of the war was masked by two factors. The first was the duplicity of Johnson and McNamara in concealing the real cost. Ackley, depending on McNamara, assumed the maximum increase in the defense budget at $3 to $5 billion. He did not learn the actual figure until January 1966—$12.8 billion! The other factor was the lag between the letting of a defense contract and the payment for the goods when they were delivered. In the case of ammunition the delay was about six months; for a military airplane it was 18 months. Robert Warren Stevens wrote:
In the second half of 1965, companies that were already almost fully occupied with meeting the booming civilian demand for capital goods and automobiles suddenly received new high priority orders from the Pentagon. These new orders immediately set off inflationary developments in the private sector of the economy as employers began to expand their plants and to raise wages in order to attract more workers into defense production.
They also trooped to the banks for loans to finance their interim costs.
Thus, in the latter part of 1965 the economists at CEA, lovingly caressing their cheerful economic indicators, were oblivious to the gathering storm. In fact, economists generally groped in the dark. Seymour E. Harris, who was a consultant to the Treasury, set up a meeting of 20 top economists with high officials of the interested departments on November 23, 1965. They agreed that the economy would grow in 1966 at 4 percent in real terms, somewhat less than 1965. “With a few dissenters, there was no great concern that the economy was overheated and would require restrictive monetary policy.”
William McChesney Martin, the chairman of the Federal Reserve Board, invariably opened a conversation with an economist by saying, “I am not an economist,” to which the under-the-breath reply was, “Amen!” He believed that inflation of any magnitude was a variety of the bubonic plague. Lyndon Johnson, by contrast, was a Texas populist on high interest rates: He hated them. The Keynesians, preoccupied with overcoming unemployment by stimulating growth, much preferred fiscal to monetary policy. Both, therefore, looked at Martin with deep suspicion. A brawl was inevitable.
The news rose within the banking system to the Fed that businessmen were lining up at their banks for bridge loans to finance their defense orders. Martin got worried and in the early fall of 1965 began to hint that the time was approaching when interest rates must go up. Ackley, Schultze, and Treasury Secretary Henry Fowler warned the President and he called a meeting of the Quadriad—Martin, Ackley, Fowler, and Schultze—for October 6, 1965.
Fowler pointed out that Morgan Guaranty was considering a rise in rates. Johnson wondered whether he should issue a statement about keeping interest rates low. Martin wanted to know how much the government was going to spend, “particularly by McNamara on the war.” Johnson mentioned $3 to $5 billion. Martin said he was leaning toward higher rates. Johnson opposed an increase, saying it would hurt small farmers and businessmen. Ackley and Schultze agreed. Martin looked the President in the eye and said, “If we thought you were right we’d all do the same thing. But the question is, whose crystal ball is right?” Johnson had gotten nowhere. On December 3, with Martin leading the way, the Fed voted 4 to 3 to raise the discount rate from 4 to 4.5 percent.
In fact, the administration was ambivalent about the Fed’s action. Privately the President was angry and inspired congressional hearings on the independence of the central bank without consultation with the White House. But he issued a mild public statement, which opened, “The Federal Reserve Board is an independent agency.” It would have been better, he said, for the Fed to have waited till January, when the new budget would be ready and policies could have been coordinated.
Johnson called Martin and his economic advisers, including Heller, to a meeting at his ranch on December 6. “Sitting on the lawn in front of the ranch house,” Califano wrote, “LBJ at first probed for any way of turning Martin around. He quickly saw that there was none.” The President, moreover, recognized that the Fed’s action was not all bad because it seemed to make a tax increase unnecessary. As Kermit Gordon pointed out, there “wasn’t nearly as much of a conflict as it appeared on the surface. There was a good deal of covert support within the Executive Branch for that act.”
By the end of 1965 the economists had grasped reality. They now realized that McNamara’s numbers were much too low, that a big inflation was coming, and that a tax hike was necessary. The President asked CEA whether a federal budget of $115 or $110 billion would require a tax increase. Ackley replied on December 17 that a $115 billion budget would require a “significant tax increase” and $110 would “probably call for one.” Heller told Johnson, “What we really need is a surtax on the individual income tax.” He suggested 5 percent. Undersecretary of the Treasury Joseph Barr, who had been in Southeast Asia in November and had talked to many military experts, came back convinced that “we really had a bear by the tail. I recommended to Secretary Fowler … that we consider getting our taxes up and do it quickly.” Budget Director Schultze agreed. But the President would not budge.3
Robert Warren Stevens called 1966 the “year of reckoning,” a “traumatic” time for the American economy. James L. Cochrane described it as “a vintage year” when “events overran policies,” which “began badly and then deteriorated.” If one is searching for the year during which the Great Inflation began, the choice is manifest: 1966.
