Goodbye Supply Side
From the May 3, 2010, issue of NR.


Kevin D. Williamson

Laffer’s rustic hypothetical is apt: There is no Clayton County in Texas, but there is a little Texas town called Clayton, population 79, represented in the House by Republican Louie Gohmert. What does Representative Gohmert think about taxes? After 9/11, he argues, the United States was headed for a serious recession, even a depression, but tax cuts saved the day — and increased government revenues in the process. “With a tax cut, then another tax cut, we stimulated the economy, and record revenue like never before in American history flowed into the United States Treasury,” he said in a speech before the House. “As it turned out, the tax cuts helped create more revenue for the Treasury, not destroy revenue for the Treasury.” That last bit is fantasy. There is no evidence that the tax cuts on net produced more revenue than the Treasury would have realized without them. That claim could be true — if we were to credit most or all of the economic growth during the period in question to tax cuts, but that is an awfully big claim, one that no serious economist would be likely to entertain. It’s a just-so story, a bedtime fairy tale Republicans tell themselves to shake off fear of the deficit bogeyman. It’s whistling past the fiscal graveyard. But this kind of talk is distressingly unremarkable in Republican political circles.

And such magical thinking is not the exclusive domain of back-benchers from the hinterlands. The exaggeration of supply-side effects — the belief that tax-rate cuts pay for themselves or more than pay for themselves over some measurable period — is more an article of faith than an economic fact. But it’s a widespread faith: George W. Bush argued that tax cuts would serve to increase tax revenues. So did John McCain. Rush Limbaugh talks this way. Even Steve Forbes has stepped into this rhetorical stinker from time to time. Reagan knew better — his Treasury Department predicted significant revenue losses from his tax-rate cuts — but his epigones preach a different gospel. Writing in the Wall Street Journal, former Reagan speechwriter Clark S. Judge made a more specific claim: “The surpluses of the late ’90s were to a significant extent a product of the growth in revenues that came after the capital-gains tax was cut.” Here he’s really making two claims: 1) that capital-gains-tax revenue growth was a significant factor in balancing the budget, and 2) that the revenue grew because of the cuts. The first claim is demonstrably untrue: The total growth in capital-gains tax revenues amounts to about 10 percent of the overall deficit reduction that led to the surpluses of the late Clinton years. On the other hand, spending cuts accounted for about half of the deficit reduction. (“Spending cuts” is a famously slippery phrase; here we’re talking about some actual cuts, but mostly about scheduled spending forgone.)

As for Judge’s second claim, it is possible, even likely, that the cuts in the capital-gains-tax rates led to greater investment activity during the years in question, 1996–2000. But if we want to credit tax cuts for even the 10 percent of deficit reduction that came from increased capital-gains tax revenues, then we have to assume that the cuts were responsible for 100 percent of the growth in those revenues. And that’s a stretch. You may remember that the late 1990s were an unusual time in the American economy, to say the least. Recall, for instance, the two big news stories of Aug. 9, 1995: Jerry Garcia shuffled off his hippie coil and Netscape had its initial public offering of stock, an event that kicked off a very long and raucous money orgy we now know as the dot-com bubble, the Age of Irrational Exuberance. From 1994 to 2000, the NASDAQ rose 500 percent in value, doubling between 1999 and 2000 alone. It was not a modest reduction in the tax rates that inspired investors to bid stocks up to five times their earlier prices and to keep bidding them up even when price-earnings ratios had far exceeded historical norms. Compared with the dot-com bubble, the effects of the tax-rate cuts probably were of not much greater magnitude than the passing of Mr. Garcia. Overselling the effects of supply-side tax cuts gives Republicans an alternative narrative for the millennial economy — which is tempting, since nobody is going to run for office promising another disruptive bubble in modish technology shares.