Growth Under High Tax v. Low Tax Regimes

Cactus caught Lawrence Kudlow spouting his free lunch supply-side stupidity again earlier this week:

Economist Art Laffer correctly noted in a recent Wall Street Journal op-ed that reducing the top marginal tax rate on investment and high personal incomes is a pro-growth revenue gainer. But cutting taxes for the middle-class and shoveling more earned-income tax credits toward the working poor is a huge revenue loser. (Of course, the Congressional Budget Office will score the top-rate tax cuts as revenue losers, despite Laffer’s strong data-driven arguments to the contrary.) But my point is a larger one. It’s really a political issue. What will McCain and Romney do? They both want to expand the defense budget and the size of the military, as they should, to strengthen our national security in the War on Terror. But this, of course, costs money. Big money. President Reagan argued successfully in the 1980s that low tax rates reignite economic growth – growth that was absolutely essential to generate the resources necessary for a strong national-security posture. Will McCain and Romney adopt the Reagan approach, or will they see higher tax rates as a tradeoff to a stronger military à la Eisenhower?

Kudlow is touting the real GOP agenda – tax the working poor but don’t tax the rich. He fails to explain why such Nibor Dooh policies foster more long-term growth. Instead he implies that some serious research paper by Art Laffer has proven this case somehow. Funny – he failed to tell us the title of this paper or which academic journal chose to publish Laffer’s laugher.

Kudlow confuses the Keynesian recovery that was to inevitably follow the collapse of aggregate demand in 1982 with long-term growth. One can also note that the 1950’s recessions with the same frequency of the 1970’s. To clarify matters, we’ve done two things. Show real GDP growth for each year of the second half of last century (1951 to 2000). While the period from 1951 to 1980 did have its share or low or negative real GDP growth, it also had some periods of very rapid GDP growth. The next two years had only two recessions but the Reagan recession leading to the largest unemployment rate since the Great Depression.

The second thing we do is to report the average annual GDP growth rates for three periods. Real GDP as of 1980QIV was 281.4% higher than it was as of 1950QIV, which means during the 30 year period that included the Eisenhower, Kennedy-Johnson, Nixon-Ford, and Carter years, average real GDP growth was 3.5%. Real GDP as of 1992QIV was 143.2% higher than it was as of 1980QIV, which means during the 12 year period of Reagan-Bush41, average real GDP growth was only 3.0%. Real GDP as of 2000QIV was 132.7% higher than it was as of 1992QIV, which means during the Clinton Administration, average real GDP growth was 3.6%. One of the reasons for the dip in long-term growth rates during the Reagan-Bush41 era of lower tax rates may have to do with the fact that government spending as a share of GDP did not decline while consumption demand was encouraged by these lower tax rates. Simply put – the 1981 tax cut lowered national savings leading to a crowding-out of investment.

In countless opeds from Kudlow where he spins the data, I have yet to see him recognize either crowding-out or the basic Solow growth model, which emphasizes the role of savings. In fact, I have yet to see this National Review nitwit recognize that when the sum of consumption and government purchases rise – which is the direct effect of the fiscal fiascos that he thinks are pro-growth – the national savings rate falls (by definition). One would think someone who cannot articulate the basics of the role of fiscal policy on long-term growth would never be asked to ink an op-ed on this topic for any respectable publication. Ah but we are talking about the National Review which prides itself on serial stupidity.