There are two schools of thought about the Reagan tax cuts. The conventional conservative view: They spurred investment, entrepreneurship, and real economic growth, helping to resuscitate the post-Carter economy, and, by doing so, they paid for themselves. The conventional liberal view: They were an ill-considered product of starve-the-beast ideology and produced crippling deficits, inaugurating a new era of fiscal irresponsibility only briefly transcended during the golden years of the Clinton presidency.
Here’s a different take: They never happened.
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. Reagan and his congressional allies had an excuse in the considerable person of Speaker O’Neill. But George W. Bush and the concurrent Republican majorities in both houses of Congress didn’t manage to cut spending, either. Part of that was circumstances — 9/11, Afghanistan, Iraq, the subprime meltdown — but part of it was the fact that a poorly applied supply-side analysis has infantilized Republicans when it comes to the budget. They love to cut taxes but cannot bring themselves to cut spending: It’s eat dessert first and leave the spinach on the table.
There is some evidence that this is both bad politics and bad policy. Many conservatives were disheartened by the Republican spending excesses of 2001–06, and abandoned the GOP in the elections of 2006 and 2008. And you may have noticed that our parks and public spaces are from time to time filled with rowdy tea-party demonstrators hollering for Washington to drop anchor post-haste on the USS Appropriations, which is nonetheless steaming on at a nauseating clip. Spending cuts are always popular in theory and detested in practice, but the deficit is now truly terrifying, and, fortunately for Republicans, it is owned by Barack Obama and Nancy Pelosi. Our gross national debt is about 80 percent of GDP today and will be nearly 100 percent by 2012. If the government applied any sort of reasonable accounting standard to its future liabilities — if it were taking the same write-downs on Social Security and Medicare that the Fortune 500 are taking on Obamacare — then our real liabilities would far exceed GDP. It’s ugly, and the numbers suggest that we aren’t going to grow our way out of it: Despite all those pro-growth tax cuts, our deficits continue to grow faster than our economy. That’s been especially true during the Great Recession, but even during periods of strong economic growth, there has been nothing to indicate that our economy is going to grow so fast that it will surmount our deficits and debt without serious spending restraint. This should be a shrieking klaxon of alarm for conservatives still falling for happy talk about pro-growth tax cuts and strategic Laffer Curve optimizing.
Some people are more sensible about that Laffer Curve talk. Laffer, for instance. Arthur Laffer, whose famous (and possibly apocryphal) back-of-the-napkin diagram launched supply-side tax policy, readily concedes that the growth effects of tax cuts are oversold in the political debate. “Does every tax cut pay for itself? No. I think Irving Kristol wrote that, once — and then did a pretty good job of arguing for it. But if some guy running for Congress in Clayton County, Texas, says all tax cuts pay for themselves, what do we want to do? Go after him with a shotgun? Sure, they’re going to cite me, and there’s very little I can do about it. But there’s the same amount of ignorance on the other side, ignoring the economic feedback effects of tax cuts.”
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.
But, in truth, nobody really should run for office on the supply-side revenue effects of tax cuts, either. As it turns out, they present a dry and technical question of limited interest to the general electorate. It is true that tax cuts can promote growth, and that the growth they promote can help generate tax revenue that offsets some of the losses from the cuts. When the Reagan tax cuts were being designed, the original supply-side crew thought that subsequent growth might offset 30 percent of the revenue losses. That’s on the high side of the current consensus, but it’s not preposterous. There is, however, a world of difference between tax cuts that only lose only 70 cents on the dollar and tax cuts that pay back 100 cents on the dollar and then some.
There is considerable debate among economists and federal legume-quantifiers about how large supply-side revenue effects are. The Congressional Budget Office did a study in 2005 of the effects of a theoretical 10 percent cut in income-tax rates. It ran a couple of different versions of the study, under different sets of economic assumptions. The conclusion the CBO came to was that the growth effects of such a tax cut could be expected to offset between 1 percent and 22 percent of the revenue loss in the first five years. In the second five years, the CBO calculated, feedback effects of tax-rate reductions might actually add 5 percent to the revenue loss — or offset as much as 32 percent of it. That’s a big deal, and something that conservative budget engineers should keep in mind. But the question of whether the CBO accounts for tax cuts at 100 cents on the dollar, 99 cents on the dollar, or 68 cents on the dollar is hardly the stuff that a broad-based political movement is going to put at the center of its campaigns. Federal spending, on the other hand, is a national crisis.