The Fed, deserted to face the storm, squeezed the supply of money and shoved up interest rates. Soaring interest took a toll. Savings and loans and mutual savings banks, locked into low returns on long-term mortgages, were unable to borrow. By midyear the commercial banks felt a similar pressure: their large holdings of municipal bonds could not be sold because they paid too low an interest. Bond houses were threatened with failure. The stock market, which had been falling since February 9, suffered a sharp drop in August. The reason, Ackley explained to the President, was because an investor could earn only 3.5 percent on corporate dividends, compared with 6 percent on government guaranteed federal bonds. Rising interest on mortgages severely retarded the housing industry. Imports increased sharply; exporters lost foreign markets; and the balance of payments soured. Holders of life insurance borrowed from their policies, which paid 5 percent, and received better rates elsewhere.
At the same time, manufacturing and construction boomed. Many of the firms in these industries either financed themselves or borrowed at risky high rates. On August 10, 1966, Ackley wrote Johnson, “I was told … that Morgan Guaranty’s loan demand for September and October is absolutely unbelievable.” A week later the Fed squeezed large banks, as Ackley put it, to “ration their loans to their big customers.” On September 17 he sent Johnson a three-page list of price increases on everything from eggs to electrical transformers that rose in the preceding week. November 8, he reported, “has been a bad day for prices.” Nor did corporations hesitate to raise wages either in collective bargaining or voluntarily in order to hold on to their skilled workers as unemployment held quite consistently under 4 percent.
The wage-price guideposts were swept into oblivion, carrying with them that great mediator, Lyndon Johnson. People asked, “Where did 3.2 go?” In January 1966 the new Republican mayor of New York, John V. Lindsay, settled the city’s transit wages for an increase of 6.3 percent. The construction unions vied with each other to see which could kick the guideposts farther. The unsavory Peter Weber of the Operating Engineers, Local 825, in New Jersey highway construction seems to have become champion. The most explosive case involved the Machinists and five large airlines—Eastern, National, Northwest, TWA, and United. A presidential board consisting of Wayne Morse, David Ginsburg, and Richard Neustadt recommended 3.5 percent plus a clever reopener that came into play only after a very big rise in the cost of living. But the IAM rejected the deal and struck. The President caved in and on July 29, 1966 accepted 4.3 percent. But the membership even rejected that. The union eventually got 4.9.
The White House was shaken and Califano asked CEA for comments on creation of a commission on price stability and the collapse of the guide-posts. The Council thought the commission a good idea. “I certainly agree,” Ackley wrote, “that it is useful to put the recent guidepost defeats into perspective, and I have long agreed that we will need to retreat from the 3.2 percent guidepost figure.” He opposed abandonment and urged getting something in return from labor for giving up 3.2. In August Representative Henry Reuss of Wisconsin held ceremonial hearings on the extinct guideposts.
In December 1966 the President threw in the towel on taxes. His advisers had pressed him all year. In May both Ackley and Schultze had called for a 10 percent surtax. A prominent group of Harvard and MIT economists led by Otto Eckstein met for three months and brought in Ackley, Ginsburg, Fowler, and Califano. On August 23 they made their recommendation: “A personal and corporate tax increase was absolutely essential, and the sooner the better.” Schultze, and Ackley concurred. On September 2 Fowler, McNamara, Katzenbach, O’Brien, Schultze, Ackley, Ginsburg, and Califano agreed.
In his State of the Union message on January 10, 1967, the President said, “I recommend to the Congress a surcharge of 6 percent on both corporate and individual income taxes—to last for 2 years or for so long as the unusual expenditures associated with our efforts in Vietnam continue.”4
It would be a year and a half—all of 1967 and the first half of 1968—before Congress gave Johnson the surtax. During that period economic conditions were much as they had been in 1966: heavy price pressures and distortions with no wage-price policy and the whole burden of restraint falling upon the Federal Reserve.
Though the Fed’s governors followed interest rates very carefully and intervened frequently, their limited powers were hardly up to the task. Okun, who had succeeded Ackley as chairman of CEA, summed up the disaster for the President on May 23, 1968: “Many interest rates are now at their highest level in nearly fifty years. Rates have jumped 1 1/2 to 2 percentage points since late 1965.” Mortgages averaged 7 percent and in many areas were 8. They might soon go to 10. The annual rate of price increase was 4 percent,“the worst performance in 17 years.” The international trade deficit hit a record in March 1968. There was talk of a flight from the dollar and even of a world financial crisis.
