The Temptation of Bob Dole
Dole is sorely tempted to
forget everything he knows about the 1980s tax cuts. Here's a reminder.
(1648 words, plus
links)
By Jodie T.
Allen
All his career, Bob Dole
has stood for fiscal conservatism and balanced budgets. Most famously, he was
almost alone among Republican leaders in his caustic skepticism about the
supply-side economics of the 1980s. Now, political and economic advisers are
urging the Republican presidential candidate to take off his green eyeshade,
push aside that unappetizing bowl of budget cuts, and scarf down a tasty dose
of tax-cut rejuvenator. Just the tonic for anemic poll numbers. And Dole is
tempted. He reportedly will endorse some kind of broad-based tax cut in
July.
Like Dole, the voters know
better. But like Dole, they are tempted, too. A persistent majority of
Americans piously tells pollsters that budget-deficit reduction is more
important than tax cuts. "Yet," says Brookings Institution economist Barry
Bosworth, "the politicians clearly believe that people are lying--and the
election results tend to support the fact that they are lying. When they
vote, they want a tax cut."
Of course, nobody is out
there urging tax cuts instead of deficit reduction. And certainly no
enthusiast is presenting tax cuts as a deficit booster . On the other
hand, few (outside the Wall Street Journal editorial page) are still
brash enough to claim that tax cuts could actually raise tax revenues. Many
"old school" supply-side economists, such as Ronald Reagan's first Council of
Economic Advisers chairman, Martin Feldstein, never did endorse the so-called
Laffer Curve, that cocktail-napkin art purporting to show that big tax cuts
would soon pay for themselves. The "loose talk of the supply-side extremists
gave fundamentally good policies a bad name," Feldstein complained in 1986.
Now,
though, Feldstein is reported to be among a group of well-known economists
urging Dole to adopt a so-called "pro-growth" tax strategy, meaning substantial
tax cuts. How they are to be paid for is unclear. The promise of painless
redemption is there--if not quite explicit. But, unlike the last time we had
this argument, in 1981, there is the record of the 1980s to show what happens
when the supply-siders get their way.
Sen. Spencer Abraham, R-Mich., is an ardent advocate of a
15-percent across-the-board cut in tax rates. "Can we reconcile the seemingly
contradictory notions of cutting tax rates and balancing the budget?" he asked
in (where else?) a Wall Street Journal article last month. "The answer
is yes," the senator revealed, if only we ignore the claims of "conventional
thinkers" and focus instead on the fact that "from 1982 to 1989, federal
revenues, adjusted for inflation, expanded by an average of 3.8 percent per
year despite a sharp reduction in tax rates."
Abraham picked his years
with care. Shortly after passage of the supposedly rejuvenating Reagan tax cut
of 1981, the U.S. economy plunged into the deepest economic downturn since the
Great Depression. The years 1982 through 1989 cover the recovery period from
the pit of that recession to the beginning of the next one. If you believe that
Reagan's 1981 tax cut was responsible for all those growth years--that
otherwise we would have wallowed in stagnation for seven years--Abraham's
choice may be fair enough. If you doubt it, you might prefer the traditional
economists' method of measuring long-term trends from equivalent places in the
business cycle.
Even so, Abraham's
trough-to-peak comparison does not support his point. Official budget numbers
do show total federal revenue growing at an inflation-adjusted rate of 3.1
percent over the period, reasonably close to Abraham's 3.8. But the components
of that growth tell the real story. Individual income taxes--which, by
supply-side theory, should have spurted since rates were cut--grew at only a
2.1-percent rate. What boosted federal revenues most was the 4.3-percent
average growth in payroll taxes. This was mainly the result of rate
hikes-- not cuts--legislated in the Social Security Reform act of
1983.
Corporate taxes also were
cut substantially in 1981. Corporate-tax revenues took a nose dive in 1982 and
1983, regained some ground with the economic recovery, but then surged
following passage of the 1986 tax reform--which deliberately raised taxes on
corporations to pay for tax breaks for individuals.
A
"conventional thinker" might be forgiven for concluding from this record that
what raises revenues is raising taxes, not cutting them.
The campaign to convert Bob Dole, and to prepare the public
for his imminent conversion, is resurrecting many golden-oldie rhetorical
points from circa 1981. For example, Abraham asserts that marginal tax rates
are what determine "whether a worker works overtime or goes home for the day
... whether Americans save and invest their income or spend it." No question,
taxes can affect behavior. Reducing very high tax rates can, at the very least,
encourage less tax evasion and avoidance. And restructuring taxes should, at
least in theory, encourage desirable types of economic behavior such as hard
work, saving, and investment.
