Hello Supply Side
In tax policy, spending isn't all that matters.


In “Goodbye Supply Side,” Kevin D. Williamson writes, “Properly understood, there were no Reagan tax cuts. In 1980 federal spending was $590 billion and in 1989 it was $1.14 trillion; you don’t get Reagan tax cuts without Tip O’Neill spending cuts. Looked at from the proper perspective, we haven’t really had any tax cuts to speak of — we’ve had tax deferrals.”

Williamson hopes to “develop a rhetoric in which ‘spending’ and ‘taxes’ are synonyms, so a federal budget with $1 trillion in new spending means $1 trillion in new taxes — levies on Americans today or on our children tomorrow, with interest.” I am sympathetic to the description of deficit spending as deferred taxation. But equating supply-side tax policy with lower revenues (“tax cuts”) is incorrect in theory and fact.

The trouble with what Williamson calls “the bottom-line question of balancing the budget” is the implication that it makes no difference whether the budget is balanced by curbing spending or increasing taxes. A 2002 study by Alberto Alesina of Harvard and three colleagues found that the surest way to make economies boom is through deep cuts in government spending. Higher tax rates had the opposite effect. Although “growth isn’t going to make the debt irrelevant,” as Williamson says, the ratio of debt to GDP can become much larger and more troublesome if GDP stagnates.

Williamson credits the 1985 Gramm-Rudman-Hollings Act with cutting the deficit from 5.2 percent of GDP in 1986 to 2.8 percent in 1989. Yet the largest contributor to that deficit reduction was actually the Tax Reform Act of 1986, which increased income-tax revenue from 9.3 percent of GDP to 10.2 percent even as revenues from the higher capital-gains tax fell by $17.7 billion. Defense spending (which had risen sharply in 1980–86) was also trimmed from 6.5 percent of GDP to 5.8 percent from 1986 to 1989. Non-defense spending accounted for only a third of the deficit reduction.

Deficit reduction under President Clinton happened mainly because defense spending fell from 5 percent of GDP to 3.1 percent, and the Fed’s low interest rates reduced federal interest expense by another 1 percent of GDP. Clark Judge rightly noted that most of the revenue gains in 1997–2001 were the result not of the higher tax rates that went into effect in 1993 but of the lower capital-gains-tax rates that went into effect in 1997. From 1987 to 1995, revenues from the 28 percent capital-gains tax accounted for only 7.3 percent of individual tax receipts. From 1997 to 2000, revenues from the 20 percent capital-gains tax accounted for 11.9 percent of individual tax receipts.
The dot-com boom certainly helped. Yet the evidence is overwhelming that a 20 percent tax on realized capital gains generates more revenue than a 28 percent tax.