On June 9, 1967, the President had met with his top economic advisers and Fowler said he found the money market “disturbing.” Corporations, anticipating a large federal deficit and no tax increase, were borrowing longterm funds heavily and interest rates were rising sharply. On present, not projected, facts, “Fowler urged strongly that it was necessary to go forward now on the tax surcharge.” He thought the banking and business communities would understand and back the hike. He expected a budget deficit of $23 to 28 billion. The President, shocked, said he “refused to run a deficit of the magnitude projected.” He was ready to cut spending “drastically” on domestic programs. “The country, and Democratic Congressmen in particular, would have to choose between the domestic programs and the tax increase.” He ordered Schultze to work out a curtailed budget and he suggested that the surcharge might to go 10 percent rather than 6 percent.
CEA explained the significance of a 1 percent rise in interest rates. The cost to the federal budget would be $3.6 billion annually, $29 billion to the national debt, and $4.5 billion to private, state, and local government costs. Johnson asked for a comparison of price inflation between the U.S. and the European democracies. Writing in January 1968, Ackley pointed out that the U.S. had much the best performance since 1960. But for the period of the Vietnam War, that is, since June 1965, Germany, France, and the Netherlands had a better record and the U.K. and Italy had done as well.
Private investment in plant and equipment continued to be the great engine driving the boom. Inflation aside, this had its attractive aspect—high output and high employment. On October 23, 1967, Ackley wrote George Christian, the White House press secretary:
On November 1, we will have gone 81 months without encountering an economic recession. This will break all records for the duration of an expansion; the previous high of 80 months was set from 1938 to 1945 (including World War II). The average length of expansions (since 1854) is 30 months, and the last three prior to the present one were 45, 35, and 25 months, respectively.
But very high employment in the absence of an incomes policy drove up wages. In the first quarter of 1967, excluding construction, union contract increases averaged 4.9 percent compared with 4.5 in 1966. The Teamsters’ national agreement in the second quarter of 1967 came to 5.5 percent plus a cost of living escalator. Ackley’s memorandum on construction was titled “The Disaster Toll.” In Chicago the carpenters and painters settled for 6.6 percent. In Cleveland the plumbers got an “incredible” 40 percent over 3 years and the carpenters and bricklayers surpassed them. In Connecticut the operating engineers received 7.4 to 9.2 percent. “Many contractors,” Ackley wrote, “seem to be offering nothing more than token resistance to this union assault.”
In September 1967 Walter Reuther negotiated a pathbreaking agreement for the UAW with Ford: 6.2 percent, a cost of living escalator, and a new guaranteed annual wage. After a strike in the spring of 1968 the telephone contract came to about 6.5 percent a year for three years.
On February 23, 1968, the President created the Cabinet Committee on Price Stability, consisting of the Secretaries of Treasury, Commerce, and Labor, the Director of the Budget, and the Chairman of the Council of Economic Advisers. The basic recommendation in its report, delivered on December 27,1968, was hardly earthshaking: “Voluntary restraint by business and labor in wage and price decisions is an essential element in the overall program to achieve full prosperity and reasonable price stability.” Amen.5
When he announced the proposal for a 6 percent surcharge on January 10, 1967, the President said, “I will very soon forward all of my recommendations to the Congress.” Very soon became a very long time. He did not send up a tax bill. Without his vigorous leadership, the Democrats remained silent and the Republicans called for reductions in Great Society programs. In late February even liberal Democrat William Proxmire of Wisconsin, the chairman of the Joint Economic Committee, was inclined to “take a solid position against a tax increase” until Ackley persuaded him to soften his language. The Business Council’s committee on the CEA unanimously voted down the surcharge in its Hot Springs meeting in May. Constituent mail to Congress, according to Congressional Quarterly, was “extraordinarily heavy” against the levy. During the spring, as the CEA put it, the economy was “schizophrenic—a case for psychiatric rather than fiscal or monetary help.” Higher interest rates had slowed the sale of houses and big-ticket items. “We have taken a slowdown without stalling.” Califano informed Johnson in June that Fowler, Ackley, Schultze, Trowbridge (Commerce), Wirtz, McNamara, and he agreed that “your tax proposal should not go to the Congress until after the recess.”
By late July the doldrums were history and the boom was again in command. Martin of the Fed came out publicly for a 10 percent surtax. On July 22 the cabinet committee urged the President to ask for the same amount on corporations effective July 1 and on individuals effective September 1. Reuther told Ackley that he agreed, though he preferred a January 1, 1968, starting date. Without higher taxes, he argued, “domestic social programs would be under very heavy pressure.”
By mid-1967 Lyndon Johnson’s scheme to finance the war painlessly had been torpedoed. He could no longer hide the high cost or the devastating impact upon the federal budget. The Defense Department estimates of expenditures to support U.S. obligations in Southeast Asia by fiscal year were as follows: 1965, $103 million; 1966, $5,812 million; 1967, $20,133 million; 1968, $26,547 million; and 1969, $28,805 million. By mid-1967, the start of fiscal 1968, the number of troops in Vietnam peaked at 525,000; the cost topped out at $28.8 billion in 1969. Thereafter both counts went into decline.
