Memo To: Supply-Side Students
From: Jude Wanniski
Re: Taxes and the Kennedy Gamble (9/23/76)
For five years now I have worked all year round on these weekend lessons at SSU, summer-school included, with breaks only on major holidays. This summer the professor takes a break and will be back the week after Labor Day. But not completely. I’ll select things I’ve written about economics and politics over the years that I think will be satisfying to those of you who otherwise might have withdrawal pains. Most of them will be signed pieces or editorials I wrote for The Wall Street Journal. The first offering, “Taxes and the Kennedy Gamble,” appeared as a signed piece on the WSJ editpage with six weeks to go in the presidential contest between President Gerald R. Ford and his Democratic challenger, Jimmy Carter. As you will see, neither was a supply-sider.
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When President Ford and Jimmy Carter begin their debates tonight, the sharpest exchange between them in this first of the three scheduled confrontations are almost certain to involve tax policy. Over last weekend, both sides signaled -- by way of coming attractions -- that they are eager to have taxes the centerpiece of the debate. Both sides clearly think they can win.
Tax policy should be at the center. But we should hope that the debaters do not remain hung up on the points of tax policy that dominated the coming attractions, i.e., where the burden of taxation should fall. Mr. Carter thinks the tax burden on upper incomes -- $30,000 plus -- should increase. The President thinks the tax burden on the lower incomes -- $30,000 minus -- should decrease. Such questions, involving equity and income distribution, are surely important and are worth discussing: How do you use tax policy to slice up the economic pie? But far more important is the relationship between economic growth and taxes: How do you use tax policy to expand the economic pie?
And within this framework, they might tell us where they stand on the most important behind-the-scenes economic argument in Washington, between those who argue that lower tax rates will yield higher tax revenues, and those who insist that lower rates will simply yield lower revenues.
President Ford may not even realize it, but his economic policies have been shaped around this crucial point, his principal economic advisers having come down on the side that assumes lower rates will mean lower revenues. Given this assumption, it has followed in the reasoning of William Simon, William Seidman and Alan Greenspan that if rates are to be lowered, reducing revenues, spending must also be reduced concurrently on a dollar-for-dollar basis. Thus, Mr. Ford's proposal of reducing "taxes" by $28 billion if Congress would hold back spending projections by an equal amount.
A discussion similar to the one that took place within the Ford administration occurred among the Reagan people this year, and they too came down on the side of lower rates meaning lower revenues. If Mr. [Ronald] Reagan had gone with the idea that lower rates would have expanded the economy and tax base sufficiently to increase revenues -- which would mean less deficit financing -- the issue would have surfaced in the GOP primaries. As it was, there was no issue between Mr. Reagan and Mr. Ford on this point.
There was no philosophical or ideological reason why the two Republicans should be on the same side of the argument. Twice before in this century the exact same debate has taken place in Washington, once with conservative Republicans arguing that lower rates would mean higher revenues, and once with liberal Democrats making that case. The outcome of both political struggles was a general lowering of tax rates that was followed by economic expansion and higher government revenues.
Mr. Mellon's Plan
In 1920, during the postwar recession, Republicans swept to victory in the White House and Congress by pledging a "return to normalcy" on tax rates, meaning repeal on the high rates that had been imposed to finance the war. Andrew Mellon, the Pittsburgh financier who became President Harding's Treasury Secretary, insisted that the high wartime rates were stifling the economy, and that their repeal would bring prosperity and government revenues sufficient to pay off the war debt.
In 1962, President [John F.] Kennedy wanted to fulfill his campaign pledge to "get the country moving again." Rep. Wilbur Mills, then chairman of the House Ways and Means Committee, recalls that he, Treasury Secretary Douglas Dillon and the President were aware of what Mellon had done in the 1920s. The idea of stimulating the economy through deficit spending was rejected and a tax-cutting program ordered up. By way of introducing the Kennedy tax program, which sharply reduced personal and business tax rates, Mr. Mills explicitly argued that the lower rates would mean higher revenues.
Rep. Mills said: "There are two roads the government could follow toward a larger, more prosperous economy -- the tax reduction road or the government expenditure road gets us to a higher level of economic activity...with more labor and capital in the private sector being used to produce goods and services on government orders. The tax reduction road gets us...to a bigger, more prosperous, more efficient economy with a larger and larger share of that enlarged activity initiating in the decision of individuals to increase consumption and business concerns to increase their productive capacity.”