But cultural attitudes,
not taxes or other government policies, tend to swamp all other explanatory
variables in international comparisons of savings and investment. This is
especially so in the United States, where tax rates are low by international
standards. So how much do tax rates matter? Not a whole lot, if the Reagan-era
experience is any guide.
Even by the supply-siders'
own calculations, any offsetting behavioral response to the Reagan tax cuts was
swamped by the direct revenue loss to the Treasury. For example, at a 1988
Manhattan Institute meeting, Lawrence B. Lindsey, a leading supply-side
flag-waver in the Reagan Treasury Department (now a governor of the Federal
Reserve) whipped out a graph (see above/below) to show that tax revenues in
1985 were some $13 billion higher than would have been predicted by "static"
revenue models used by the Congressional Budget Office during the 1981 tax-cut
debate. ("Static" is the supply-siders' pejorative term for thinking that
doesn't acknowledge sufficiently the explosive power of tax cuts.) What didn't
seem to attract Lindsey's attention in his own graph was that actual revenues
were almost $100 billion lower in 1985 than they would have been if the 1981
tax cut had not been passed. [NOTE: JODIE HAS SUPPLIED this graph]
As for
people working harder because of lower tax rates, the record of the 1980s is
more complex than supply-side rhetoric predicted. Studying the effects of 1980s
tax policy, Bosworth and his Brookings colleague Gary Burtless found that only
one group--high-income women--substantially increased their hours of work in
response to lower taxes. The group whose work effort increased most
sharply was not the well-paid, whose tax rates declined most sharply. It was
the poorly paid, whose marginal tax rates, thanks to Social Security tax hikes,
actually went up. For these workers, higher taxes prompted harder work to make
up for the lost income.
Even more damaging to the supply-siders' case was the
disappointing performance of the nation's savings behavior. The Reagan program
provided numerous inducements: not just marginal rate cuts on income but
capital-gains tax reductions, a variety of new tax-exempt investment vehicles,
vast new opportunities for tax sheltering--plus the Federal Reserve's tight
money policies which, along with financial deregulation, sent the interest
rates available to savers soaring. The more sober-minded supply-siders figured
that even if the tax cuts didn't pay for themselves, the increased savings they
generated would make the resulting deficits easy to finance. (Even today,
Feldstein says he still believes that while it's a "tall order," the right tax
cuts can, "in some cases," raise saving by more than they raise the budget
deficit.)
But in the 1980s, savings
did not cooperate. The national savings rate, which ran at close to 12 percent
in the 1960s, and more than 9 percent in the 1970s, sank to only 5.8 percent in
the 1980s. The swelling government deficit, which amounts to national
dis saving, did much to drag down the 1980s figure. But even private
savings in the 1980s ran well below their 1970s level.
Still more perverse was
the behavior of business investment. During the eight years of the
business-friendly Reagan administration, business-equipment investment rose at
an inflation-adjusted annual rate of only 4.4 percent while corporate
before-tax profits grew at 4.7 percent. By contrast, during the presumably
hostile Clinton years, business investment has grown at an annual real rate of
10.6 percent while corporate pre-tax profits have climbed at a 13.2-percent
rate.
The
overall national economic growth rate has been about 0.8 percentage points
lower under Clinton than under Reagan. But, amusingly, that difference is
totally accounted for by the shrinking government. While government spending
grew by an average 3.6 percent annually under Reagan, it has
shrunk at a 4.1-percent rate under Clinton. The way national economic
growth is calculated, the expansion of government under Reagan adds to his
growth total, while the contraction of government under Clinton reduces his
growth total.
In addition to supply-side arguments, there are the
traditional demand-side arguments that a tax cut stimulates the economy by
pouring more money into it. But this would be a very odd time for a demand-side
tax cut. As former Congressional Budget Office Director Robert Reischauer
notes: With unemployment well below the 1980s average and considerably lower
labor-force growth, the economy seems to be operating near capacity--"or, at
least the Federal Reserve thinks it is, which is what counts." Any
deficit-increasing tax cut would surely prompt the Fed to tighten the money
supply, curbing economic growth or even prompting a recession.
Dole could, as Abraham
counsels, offset part of the costs of a tax-rate cut by dumping other
tax-reform plans--such as the child tax credit, once a key feature of the GOP's
"pro-family" agenda. What would the Christian Coalition think about that? Or,
he could propose to cut spending even more than his party has already
promised--but that sounds like spinach, and the GOP seems to have lost its
appetite for even the healthy serving it has promised to serve up over the next
seven years.
Or, of course, Bob Dole
could resist temptation. After all, he really does know better.