And that’s one thing the gentleman from Clayton has right: Tax cuts aren’t really the problem. The hot action is on the spending side of the ledger, and nobody wants to touch it. The problem with magical supply-siderism is that it gives Republicans a rhetorical and intellectual framework in which to ignore spending — just keep cutting taxes, the argument goes, and somebody else will eventually have to cut spending. The results speak for themselves: Tom DeLay and Dennis Hastert and Trent Lott and Bill Frist all know how to count, but, under their leadership, Republicans spent all the money the country had and then some. Deficits boomed, and Republicans’ claim to being the responsible britches-wearing adults when it comes to spending got unpantsed. Cutting taxes is easy. Cutting spending is hard.
Professor Laffer appreciates this. “It’s hard to win on spending. If it’s a Louisiana Purchase or the Cornhusker Kickback or earmarks, you can win on some of those, but it’s real hard. If you’re on a college campus, you can whip the kids into a wild rage on defense spending, on Iraq and Afghanistan. People love getting government benefits and they hate paying for them.” Supply-side icon Jude Wanniski understood the politics of spending cuts and described his own approach as the “Two Santa Claus Theory.” Short version: Nobody votes for Scrooge. Tax cuts give Republicans an opportunity to distribute economic benefits through the tax code the way Democrats distribute them through appropriations, and the exaggeration of the supply-side effect gives them an opportunity to pretend like those benefits are cost-free.
Laffer is confident that smart politics — a platform that includes tax cuts, preferably in the form of a flat tax – can produce the kinds of economic conditions that will make budget-balancing possible in the long run. But he is hesitant to address the issue of spending. He points to the case of California’s Proposition 13, the 1978 tax revolt that arguably launched anti-tax conservatism as a national political force. Proposition 13 was all tax cuts. Five years before, Reagan had pushed for Proposition 1, a mix of tax cuts and spending cuts. “We cleaned their clocks with Proposition 13,” Laffer brags, “but Milton Friedman and Reagan got killed on Proposition 1.” But Proposition 13 can hardly be considered a real success in anything other than political terms: It did not produce fiscal discipline, and it did not provide a long-term solution to California’s budget problems. Legislators are legislators, and California is California: Proposition 13 was the shot heard round the conservative world, but the Golden State took only a few decades to degenerate into its presently bleak fiscal condition.
It’s really hard to create political incentives that will keep legislators from overspending. Conservatives should know this, because we’ve tried it before. The Gramm-Rudman-Hollings Act of 1985, which enacted automatic federal spending cuts if the deficit exceeded predefined targets, went through hell, high water, and the federal courts before its provisions were allowed to kick in. But when they did kick in, they worked. They worked with a hard and furious vengeance: The deficit was reduced from $221 billion in 1986 to $153 billion in 1989, from 5.2 percent of GDP to 2.8 percent of GDP. In fact, Gramm-Rudman worked so well that Congress, facing real spending constraints for the first time, killed the act, replacing it with the toothless Budget Enforcement Act of 1990.
This we know: Tax cuts don’t get us out of the spending pickle, and growth isn’t going to make the debt irrelevant. Legislative mandates and gimmicks like spending caps and the like will not constrain the spendthrift habits of appropriators — because, if they do, they will be repealed, just like Gramm-Rudman was. You can’t starve the beast if the Chinese and the bond markets keep lending him bon-bons by the ton. And the prospect of enacting a balanced-budget amendment to the Constitution is a castle in the sky.
So, what should conservatives do? One, abjure magical thinking about tax cuts. Two, 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. Three, get a load of those tea-party yokels, with their funny hats and dysgraphic signage, and keep this in mind: They are opposed to the Democrats, but what they are really looking for is an alternative to the establishment Republicans, whom they distrust, with good reason, when it comes to the bottom-line question of balancing the budget and getting our fiscal affairs in good order. And then, finally, decide which angry mob you want to face: today’s voters or tomorrow’s bondholders.
– Kevin D. Williamson is deputy managing editor of National Review. in whose May 3, 2010, issue this article first appeared.