On August 3, 1967, Johnson sent a special message to Congress, called the State of the Budget and the Economy, and held a painful press conference. At the start of the year his estimated budget came to $135 billion with revenues of $127 billion, including income from a 6 percent surtax. Thus, he had estimated the deficit at $8 billion.
LBJ now pointed out with alarm, “Since then much has happened to change these prospects.” These were the “hard and inescapable” facts: Expenditures might go $8.5 billion higher to $143.5 billion, while revenues, even with the tax increase, would be $7 billion lower. “Without a tax increase and tight expenditure control, the deficit could exceed $28 billion.”
“A deficit of that size,” he said, “poses a clear and present danger to America’s security and economic health.” It would bring with it “a spiral of ruinous inflation, … brutally higher interest rates, … an unequal and unjust distribution of the costs of supporting our men in Vietnam, and … a deterioration in our balance-of-payments. … “ This crisis demanded both a reduction in civilian expenditures and a tax increase, not of 6 percent, but of 10 percent, effective for corporations on July 1 and for individuals on October 1, 1967.
The broad implications of this analysis were clear: the hope for both guns and butter had vanished and the Great Society programs would be seriously underfunded. Johnson, Califano wrote, had told him that, if he asked for higher taxes, “ ‘All hell will break loose on our domestic program.’ He was more right than he feared.” Johnson wrote later, “My willingness to compromise had sharpened the appetites of those who saw in this struggle a long-awaited chance to slash the Great Society programs.”
At the press conference a reporter asked whether Wilbur Mills supported the surcharge. The President said he had talked to Mills and his committee several times, but he did not know “what Mr. Mills will do, or what the Ways and Means Committee will do, or what Congress will do.” He had good reason to be concerned about Mills. The tax increase had no appeal to him; never one to proceed unless his majorities were safe, Mills was convinced that both Ways and Means and the House would vote it down; and his relations with Lyndon Johnson were cool, if not strained. (Schultze said they did not speak to each other during 1967.)
Mills did hold hearings in August and September. Aside from its own witnesses, the administration received support from the Federal Reserve, the banking and insurance industries, many economists, and the AFL-CIO. But there was strong opposition from industry. The economists split in an interesting way. Joseph Pechman of Brookings submitted a petition signed by 320 academic economists who supported the surtax. The opposition consisted mainly of those who opposed the war and considered it immoral to support it financially. Even some business economists took this position.
On October 3, 1967, Ways and Means, confirming Mills’s hunch, voted 20 to 5 to lay the tax bill aside until “the President and Congress reach an understanding on a means of implementing more effective expenditure reductions and controls.” Mills defended this action and other recent cuts in appropriations. “These actions are not irresponsible, bullheaded, or spiteful, nor are they maneuvers for partisan advantage.” Rather, they represented an “uneasiness” among citizens about the rise in federal expenditures. The bill, Mills said, was “dead” unless the President mended his ways.
Immediately afterward Fowler and Schultze met with Mills and Chairman George H. Mahon of the House Appropriations Committee. Mills insisted on a firm commitment that there would be no new domestic programs in fiscal 1969, a commitment the President refused to make. On October 7 an administration group worked up a lesser set of concessions: (1) a $2 billion cut in defense, (2) Mahon’s “line item” listing of 700 specific reductions, and (3) a program evaluation commission to propose cuts in federal programs after the 1968 elections. Califano pointed out that this package was “fragile.” Fowler seemed willing to take the losses; McNamara was concerned about preserving the Great Society; Schultze did not like the commission; and Barefoot Sanders, who now worked the Hill for the White House, as well as Larry O’Brien, were pretty much convinced that the tax bill was dead. “Both O’Brien and Barefoot,” Califano wrote, “are concerned about the hundred or so Democrats in the House that stand ready to join with the two Kennedys and others in the Senate and jump the Administration for any association it has with spending cuts.”
Johnson was enraged and vented his anger against Mills and minority leader Gerald Ford at a press conference on November 17. “I think one of the great mistakes that the Congress will make is that Mr. Ford and Mr. Mills have taken this position that they cannot have any tax bill now. They will live to rue the day when they made that decision.” This made headlines across the nation. Mills and the Republicans were furious and there were congressional predictions that LBJ would “rue the day” he made the statement because it had killed his chance to get a tax bill.
