Tale of Two Tax Cuts

Is the title of the latest from Jack Kemp:

The historical record couldn’t be clearer. The Kennedy tax-rate reductions that triggered the prosperity of the 1960s and produced a windfall of government revenues indeed ended up helping balance the budget in 1964-65. Federal revenues doubled in the 1980s as a result of the Reagan tax-rate cuts. Today the evidence continues to mount that the Bush tax-rate reductions of 2003 also got the economy moving again and are leading to increased federal revenues.

Kevin Drum and yours truly took on this alleged doubling of revenues during the 1980’s earlier. In response to my comment about real GDP growth being only 3.0% per year over the Reagan-Bush41 period, I was accused of “cherry picking” by Homer Simpson and Jane Galt. Before I move to the 1964 tax cut (which Homer wants me to do), let me repeat my comment that my choice of this 12-year period had nothing to do with party politics or personalities and was simply trying to select a period that began and ended with a similar state of the business cycle (recovering but not full recovered from a recent mild recession). Let me also suggest that the reduction in national savings during the 1980’s – often attributed to fiscal irresponsibility – did tend to reduce long-term growth per Reagan’s own “save and invest” logic.

If Jack Kemp has read the writings of most economists – including those who served in Kennedy’s CEA – he would know that the logic behind the tax reductions signed into law by Lyndon Johnson was to stimulate aggregate demand. These same economists in December 1965 were warning President Johnson that this fiscal stimulus would need to be reversed if a credit crunch was to be avoided. Supply-sider Norman Ture, however, told Wilbur Mills that the CEA was wrong. The fiscal stimulus was not reversed and we did have the 1966 credit crunch.

But these discussions of the 1964 and 1981 tax cuts are old hat. The latest in revisionist history from Supply Side University seems to be that they opposed the 2001 tax cut. This is very odd coming from the same camp who campaigned for George W. Bush because he was touting the Lawrence Lindsey tax proposal that was passed in 2001. Yet, Kemp writes:

The economy clearly performed better and tax revenues grew faster after the 2003 tax-rate reductions than after the 2001 tax legislation, which included a tax rebate, a new refundable child tax credit, a minuscule 1-percentage-point income tax-rate reduction and a small, gimmicky reduction in the death tax. The reason, as Mitchell pointed out, is that the 2001 tax cuts were based on the Keynesian demand-side notion of putting money in people’s pockets in the form of rebates and credits, which simply does not work to change economic incentives. “Supply-side tax cuts, by contrast,” Mitchell observed, “do improve economic performance because they reduce tax rates on work, saving and investment.” The contrast between the effects of the demand-side 2001 tax cuts and 2003 supply-side tax rate reductions proves the point. In Mitchell’s words: “Economic growth since the 2003 tax cut has averaged nearly 4.4 percent on a yearly basis, compared to just 1.9 percent in the period following the 2001 tax cut. Net job creation since the 2003 tax cut has averaged more than 150,000 per month, compared to declining job numbers in the period after the 2001 tax cut.

The gimmicks in the 2001 tax legislation were put in place by its architects in order to disguise the true long-run budgetary costs of the tax rate reductions. But the same tax rate reductions that were championed by the free lunch supply-side crowd are being scoffed at by the very same people. As far as the economy growing faster since mid-2003, Kemp is correct but his logic strikes me as quite odd. The 2001 recession and subsequent weak aggregate demand growth was primarily due to weak export and investment demand. Most of us Keynesians expected an even more rapid return of export and investment demand than actually occurred given the Federal Reserve’s expansionary monetary policy.

Has there been some favorable supply-side effect distinct from the normal return to full employment as Keynesian aggregate demand factors tend to self-correct (albeit rather slowly during the latest period)? National savings and investment as a share of GDP are still below their 2000 levels so the spin from Daniel Mitchell provides no real support of a supply-side miracle. Of course, Reagan also mentioned “work” along with “save and invest”. But a lower proportion of the adult population is currently working relative to 2000 and the average workweek has also declined.