Thursday, March 15, 2012

Supply-side Economics: An Exercise in Fantasy

In 1981, President Ronald Reagan passed into law a series of tax cuts that heavily reduced marginal tax rates. This, he said, would be highly stimulative to the economy and that it would pay for itself. Today, Mitt Romney, Newt Gingrich, and Rick Santorum all are espousing similar plans for taxes. Who doesn't like the idea of paying less in taxes? I definitely like the idea, but shouldn't we examine the evidence for said tax cuts before proclaiming them a magic bullet for the economy? Since none of the people pushing for these policies will provide any evidence, I guess I will.

The original idea of supply-side economics was that cutting taxes could plausibly raise revenues under certain special circumstances. This isn't a ridiculous proposition, and it was tested by the Kennedy Administration in 1964 when the top marginal tax rate was cut from 91% to 70%. Yes, top rates used to be 91% under Eisenhower (compared to today's top rate of 35%). So next time you complain about how high taxes are, well, don't. Anyways, back to the Kennedy tax cut. When they cut the rates, revenue actually rose, which is what the original supply-siders asserted. Then, despite warnings of large budget deficits, Reagan and Bush 43 went on to cut taxes as well. The outcomes on revenues, however, were simply not good at all, to say nothing of their economic effects. However, like Reagan and Bush 43, today's Republican presidential candidates are all attempting to push this idea to its logical extreme. Every single one of them has released economic plans that involve cutting taxes. They argue that all tax cuts under all circumstances raise revenues by broadening the base and simultaneously lead to much faster economic growth. 

Without getting too nitty-gritty, I'll attempt to break down their logic as best as I can. The entire idea behind this is something called the Laffer Curve, which basically says that increasing taxes will only increase government revenues up to a certain point. After that point, revenues actually would decrease because people had less incentive to work harder, as their money would be taxed at high rates. Conversely, cutting taxes from a higher rate to a lower rate would make people work harder because they'd pay less of their profits in taxes. In so doing, more people would work harder, and thus create more taxable income (i.e. broadening the tax base). Let me be clear in stating that this idea makes sense in theory. However, pushing this idea to its logical extreme makes precisely no sense.

My point in fleshing all of this out is to try to overturn the idea that tax cuts are somehow always highly stimulative to an economy. The evidence simply isn't there, and every conservative I've seen speak on the issue doesn't seem to offer any. I'm not trying to be biased when I say this, but they seem to accept it as a simple fact of life that cutting taxes will create prosperity (never mind the budgetary implications) and that any rise in tax rates will cause the economy to tank. It just isn't that simple. Make no mistake, I'm not saying that we have free reign to raise taxes as high as we want either. There's simply something to be said for looking at the evidence.

During the postwar period, top tax rates were anywhere between 70 and 91 percent, and yet average GDP and median family income growth during that period was higher than it was post-1980! So the greatest period of broad-based prosperity the U.S. has ever seen was characterized by high minimum wages, high taxes, strong unions, and tight regulations. I'm not saying that correlation equals causation, but the fact that a period of strong growth like this happened with those conditions seriously calls into question the Republican assertion that any tax increases will be tantamount to Armageddon.

Moving on then. In 1982, after cutting top rates from 70% to 50%, Reagan was convinced by budget advisers that he needed to raise taxes again because of a growing deficit (the tax cuts didn't pay for themselves, as you may recall). The U.S. Chamber of Commerce had this to say about his plan to raise taxes:
“If H.R. 4961 is passed in these troublesome economic times, we have no doubt that it will curb the economic recovery everyone wants. It will mean a lower cash flow as more businesses pay more taxes, with a depressing effect on stock prices. It will reduce incentives for the increased savings and investment so badly needed to improve productivity and create more jobs. It will mean higher prices for many products and services. It will increase government costs in caring for those who, because the economy is held down, cannot find employment.” 
How did this prediction pan out? Well, Bruce Bartlett (former adviser to Reagan) tells all: 
"Looking at real gross domestic product, it grew 4.5 percent in 1983 and 7.2 percent in 1984 – an exceptionally strong performance. The stock market had one of its best years ever in 1983 – both the Dow Jones Industrial Average and the S&P 500 Index rose 35 percent. . .The unemployment rate fell from 10.6 percent in December 1982 to 8.1 percent by December 1983 and 7.1 percent in December 1984."
Another swing and another miss. In the 1990s, similar predictions were made when President Clinton wanted to raise taxes. Conversely, when President Bush cut taxes in 2003, we were promised prosperity and rapid job growth. Well, how did these years pan out? According to the BLS, average job growth during Clinton's terms was 240,100 jobs added per month. During George W. Bush's terms (I've excluded the recessions of 01-03 and 08 for clarity) job growth was around 148,036 jobs per month. 

So, all in all, this evidence blows a gaping hole in assertions that all tax cuts lead to prosperity and that all tax hikes slow economic growth. The fact is, tax policy is much more complicated than that, and pretending it isn't only hurts any policy discourse that we might have as a nation. You might say that simplifying it for voters is all that's going on, but that's no excuse to tout economic policies that, quite frankly, are unsubstantiated.