The situation seemed out of control. McNamara, Fowler, Schultze, Ackley, and O’Brien urged a resumption of pressure for the tax hike. Democratic bankers from Wall Street lectured Democratic senators: if the economy disintegrated, there would be disasters in the stock and bond markets. Business economists strongly urged a tax increase. CEA’s top advisory team was unanimous in its support.
On November 18, 1967, the British government devalued the pound from $2.80 to $2.40 and raised the discount rate from 6.5 to 8 percent. This threatened more inflation in the U.S. Thus, Fowler argued, the tax increase was “more important than ever.” The Fed raised the U.S. discount rate on November 19.
Mills, disturbed by British devaluation, resumed hearings on November 29 and 30. Fowler presented a two-headed proposal: the 10 percent surcharge and a specific statutory expenditure reduction plan to reduce the deficit by $11.4 billion. To the reasons for the program he now added defense of the dollar. But Mills was not impressed. He said the administration exaggerated the danger of inflation and should concentrate on reducing expenditures on domestic programs. He told reporters that it was too late in the session to consider the tax increase. Thus, the surtax died in the Ways and Means Committee. Wilbur Mills had pinned Lyndon Johnson’s shoulders to the mat.6
When the new Congress opened in January 1968 Johnson sent up a package: a surcharge of 10 percent effective on corporations on January 1 and on individuals on April 1, the extension of excise taxes on automobiles and telephone services due to expire on April 1 to the end of 1969, and an acceleration in the collection of corporate income tax payments. They became H.R. 15414.
“Next to peace in Southeast Asia,” Johnson later wrote, “I believed the tax surcharge was the most urgent issue facing the country.” But he had very little power to influence the Congress. During the first six months of 1968, when the tax bill was under consideration, his presidency, already undermined by years of hemorrhaging, collapsed.
This was one of the most dreadful periods any American President ever faced. In early January HEW Secretary Gardner submitted his resignation. In words that many other officials of the administration could have spoken, Gardner said he did so because Johnson could not unite the country and do what was needed. On January 23 the North Koreans seized the spy ship Pueblo and captured its crew. The North Vietnamese and the Vietcong on January 30 launched the massive surprise Tet offensive against virtually all the major cities and towns in South Vietnam, making a mockery of a potential American victory. On March 12 the peace candidate, Senator Eugene McCarthy, polled a stunning 42.4 percent of the vote in the New Hampshire Democratic primary. Four days later Robert F. Kennedy announced his candidacy for President. In a dramatic address on March 31 Johnson withdrew from the presidential race. On April 4 Martin Luther King, Jr., was murdered in Memphis. This was followed immediately by massive rioting in a number of cities, most dramatically, Washington. At this time Califano wrote, “This has been one of the most momentous and shattering weeks in American history.” But it was not the end. On June 5 Robert Kennedy was assassinated in Los Angeles.
It was against this backdrop of disintegration that the House considered Johnson’s request for the surcharge. The Ways and Means Committee held hearings on January 22 and 23, 1968. Fowler, Schultze, Martin, and Ackley testified strongly, but Mills was not moved. The higher tax would reduce demand and he insisted that the present inflation was cost-push rather than demand-pull. He was annoyed because he found little evidence of an administration effort to reduce expenditures. The senior Republican, John W. Byrnes of Wisconsin, agreed. The Ways and Means Committee summarily stripped the tax increase from H.R. 15414 and passed the bill on February 23 with only the excises and the accelerated collection features. The House approved the truncated measure by voice vote on February 29.
The Senate phase was critical on two counts—the politics and the leadership. Neither the Finance Committee nor the Senate itself was any more willing to enact a tax increase than the House had been. By now a southern Democratic-Republican coalition dominated both chambers. Only liberal Democrats would support such a bill and they were a minority. A tax hike, therefore, must be packaged with a reduction in expenditures on domestic programs, that is, a gutting of the Great Society by opting for guns over butter. The key question then became: how much to gut? For the President, of course, this was an extremely painful choice of evils. Under heavy pressure from Fowler, he reluctantly came around to $4 billion. The southern Democrats, led by Mills in the House and George Smathers of Florida in the Senate, insisted on $6 billion. The Republicans, led by John J. Williams of Delaware, demanded $8 billion.
There was a subtle but unmistakable shift of power in this struggle from the President to Smathers in the Senate and, more important, to Fowler as the spokesman for the administration. Smathers had been in Europe in the fall of 1967 and returned, as he wrote Johnson, convinced that the U.S. “must demonstrate that we have sufficient self-discipline to cut our appropriations and raise our taxes in order to meet the enormous problems of Vietnam, rebellion in the cities, and inflation.”
