All Right, We've Been In Enough Deep Voodoo. Next?Robert Kuttner
A reluctant President Bush, pinioned by his own right wing, has swallowed another dose of tax-cut tonic. This is toxic medicine--but it could serve as a useful purgative. Supply siders led by Housing & Urban Development Secretary Jack Kemp, Representative--and Bush campaign co-chairman--Vin Weber (R-Minn.), and House Minority Whip Newt Gingrich (R-Ga.) persuaded the GOP platform committee to disavow the 1990 tax increase as "recessionary" and to propose new tax cuts. These are referred to, unconvincingly, as "growth measures." Now, the recidivist GOP platform calls for cuts in personal, corporate, and capital-gains taxes, which would widen the deficit by about $75 billion, and then simultaneously calls for a balanced budget!
This tonic has been tried before, and we are now suffering its aftereffects. In 1978, when the claims were new, policymakers might have been forgiven for yielding to temptation. After all, it doesn't take great political courage to offer voters, especially well-off ones, tax cuts. The theory was that lower taxes, especially on capital income, would increase rates of savings, investment, and growth. The economy would grow so prodigiously that new revenues would make up for the tax cuts. Supply siders forecast a balanced budget by 1984.
What actually occurred, of course, was a permanent hole in the tax base. The economy enjoyed a temporary, deficit-driven jolt to growth, extended briefly when the Federal Reserve helpfully reversed its tight-money policy. But contrary to the claims, neither personal savings nor investment increased--and growth gradually petered out. The economy, lacking adequate investment, grew dependent on ever larger deficits and ever cheaper money just to tread water. Since 1989, per capita income has actually fallen.
GROWTH YEARS. For both parties, restoring growth is the key election issue. To the supply siders, what killed growth was not the failure of their theory, but ill-conceived tax increases. Their remedy is to revert to Reagan-style tax cuts. But this diagnosis is belied by recent history. The biggest tax hike of the Reagan-Bush era was the $150 billion tax increase of 1982, supported by leading House and Senate Republicans, which partially compensated for excesses in the 1981 Economic Recovery Tax Act. The 1982 tax act restored less than half the revenue losses created by the tax cut of 1981--but it nonetheless ushered in seven years of growth.
The far smaller 1990 tax increase, which enjoyed bipartisan support as a deficit-reduction measure, raises about $26 billion a year--less than one-tenth of the projected annual deficit, less than half of 1% of gross national product--far too little money to have much impact on capital supply. After a decade-long test and refutation of the supply-side hypothesis, only hard-core believers still insist that lower taxes on capital are the key to investment and growth. Yet this group still pulls the strings of a Republican Party whose incumbent evidently believes what he said back in 1980--that supply side is "voodoo economics."
With a tarnished Republican candidate unconvincingly carrying a tattered supply-side banner, we shall have a useful three-way debate about the economy. The Clinton approach and the supply side do have two things in common. Both believe that increased growth now is the key to greater revenues and falling deficits down the road. And Clinton, like the supply siders, wants to boost growth by increasing investment. But where supply siders hope to lure investors with across-the-board tax cuts, Clinton would stimulate investment directly, through public outlays and narrowly targeted tax subsidies.
AUSTERITY'S CASE. The third party to the debate represents austerity and deflation--a bipartisan view now championed by noncandidates Ross Perot, investment banker Peter G. Peterson, former Senator Paul E. Tsongas (D-Mass.), and retiring Senator Warren Rudman (R-N.H.). In the austerity view, the top priority is deficit-reduction: If the deficit is cut, higher rates of savings and private investment will soon follow, leading to restored growth.
But the deflationist claims, like those of the supply siders, are based on false logic. In the early 1980s, a permanent tax cut on capital income was supposed to gun investment. It didn't. In the late 1930s, smaller deficits were supposed to restore business confidence, but they only prolonged the Great Depression. Today, investment is slack because household purchasing power is flat, and business sees no reason to invest--despite ever lower interest rates and tax rates far lower than those of the post-World War II boom. An abrupt cut in the deficit would only be that much more deflationary. In this economy, the only solution is growth led by investment. And only one source can overcome the reluctance of business to invest: public investment, most of which soon translates into private investment through government-procurement contracts.
This debate is a healthy one, and it deserves a full airing. The supply siders have been discredited by recent history. They may soon be repudiated by the voters. The deflationists are always with us. But self-confident, progressive Administrations are wise to pay them no mind.