Monday, June 20, 2011

Book Review (#14 of 2011)

Supply-Side Economics: A Critical Appraisal. Edited by Richard H. Fink, George Mason University.
Why did I devote four different blog posts to this book? Because I'm convinced most people blogging and pundit-ing today are about my age, and they don't remember the details of policy debates from 30 years ago. Many of the essays in this book could have been edited and easily re-printed today. The people advising the candidates for office are likely much younger than me, and probably were born after Reagan left office.

For example, Tim Pawlenty is running for President and made this claim recently (emphases mine):
"So as people look back to the historical examples, there's been other chapters where tax cuts have been enacted, and almost always they raise revenues if you just isolate the effect of the tax cuts...When Ronald Reagan cut taxes in a significant way, revenues actually increased by almost 100 percent during his eight years as president. So this idea that significant, big tax cuts necessarily result in lower revenues -- history does not [bear] that out."

Bruce Bartlett was there. He helped author the Kemp-Roth tax cut bill. He reminds Pawlenty (emphases mine):

In point of fact, this assertion is completely untrue. Federal revenues were $599.3 billion in fiscal year 1981 and were $991.1 billion in fiscal year 1989. That’s an increase of just 65 percent. But of course a lot of that represented inflation. If 1981 revenues had only risen by the rate of inflation, they would have been $798 billion by 1989. Thus the real revenue increase was just 24 percent. However, the population also grew. Looking at real revenues per capita, we see that they rose from $3,470 in 1981 to $4,006 in 1989, an increase of just 15 percent. Finally, it is important to remember that Ronald Reagan raised taxes 11 times, increasing revenues by $133 billion per year as of 1988 – about a third of the nominal revenue increase during Reagan’s presidency.

The fact is that the only metric that really matters is revenues as a share of the gross domestic product. By this measure, total federal revenues fell from 19.6 percent of GDP in 1981 to 18.4 percent of GDP by 1989. This suggests that revenues were $66 billion lower in 1989 as a result of Reagan’s policies.

Bartlett points out that Sen. Mitch McConnell (R-KY) has also repeated the similarly false claims that the Bush tax cuts were self-financing. The data firmly disagree. In a different article, Bartlett notes that "there’s no evidence that the 2003 tax cut did anything to stimulate corporate investment," another crucial claim of supply-siders and current GOP candidates. "(N)either taxes nor spending by themselves are the most important government contribution to the investment climate; it’s the budget deficit. Consequently, a reduction in tax revenue which raises the deficit is unlikely to stimulate domestic investment..."

Where I disagree with Bartlett is the claim that "no one in the Reagan administration ever claimed that his 1981 tax cut would pay for itself or that it did." Technically, Art Laffer and Jude Wannisky didn't work for the Reagan administration. But Laffer's ideas were what everyone in the Reagan administration pointed to as the basis for cutting taxes, and his essay clearly says the tax cuts would be self-financing and balance the budget within four years. Those were the numbers that David Stockman presented to Congress.

But the problem worsens. The Heritage Foundation, which in 2001 erroneously predicted the Bush tax cuts would create an economic miracle, similarly predicted the Ryan Plan would create one of the biggest investment (and housing) booms in history and drive the unemployment rate to 2.8% by 2020 without increasing inflation-- a supply-side miracle never seen before. Economist Menzie Chinn took the analysis apart and found "Laffer Redux." It's the same type of bogus claim that ignores hundreds of years of economic thought and historical evidence just as Laffer & Co. were doing 30 years ago.

Let's not forget that Laffer was also extraordinarily wrong on monetary policy, claiming that tighter money and raising interest rates would cause capital flight and inflation in 1981.

Laffer also laughed off the idea of a housing bubble and impending recession back in 2007. How'd that work out?

I'm convinced that there are many people teaching in business schools today, influencing generations of entrepreneurs, accountants, investment advisers, lawyers, and politicians, who believe that "Ronald Reagan proved that tax cuts pay for themselves. Art Laffer was right. Tax cuts always boost investment and grow the economy," with very little understanding that the data firmly say otherwise.

Many people of all political stripes are pining for a mythological "better time" in American history and seem easily duped by pundits and politicians promising easy solutions and a return to that mythological "better time." That makes it easy to paint political opponents as obstructionists who stubbornly refuse to let us go back to the "paradise" we once knew. For the Left it's the 1950s and early 1960s. For the Right it's usually 1984, or in some cases 1784.

Those who don't know their history are condemned to be constantly frustrated.

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