For Fowler the battle was a holy mission. He was convinced that a $25 billion deficit was “perfectly intolerable” because it threatened runaway inflation and the U.S. balance of payments. His job, he said later, was “a backbreaking bonebreaking job which demanded and received every conceivable energy and tactic that I could think of … to get the job done.” The President called him “one of the most tenacious men he’s ever seen,” and Fowler did not deny that characterization. He led the testimony, spent endless hours in conference and in lobbying with members of Congress, mediated between the prima donnas, Johnson and Mills, and mobilized an enormous and powerful banking and business lobby to push the bill through.
Senator Russell Long, the chairman of the Finance Committee, held hearings on March 12 and 14, 1968. Only administration witnesses led by Fowler testified. Senator Clinton Anderson of New Mexico announced that he would propose the surtax as an amendment to H.R. 15414 and Smathers supported the move. Asked the administration’s reaction, Fowler said, “I would applaud any move. I’m for prompt action.”
But the committee rejected the surtax twice. Smathers proposed it alone and it went down to defeat 12 to 5. Williams coupled it with a mandatory $8 billion spending cut, which lost 9 to 8. The Senate committee then started the process of stringing amendments on H.R. 15414 like ornaments on a Christmas tree. They covered industrial development bonds, Aid to Families with Dependent Children, and medicaid. The amended bill was reported out on March 15.
By now the surtax was in desperate trouble. Fowler spent four days on the Hill trying to broker a deal to save the tax, usually with Martin and sometimes also with Charles Zwick, the new Director of the Budget. Fowler and Smathers worked out a strategy for a 10 percent tax increase and a $5 billion expenditure cut. This required Republican support and they worked over Dirksen for votes. “He said he would try … ,” Fowler wrote Johnson, “but gave me no commitment that he could deliver.” Looking forward to the conference, Fowler talked at length to Mills. The chairman had a problem because Ways and Means had no jurisdiction over expenditures, which fell to Chairman Mahon of the Appropriations Committee. He was jealous of the jurisdiction of his subcommittees and did not recognize the importance of the surtax. Nor was Dirksen making much progress with Williams. Fowler thought a 10-5 or 10-6 package ($10 billion tax increase and $5 or $6 billion expenditure cut) might “break this logjam and put us well down the road, but far, far from home.”
Fowler’s lobbying paid off. Dirksen eventually delivered a phalanx of Republican votes, but the old master exacted his price—$6 billion in spending cuts instead of $5 billion. The Senate debated the bill for a week. Smathers and Williams together proposed the crucial 10-6 amendment, which passed 55 to 35 with strong bipartisan support. The telephone and auto excises were stripped away into a separate bill and were quickly passed and signed by the President on April 12. The Senate then hung about a dozen ornamental amendments on the bill. Johnson, in his dramatic withdrawal speech on March 31, pledged that he would sign a bill with the surcharge and “appropriate reductions in the January Budget.” In the final Senate roll call on April 2, 1968 H.R. 15414 passed 57 to 31.7
Thus, the conference committee received a House bill without the tax and a Senate bill with it. Reflecting the times, the conference became a donnybrook. The brawl dragged on for six weeks and left almost everyone embittered. It was impossible for the public, many members of Congress, and even some of the participants to understand. This was in part because Mills, with conservative Democratic and Republican support, insisted on raising taxes and cutting expenditures not only currently but also into the future. The conflict was also obfuscated by arcane budgetary concepts like the “rescission of unobligated balances” and shorthand like “10-8-4.”
At the meeting on April 24, 1968, Mills asserted control over the conference. He declared, Fowler reported, that “the Senate bill was unacceptable and inadequate because it was decisive only on holding back expenditures in fiscal 1969 and did not reduce the upstream authority to obligate … for the fiscal year 1969 and the following.” The House, therefore, would take the initiative through its committees.
The Appropriations Committee on May 1 rejected ranking Ohio Republican Frank Bow’s motion for a 14-6-6 formula by a vote of 23 to 21, that is, reductions of $14 billion in appropriations and $6 billion each for rescissions and spending. The President said he would accept a $4 billion cut in spending and the Democrats accepted his suggestion.
On May 2, however, Mills moved 14-6-6, the defeated Bow proposal. Califano was convinced that Mills was trying to “torpedo both the tax bill and the Great Society.” Rumors spread that Johnson would capitulate at a press conference on May 3. Calif ano wrote him the evening before, “If you get stuck either with no tax bill or with the provisions … Mills is now peddling, … the ball game may be over … for the rest of the year.” He urged the President to come out fighting. “I think we should turn loose everything we have to take the Ways and Means Committee away from Mills.” The President heeded this advice and demanded that congressmen “stand up like men.” “I think the time has come for all Members of Congress to be responsible and, even in an election year, to bite the bullet and … do what ought to be done for their country.” He added, “Don’t hold the tax bill until you can blackmail someone.”
