Be wary when anyone tries to read too much into a single historical incident. That was the case in Washington Post columnist Robert Samuelson’s March 3 assertion that the 1964 “Kennedy tax cut” caused a litany of economic woes culminating in the current sequester.
These days, it seems rare that a conservative-leaning columnist would denounce any tax cut, especially because most Republicans now cite the very same tax cut as proof that cutting tax rates can increase tax revenues, cut budget deficits, increase output and decrease unemployment.
Samuelson, once centrist, has become steadily more conservative in his political and economic views in recent years. In this bizarre essay, his interpretation is sharply at odds with most others who occupy the same political space.
I feel particular disappointment, since for 20 years I recommended Samuelson to students as an excellent commentator on economic issues. But this has not been true in the past eight years.
First a bit of history: President John F. Kennedy was the first president with economic advisers who were explicitly Keynesian, advocating that when the economy was performing below its sustainable potential, government manage the business cycle by cutting taxes and increasing spending and, when output was robust, it increase taxes and cut spending.
Kennedy had campaigned on the assertion that economic growth during the preceding Eisenhower years had been too slow and unemployment too high. So when the rate of growth of gross domestic product began to slump in 1962, his advisers, led by the University of Minnesota’s Walter Heller, called for a tax cut.
Kennedy, however, resisted the idea at first. And, like Barack Obama, he was a president with precious little congressional experience or expertise. So his tax cut bill languished until after his death when his successor, Lyndon Johnson, a master of Capitol Hill politics, rammed it through.
By that time the economy was growing somewhat faster. And after the tax bill lowered the top rate on the personal income tax from 91 percent to 70 percent and the rate on corporations from 52 percent to 48 percent, it grew even faster.
Inflation-adjusted GDP, which had grown about 3 percent per year during the Eisenhower years, grew 5.1 percent in 1964 and 8.5 percent in 1965. Unemployment, which had touched 7 percent in Kennedy’s first few months in office had fallen to 5.4 percent by the time the tax bill passed in February 1964, and to 4 percent by December 1965. It was not to rise above 4 percent again until a full year after Richard Nixon was inaugurated.
Kennedy’s advisers expected tax revenue to fall at least slightly as a result of the cuts. But this was deemed an acceptable risk, the annual budget deficit was only 0.8 percent of GDP and the ratio of the national debt to GDP, at 42 percent, was down by a third from a decade earlier. It would continue to fall until bottoming out at 26 percent at the end of the Carter administration 16 years later.
Revenues from the personal income tax did fall slightly in 1965, but by 1966 were up 10 percent over 1963, even after adjusting for inflation. Corporate tax revenues did not fall at all and grew 32 percent over the same three-year interval. Hence the frequent assertion that this was a tax cut that paid for itself.
Samuelson, however, sees this tax cut as touching off the inflation experienced a decade later. This is a bizarre conclusion.
If conservative Nobelist Milton Friedman convinced economists of anything, it was that inflation results from excessive money growth rather than budget deficits, union demands or corporate price hikes.
The inflation of the 1970s came about because the Federal Reserve let the money supply grow too fast for too long, largely during the 18 years when chaired by Arthur Burns, a Nixon appointee, and the 17 months of G. William Miller, appointed by Carter.
Samuelson does acknowledge that Paul Volcker, another Carter appointee, ended this inflation “with Ronald Reagan’s support,” neglecting to note that Reagan’s staff waged an unprecedented battle against Volcker that culminated in his stepping down in 1987.
Federal finances remained healthy for several years after the tax cut, with budget deficits averaging only 0.7 percent from then through 1970. The inflation a decade later was caused by the Fed. So how can a slight cut in effective tax rates in 1964 be the cause for big deficits and a burgeoning national debt 45 years later?
It seems that Samuelson somehow believes our nation somehow lost its fiscal virginity with the 1964 tax cut and that an unbroken record of financial prudence over 175 years was callously tossed out the window, never to be retrieved again. Once having experienced sin, American politicians, businesses and households based all subsequent decisions on the assumption that government imprudence would repeat itself.
Simply put, this is preposterous. The argument is that with this one instance of using fiscal policy to try to speed economic growth, U.S. labor and U.S. businesses became irrevocably convinced that the government always would step in to try to keep unemployment low, regardless of the consequences.
This disregards the fact that only four years later, LBJ asked for a tax increase to reduce budget deficits and cool the economy. Yes, he did this reluctantly and under pressure from Republicans and conservative Southern Democrats in Congress, but he deserves some credit for being the only U.S. president who was willing to follow both sides of Keynes’ prescription.
That is, he was willing to use fiscal policy to slow an economy running above its long-term sustainable level as well as to speed it when in the doldrums. Deficits only exceeded 2 percent of GDP twice in the decade after the 1964 tax cut. And, except for a recession-caused blip during Gerald Ford’s brief term, they didn’t really balloon until the 1980s, after the Reagan administration forcefully repudiated Keynesian micromanagement.
Rational expectations economists, including Nobel laureates like the University of Chicago’s Robert Lucas and former University of Minnesota professors Edward Prescott and Thomas Sargent, made a cogent case about the internal inconsistencies and the self-defeating nature of Keynesian policies. But this is far more nuanced and sophisticated than Samuelson’s silly post-hoc assertion that a one-time tax cut is responsible for problems 50 years later.