The new year is a time for making resolutions, so I am making one. I resolve to do more in the future to correct the economic misinformation that appears in the news pages of major newspapers. This is hard work because there is so much of it.
In defense of the media, I should say that the worst misinformation is so deeply embedded that it is really just conventional wisdom. Everybody has heard it so many times before that it is just assumed to be true by reporters, editors, and readers alike.
A good example of this is the myth that the budget deficits of the 1980s resulted from a trick — some would even call it a lie — played by Ronald Reagan and a group of supply-side economists. Supposedly, they sold Congress and the American people a bill of goods by saying that the 1981 tax cut would lose no revenue. Based on something called the “Laffer Curve,” they are said to have asserted — on the basis of no logical or empirical evidence — that there would be such an outpouring of work, investment, and economic growth that higher revenues would be collected at lower tax rates.
This whole story is, of course, complete nonsense. No one in a position of authority ever said any such thing. And even if they had, how can one possibly believe that a skeptical Congress and a liberal news media would allow anyone to get away with it?
The truth is that every official estimate made by the Reagan administration, published in the budget and elsewhere, showed large revenue losses associated with the 1981 tax cut. Furthermore, these estimates were comparable to those made by independent agencies such as the Congressional Budget Office.
For example, if one goes to a CBO report entitled, “Economic Policy and the Outlook for the Economy,” issued in March 1981 (page 47), one will see that the CBO predicted federal revenues of $769 billion in 1984, after the tax cut, and the Reagan administration predicted $771 billion. It turned out that both were wrong, but the point is that the Reagan administration used standard revenue estimating methods in making its estimates.
As economist Bill Niskanen wrote in his book, Reaganomics (Oxford University Press, 1988): “Supply-side economics . . . does not conclude that a general reduction in tax rates would increase tax revenues, nor did any government economist or budget projection by the Reagan Administration ever make that claim.”
In addition, I have looked carefully at statements made on the record by economists affiliated with the supply-side school. In every case, they forecast large revenue losses for many years after the tax cut. Ironically, it was liberal economists who actually said that the tax cut might raise revenue.
For example, testifying before Congress’s Joint Economic Committee in February 1981, Professor Richard Musgrave of Harvard said that supply-side effects of the Reagan tax cut might recoup 30% to 35% of the lost revenue, with demand-side effects bringing in another 18%.
In a 1987 study, the Congressional Budget Office concluded that the economic effects of the tax cut probably had reduced the net revenue loss of the 1981 tax cut by about 25%.
So where did the deficits come from? The main reason is that inflation came down much more quickly than any economist in 1981 thought possible. It fell from 12.5% in 1980 to just 1.1% by 1986. This lowered expected revenues by reducing bracket-creep, where taxpayers are pushed into higher tax brackets by inflation. Secondarily, spending was much higher than expected.
One can fault the Reagan administration for not doing more to hold the line on spending. But to claim that deficits resulted primarily from a mystical belief in the power of tax cuts to raise revenue has no basis in truth.
Interestingly, today it is Democrats who are more likely to say that tax cuts may raise revenue. It was House Minority Leader Dick Gephardt, Democrat of Missouri, who said this on Meet the Press (1-27-02): “The purpose of tax cuts is . . . to get the economy to grow. If you can get the economy to grow, you will start having more money coming into the government.”
Although I resolve to address this issue again, when it inevitably turns up in the press, I am not optimistic of prevailing. I am reminded of H.L. Mencken’s experience. In 1917 he wrote a tongue-in-cheek article claiming that Millard Fillmore had installed the first White House bathtub. Later, Mencken was horrified to see this cited as fact. Although he wrote other articles saying that he made the whole thing up, and despite the lack of any historical documentation, one still sees President Fillmore credited for the first White House bathtub to this day. (For more on Fillmore and the bathtub, go here.)