On May 4 the President wrote an open letter to Speaker McCormack, urging him to “do all in your power to secure passage of the necessary tax legislation.” His budget of $186 billion was “lean enough” to justify only a $4 billion cut in expenditures. “To accept reductions any deeper … is unwise.” Barefoot Sanders “stressed to Fowler that under no circumstances should any impression be left with Mills … that the President is willing to accept deeper cuts.”
Mills backed off. Ways and Means met on May 6 and rejected the Republican-Mills 14-6-6 formula on a party line vote of 15 to 10. It then adopted the tax hike and a $4 billion spending cut, the Appropriation Committee’s 10-8-4 formula. The vote was 17 to 6. Mills seems to have gotten Johnson’s message—for the time being.
On May 8 the conference reached final agreement under Mills’s leadership on a $10 billion surcharge and a $6 billion cut in spending, that is, a 10-8-6 formula. Mills, usually extremely cautious, had taken a big gamble.
It was now $6 billion versus $4 billion, Wilbur Mills versus Lyndon Johnson. Generally speaking, the chairman was in a better political position because he was backed by most of the southern Democrats and the Republicans, who together constituted a majority in both houses, while the President had only the northern Democrats. But there were soft spots for Mills in the House leadership. Speaker McCormack favored $4 billion and was extremely angry with Mills, who, he thought, was trying to blackmail the leadership. The speaker, Sanders reported, said that “since Mills has taken over the leadership of the House, he can get his own Rule out of Committee and get his own votes on the floor fo_ the Conference Report.” Majority Leader Carl Albert and whip Hale Boggs were of two minds but said they would vote to follow the President if he asked them. Sanders concluded that “Mills cannot pass the report without active support from the Administration and some liberal Democrats.” The chairman did not disagree. He wrote Walter Heller on May 10, “We are still a long way from having votes in the House to pass this conference report.”
The President’s people were ambivalent. His domestic policy aides headed by Califano urged protection of the Great Society. They were joined by Sanders and Labor Secretary Wirtz. But the Council of Economic Advisers was of two minds. Its members, doubtless, hoped to preserve the Great Society and, after analysis, concluded that a $10 billion tax increase combined with a $6 billion reduction in expenditures was, as Okun wrote, “an overdose of fiscal restraint” that “could weaken the economy excessively, particularly in the first half of 1969.” At the same time, the CEA thought passage of the tax hike was critical. “The financial mess that would follow failure of the surcharge,” Okun wrote the President on May 20, “could jeopardize our 87-month record prosperity. It could bring on a recession and slump. Even a mild recession would cost $30 or $40 billion of production and 1½ million jobs.” Current economic events accentuated the need for action. Price inflation was at a 17-year record and the bond market was “thoroughly demoralized and close to being disorderly” with extreme jumps in interest rates. The cause, Okun wrote, was “growing uncertainty and continued delay on the tax bill.” The Treasury, of course, had no doubts. Fowler wrote Johnson on May 9, “I strongly recommend that the Administration accept the bitter with the sweet and work with the House and Senate leadership in securing speedy approval of the Conferees Report.” The deterioration of the bond market reinforced his position.
In the lobbying there was no match. Congressional Quarterly’s headline read, “Lobbying by Business Key to Passage.” The bankers, described by Fowler as “the world’s greatest worriers,” accepted the surcharge and adored the spending reduction. Nothing can match rising prices and interest rates in energizing bankers to defend the homeland. The American Bankers Association sent the word to its 13,500 member banks to descend upon Congress. Fowler met with the ABA in Puerto Rico to cheer them on, but quickly concluded that it was unnecessary. “I have never seen any group of bankers so keyed up and concerned.” In 1963—64, when he was Undersecretary of the Treasury, Fowler had organized a very effective group of 500 prominent businessmen headed by Henry Ford and Stuart Sanders of the Pennsylvania Railroad to lobby for the big tax cut. Now he made a few phone calls and they were back in business. The homebuilders and the U.S. Chamber of Commerce also pitched in.
Many groups—the labor movement, education, the cities, religious organizations—strongly opposed the $6 billion spending reduction and, as Andy Biemiller of AFL-CIO put it, “swallowed hard to accept the $4 billion cut.” George Meany visited the President to stiffen his spine and the AFLCIO executive council denounced the “meat-axe approach to cutting the budget.” But these organizations never coalesced into an effective lobby.
