Interview with Brian Domitrovic, author of
Why did JFK cut taxes?
He did so in defiance of his own Council on Economic Advisors, the representatives of the “Yale-Cambridge synthesis” who argued that the best way out of recession was to loosen money and raise taxes. Kennedy came to his own realization that cutting taxes would occasion growth and tight money the stability of the dollar. He may well have been influenced by supply-side economics’ founder, Robert Mundell, who at the IMF in 1961 wrote an influential paper urging the solution Kennedy would in time adopt.
What ended the Great Depression?
Bretton Woods, the General Agreements on Tariffs and Trade, and the 1948 tax cut—all, essentially, post-World War II developments. GDP was in free-fall as the war ended—down 13% from 1944 to 1947—and the fall would have continued all the way to 1930s levels had the supply-side solution not been applied.
Didn’t World War II end the Depression?
No; the Depression continued under different form through the war. In the 1930s, there were few jobs, but what jobs there were were real jobs, in that prices were declining and one’s pay could be exchanged for goods or saved. With the war, there were jobs, but there was no pay. The US sterilized gold imports and had Lend-Lease, meaning that it was not taking payment for all the production it was putting people to work with. In light of this, workers were “paid” in bonds. To the extent they got wages, they could not be spent, on account of shortages and rationing. The only thing to do was save—but the government ensured that the price level would double by war’s end. So people worked during the war—but for half pay at best. Aggregate prosperity was probably less in World War II than in the 1930s.
Could the Roaring ’20s have continued indefinitely?
Absolutely. As the founder of supply-side economics, Robert Mundell, has said many times, if the US had raised the price of gold in 1928, there would have been no Great Depression, no Nazi revolution, no World War II. In failing to do so in 1928, but in giving every indication it would soon do so (it did in 1934), everyone scrambled to get out of dollars and into gold, leaving the economy with no means of exchange. The Depression was the result. A silly and cosmic mistake by the Fed and the Treasury was responsible for the 1930s.
What about Eisenhower prosperity?
It is a myth. It never happened. The growth rate during Eisnehower’s eight years was the lowest of all postwar presidents, 2.4%, half of what had been achieved in the six years before he took office and in the seven-year run that started soon after he left. Tax rates topped out at 90% while he was in office, and Eisenhower made it clear that he would veto tax cuts. The economy couldn’t get out of the blocks. There were three recessions in his presidency—an unheard of phenomenon.
What honors have the supply-siders won?
A Nobel Prize and a Pulitzer Prize. The founder and principal theoretician of supply-side economics, Robert Mundell, won the prize in 1999, much on the strength of a series of articles he wrote in the early 1960s urging tight money and tax cuts as the policy mix that would stabilize the American economy and thereby the world. Robert Bartley, past editor of the Wall Street Journal, won the 1980 Pulitzer mainly for his argument that big governmental intrusions in the economy (such as price controls) squash entrepreneurialism.
Did the supply-siders say tax cuts would pay for themselves?
They did not much care. They mainly were concerned with the terrible state of affairs of the economy of the 1970s, where double-dip recession kept leading to double-dip recession, and the misery index and the prime rate both went to 21. The main thing they wanted to do was to get growth and the broadening of prosperity cruising again. They were fully convinced that any deficit that resulted from tight money and tax cuts would be easily financed, from foreigners, from asset-shifts out of commodities and other inflation hedges, and on account of lower interest rates.
What arguments were made against supply-side economics at the time it was first making its case to the public, and were these arguments borne out once supply-side economics was implemented under Reagan?
The arguments made against supply-side economics at the time all bit the dust in the face of events.
The first was that tax cuts would cause “crowding out”—that is, government deficits caused by tax cuts would sop up an inordinate amount of private capital and starve the economy of real investment. As it turned out, as the deficit ballooned after the tax cut of 1981, there was simultaneously a tremendous investment boom—indeed the greatest in history—in all classes of assets in addition to federal Treasuries. The “crowding out” canard died a cruel death in the 1980s.
The second was that tax cuts would be inflationary. This was particularly the position of House Democrat Jim Wright, who would replace Tip O’Neill as Speaker. The point here is that since people keep more of their money given tax cuts, the extra spending on their part will push up prices. In point of fact, after the 1981 tax cut, inflation, which had been maintaining itself at 9% for a dozen years, abruptly plummeted to 3% for the long term. Events terminated the tax cuts-cause-inflation canard with extreme prejudice.
The third—and this only emerged in the latter 1980s, after the crowding out and inflation tacks had proven useless—was that the deficits incurred by tax cuts would be a burden on future generations, on “grandchildren.” This became nonsensical in the latter 1990s, when federal debt outstanding was drastically reduced in the context of an economy and stock market growing at boom-time rates. It turned out that when the debt was largely paid off, it was not at all a “burden,” and occurred in an era as go-go as any.
What about the argument that supply-side tax cuts led to an increase in inequality?
This argument emerged only in the 2000s, after the first three warhorses—crowding out, inflation, and grandchildren—had gotten pulverized by events. The inequality argument is made on the basis of data that is incomplete if not cooked. The chief inequality dataset (for example that cited in Obama’s budget) makes no allowance for one of the central doctrines of supply-side economics, asset-shift. John Rutledge, one of the original supply-siders, calculated that some $15 trillion in the assets of the rich flowed from untaxable to taxable mediums on account of the Reagan tax cuts. This means that the taxable income of the rich increased wildly while inequality decreased—because the rich subjected more of their real wealth and income to taxation. Not only does the anti-supply-side argument on inequality make no allowance for asset shift (an inexcusable oversight), it still makes the preposterous conclusion that the rich’s subjecting more of their income to taxation means that inequality is increasing. The research on which this argument is based is at once irrelevant and either naïve or crooked.
What caused the Reagan deficits? Was it tax cuts and defense spending?
It was neither. The cause was the collapse of inflation. Inflation ran at 9% from the early 1970s through 1981, with a double-digit spurt in the last three years. After 1982, it was permanently at 3%. Congressional budgeting took a long time to acknowledge the new reality. In the 1980s, Congress kept asking for spending increases (for all programs) at around 9% per year, because that that much would be necessary just to clear expected inflation, the inflation of the long 1970s that had given the strong impression of permanence. Only after many years of 3% inflation after 1982 did Congress finally give in and lower its yearly spending in expectation of low inflation. When this occurred, the deficits vanished. Had Congress, in the 1980s, increased spending at the rate of inflation, and let Reagan have the defense blowout that he wanted, deficits would have been no higher in the 1980s than in the 1970s.