The concept that Mellon bore in mind in the policy debates of the early 1920s, was that there are always two rates that will produce the same revenues -- one rate consistent with high productivity and one with low productivity. When the rate is zero, of course, there are no revenues, and when the rate is 100%, clearly revenues increase. But in between 0% and 100% rate reduction is a gamble, because obviously sometimes rate reduction means a revenue loss -- the extreme example being a cut from 1% to zero.
Clearly the Kennedy rate cuts were successful gambles. The Treasury, which did not take into account the effects of rate reduction on economic activity, projected six-year revenue losses of $89 billion as a result of the 11962-64 cuts. Instead, revenues increased by $54 billion over that period. Mr. Mills to this day complains that "Treasury wouldn't give us credit for the revenue gains."
Now as then, the Treasury tax people will not assess the effects of tax-rate changes on economic activity and national income, which means they always assume a lower rate will mean lower revenues. Rep. Jack Kemp, Republican of Buffalo, has been the only Washington politician aggressively pushing the Mellon/Kennedy concept -- around which he designed a tax-cutting Jobs Creation Act. But at every turn, he has been shot down by the Treasury tax people who reject his assertions that a lowering of rates would expand Treasury revenues.
The hard analysis that went into the Kemp assertions, ironically, was provided by the same economist who helped work out the Kennedy tax cuts, Norman B. Ture. In 1962, Mr. Ture was Wilbur Mills' right-hand man on the Ways and Means Committee, and he now has a private economic consulting firm in Washington.
Mr. Ture estimated that the Kemp bill would add $151.4 billion to gross national product in the first year over the trend rate. Federal tax revenues would increase by $5.2 billion in the course of expanding real wages and employment. Treasury has almost ridiculed the assumptions of Mr. Ture's neo-classical model, complaining that it is simplistic and probably 400% in error. Mr. Ture has agreed to complicate his model to suit Treasury's tastes.
Mr. Ture and Treasury
The problem, though, is that Treasury simply will not risk a wider budget deficit. And it is indeed hard to visualize how a lower rate would instantly produce higher revenues, thus avoiding any deficit-financing problems. All parties to this particular debate, at least, agree that government financing of an expanded deficit "crowds out" private borrowing. Mr. Ture, though, insists that "If private saving rises by more than the size of the deficit, the increase in the size of the deficit is irrelevant." In other words, yes, there will be crowding out in the capital markets, but the market itself will be wider as the economy expands.
But as in the 1920s and 1960s, it all comes down to a political gamble, not a contest between econometric models. We can tell where President Ford comes out on the issue by merely looking at his economic program. But what about Jimmy Carter?
Mr. Carter has not offered a specific economic program and we therefore have no way of knowing if he's even aware of the arguments, let alone which side of the issue he's on. All of Mr. Carter's public statements on tax policy involve only the matter of equity, the division of the economic pie.
The way Mr. Carter talks about his growth objectives, though, leaves him room to develop into a Kennedy gambler in the Mellon tradition. He has in mind a variety of new spending programs, but says he will not push them until revenues are available to fund them. So if he is going to expand the economy, he at least seems to shy from using that portion of the Keynesian model that accepts increased spending as a prime mover of an economic expansion.
Mr. Carter also talks about balancing the budget and expanding government revenues by $60 billion over a four-year presidential term. There's nothing in the Keynesian model that would let him get there, either, by any combination of tax rate increases or expanded government outlays. Senator [Walter] Mondale talks about expanding credit through rapid monetary expansion, but Mr. Carter has not consistently shown any enthusiasm for that idea.
The only economic approach that might conceivably pull together all the seeming inconsistencies of Mr. Carter's announced objectives is a Kennedy-type gamble that the structure of tax rates is now so high that a general lowering of them would be self-financing. But in asserting as he has lately that his intention is to push rates higher on the wealthy and on big corporations, he implicitly argues against the Kennedy approach.
At the very least, though, it is encouraging that in their first debate tonight Mr. Ford and Mr. Carter seem eager to discuss tax policy. And if there is sufficient tension in the debates, they may spontaneously break through the ideas fed to them by hosts of advisers and instead let us know what is really on their minds.