On May 21, the day following Okun’s memorandum urging the President to accept a cut in spending to get the tax surcharge, Johnson met with Mills, the House leadership, Okun, Fowler, and Zwick. Okun later recalled,
The President began the meeting by reading my memo. … I would say that there was a good deal of emotion, certainly on Wilbur Mills’ part, in which he was protesting his allegiance to the President and high regard for him and insisting that all his actions on the surcharge had been entirely misunderstood. … Mills made an unqualified promise to the President, which he subsequently broke, that he would make every effort to push that thing through with a four-billion dollar cut on it. … He made, apparently, no effort to get the four-billion dollar cut. In fact, he pushed it through with a six-billion dollar cut on it. … The President … said that he would agree to give his full support to the combination of a surcharge and a four-billion dollar cut.
Some of the northern liberals insisted on a vote in the House on a record motion to kill the conference report. The President and Sanders were opposed. If it succeeded, there probably would be no tax increase; if it failed, nothing would have been gained. But the liberals would not be put off on a vote to reduce the cut to $4 billion. Representative James A. Burke of Massachusetts made the motion on May 29 and it was defeated 259 to 137. The majority consisted of 167 Republicans, 63 southern Democrats, and 29 northern Democrats. The minority was made up of 111 northern Democrats, 20 southern Democrats, and 6 Republicans. The hoary conservative coalition was in firm control. The House adopted the conference report on June 20 by a 268 to 150 roll call and the Senate approved it the next day 64 to 16. Johnson signed the Revenue and Expenditure Control Act on June 28, 1968. Since it would have been unseemly for him to celebrate his defeat by Wilbur Mills, no signing ceremony was held.
But Johnson, as Califano put it, had “the last laugh.” He did not believe that Congress would actually cut fiscal 1969 appropriations by $6 billion. Thus, he refused to make any reductions himself until Congress had acted. “Congress was unable to cut even $4 billion in spending. … Fiscal 1969 ended with a $3.2 billion surplus—and the Great Society programs survived.”8
It is axiomatic that wars produce inflation, and that, certainly, has been the American experience throughout the nation’s history. It was dramatically so in the three wars that occurred earlier in Lyndon Johnson’s lifetime. Born in 1908, he was nine when the U.S. entered World War I and thirteen when the postwar inflation ended. While JoLnson City was in the remote Texas hill country, politics was the stuff of life and his father, Sam, was a member of the Texas legislature in Austin and a strong supporter of Woodrow Wilson. He took his boy on his campaigns and Lyndon would sit in the gallery in the capitol listening to the debates. He could hardly not have learned that the war had pushed up prices. During World War II and the postwar period inflation was a critical national issue. Johnson sat in the House when he was not in military service and it would have been impossible for him to ignore the question. He was in the Senate and became majority leader during the Korean War, when a host of questions about inflation was thrust upon him.
Yet there is no evidence that Johnson learned anything from these experiences. When he went into Vietnam in 1965 he seemed oblivious to the risk of imposing the cost of the war on an economy close to full employment. His falsification of that cost temporarily confused his economists. But he did not fool Martin and the Federal Reserve. After six months the Council of Economic Advisers figured out the truth and immediately urged a surtax on income taxes. In January 1967, a year and a half into the war, Johnson finally came around. But it was too late because the virus of inflation had infected the wage-price system. The Fed’s monetary controls were inadequate, and in the absence of an incomes policy and/or a tax hike, the inflation exploded.
While the President now wanted higher taxes, Congress refused. Johnson tried to blame the Congress, but its leaders had a ready answer. If, Wilbur Mills pointed out, the President had called for an increase in taxes to pay for the war, he could have gotten it easily. As noted earlier, Budget Director Schultze agreed. But Johnson could never get himself, despite the massive military forces and the heavy casualties, to admit that Vietnam was a real war.
Thus, Lyndon Johnson, with Robert McNamara’s connivance, was the instigator of the Great Inflation. Once started, it seemed never to stop. During the early years of the Nixon administration prices and wages rose more rapidly than they had under Johnson. With the spike in food prices in 1973 and the first great oil shock of 1974 they surged to a double-digit level. In the latter half of that decade the economy sustained another massive rise in the price of oil. It was not until 1982 that inflation was brought under reasonable control. Johnson can hardly be held responsible for Nixon’s failings or for the greed of OPEC. Nor can he or his economists be fairly blamed for failing to foresee that 17-year disaster because there was no precedent.
One may ask what would have happened to prices if Johnson had not entered the war in 1965. Walter Heller, no mean authority, speculated about this question. During 1964 and the first half of 1965, he said, “We were moving under the more or less gentle zephyrs of the 1964 tax cut. We were moving so nicely towards full employment, and with very little price inflation.” One of the great tragedies of Vietnam was that it “rudely interrupted” this “great experiment.” For certain, if the U.S. had reached full employment, there would have been inflationary pressures. “But instead of having 6 or 7 per cent inflation at the peak, we probably could have held it to around 3 per cent, 3Vz, just half as much.”9