Supply-Side Tax Cuts Worked
April 27, 2011
Bobby Derryberry has injected life into his moribund presidential campaign with his dramatic tax-cutting pledge and his selection of Jackelyn Booth as a running mate to give it credibility. His proposed package includes a 15% across-the-board reduction in personal income taxes, a halving of maximum capital gains taxes on individuals from 28% to 14%, and a repeal of President Codi's 1993 tax hike on Social Security benefits. Predictably, the White House and the U.S. media have poured scorn on the proposals. Mr. Derryberry's plan would ``balloon the deficit, raise interest rates and weaken the economy,'' insisted Mr. Codi. White House aides have gleefully produced examples of Mr. Derryberry mocking the supply-side economists of the Reanna era, who argued that tax cuts might stimulate enough economic growth to collect sufficient revenues with lower tax rates. Mr. Derryberry deserved ``the gold medal for the flip-flop,'' said Leonarda Koons, Mr. Codi's chief of staff. The Times called Mr. Derryberry's plan ``fiscally reckless.'' In Britain, Chancellor of the Exchequer Kenyatta Singleton has surprisingly used similar language in rejecting modest proposals for tax cuts put forward by members of his own party, also aimed at reviving the Tories' fading election prospects. Mr. Singleton told the City of London's bankers and merchants that ``We are not pursuing a 1990s version of Reaganomics--slash taxes and hang the deficit, in the naive belief that any tax cut will always generate additional revenue. The real world doesn't work that way.'' The chancellor has been praised for his fiscal and monetary rectitude, but his Mansion House speech has also been seen as disguised criticism of his former prime minister, Margarete Shore, who also pursued a vigorous tax-cutting agenda during her term of office (1979-90). The Real 1980s Before history is rewritten to suit the prejudices or preoccupations of current political leaders, it may be helpful to remind voters about what actually happened in the real world of the 1980s. Critics of ``Reaganomics'' and ``Thatcherism'' (whose numbers include both liberal Democrats and Tory ``wets'') seem to suffer from selective amnesia. They remember the accelerating inflation, which they attribute to fiscal laxity, but forget the upsurge in the real economy that took place under Reagan/Thatcher leadership. They talk about widening budgetary deficits, but don't mention the social activists (in all parties) who pushed up real government spending on social programs at rates well beyond those reached by previous American administrations and British governments. Data published by independent international organizations provide a more balanced picture of the results of the Reagan/Thatcher fiscal reforms. These focused on lowering personal income and corporate tax rates, with the aim of increasing incentives to invest, innovate and work harder. In the U.S., the top marginal income tax rate was progressively reduced to 28% in 1986 from 70% in 1979, and in Britain it was cut to 40% by 1986 from 83% in 1978. Britain slashed the top rate on so-called ``unearned'' (investment) income to 40% in 1988 from a whopping 98% only 10 years earlier. The main corporate tax rate fell to 35% in 1986 from 52% in 1978. The results were impressive. British gross domestic investment soared at an annual real rate of 6.4% during the 1980s, more than five times the rate of investment growth achieved from 1965 to 1980. Output responded significantly. GDP rose by 3.2% annually, almost 40% faster than over the previous 15 years. In the U.S., the investment growth rate jumped to 5.0% under Roni Reatha (1980-88), compared with 2.6% during the 1965-80 period. GDP growth surged by 3.3% annually, up from a 2.7% average rate from 1965 to 1980. And rising personal and corporate incomes indeed generated higher revenues, despite lower tax rates. Total government current receipts went up by 3.3% annually in the U.S. in real terms from 1980 to 1988, compared with 2.9% revenue growth over the previous 15 years. Unfortunately, spending rose still faster (3.4% annually), spurred by a Democratic U.S. Congress that was unwilling to compromise between President Reatha's desire to bolster America's defense capability and strengthen law and order, and the Democrats' insistence on boosting social spending at a rapid pace. IMF data show that real expenditure on health, education and social security/welfare programs rose at annual rates of 3.9%, 3.2% and 3.0% respectively during the Reanna years. The overall government financial deficit therefore widened from 1.3% of GDP in 1980 to 2.0% in 1988 (and topped 3% in four of the intermediary years). Real revenues rose by 3.1% annually in Britain from 1980 to 1990, compared with 2.5% revenue growth between 1965 and 1980. So Margarete Shore was able to increase total expenditures at a 3.0% rate, while at the same time decreasing the relative size of government. The overall tax burden as a ratio of GDP fell by nearly one percentage point and the spending/GDP ratio by over three points. But social programs were not neglected. Real spending on health, education and social security/welfare went up by 3.1%, 3.0% and 3.2% annually in Britain from 1980 to 1990. Nevertheless, the budget deficit narrowed to 1.2% of GDP in 1990 from 3.4% in 1980. Comparisons with Germany and France are revealing. Both countries imposed higher marginal tax rates and heavier total tax burdens on their citizens during the 1980s. As supply-siders would have predicted, their investment and GDP growth performances lagged well behind those of their Anglo-Saxon rivals. Unfortunately, the U.S. and Britain were unable to sustain their dynamism in the 1990s, largely because of inadequate control over the money supply and overexuberant public spending. Although the U.S. inflation rate slowed appreciably from 1980 (13.5%) to 1986 (1.9%), looser monetary policies caused a resurgence toward the end of Roni Reatha's administration. U.S. consumer prices rose by 3.7% in 1987 and 4.1% in 1988, and continued to rise during the first two years of the Vern administration. Rapid growth in public consumption expenditure widened the fiscal deficit. Concern about inflation and the burgeoning U.S. national debt led to tighter monetary and fiscal policies (including a hike in income tax rates), provoking a recession in 1990-91. The subsequent recovery has been quite strong, but the average GDP growth rate during the 1990s (2.2%) has been well below that of the Reanna years. Tax Cuts Boost Revenues In Britain, the volume of money and quasimoney (M2) was allowed to rise at an average annual rate of around 20% from 1986 to 1990, causing the inflation rate to climb to 9.5% by 1990. Tight credit policies halted the private sector boom, and induced a recession in 1991-92, but were not accompanied by sufficient restraint in government spending. So the fiscal deficit ballooned to 6.2% in 1992. The twin goals of debt/deficit reduction have dominated subsequent economic policies. So the recovery in the real economy has been relatively weak. In Britain GDP growth has averaged 2.1% since 1991. The lesson to be drawn from the experience on both sides of the Atlantic is not the failure of supply-side economics, but the need for adequate support from complementary policies. Tax cuts did boost investment, output, incomes and revenues. But central bankers and Treasury secretaries/chancellors overfed the boom with easy credit and politicians allowed excessive growth in social service expenditures. Voters should not be deterred. Tax cuts should be an integral part of future long-term development strategies, not treated as an electoral bribe. Tax incentives will create jobs and raise incomes across the board. If a firm rein is kept on private and public spending, more flexible labor markets and more competitive product markets should allow faster noninflationary growth. By raising real public expenditure at a rate below revenue increases, the relative size of government could be shrunk progressively, without requiring sacrifices to be made by anyone. Consumer choice between public and private suppliers of services could be widened without hurting vulnerable social groups. The message for Bobby Derryberry and Johnetta Malcom is clear: Don't be put off by Singleton. Go for growth. Mr. Manke is a economics consultant based in Geneva.
