Reaganomics: Tax Cuts Alone Are Not Enough

International Herald Tribune, Zurich – August 24/25, 1985

Washington – … The bulk of U.S. tax cuts began on Jan. 1, 1983, and the economic recovery began at the same time. Isn’t it amazing how tax reductions do not work until they take effect?

More to the point, the downturn of 1981 and 1982 as foreseen by many a supply-side economist was actually the consequence of the delayed reductions in tax.

In the year before a tax cut, most people do everything that they can to postpone realizing income from the higher-taxed year in order to defer its recognition until the lower-taxed year commences.

By all accounts, the recovery of 1983 and 1984 was spectacular. Real gross national product, which measures the total value of goods and services, including income from foreign investments, grew in those two years at an average annual rate of some 6 percent.

Notwithstanding the masses of data and commentary emanating from the White House and the Republican Party during 1984 and beyond, some people still have not comprehended the magnitude of the effects of tax cuts.

Perhaps most surprising to traditionalists is the fact that inflation has fallen during this period of nascent and actual tax cuts.

To supply-siders and the electorate, this result seems quite rational. Just as a bumper crop of apples leads to lower apple prices, so an aggregate supply increase leads to a lower inflation rate.

In the period from 1981 to 1983, consumer price inflation fell to 3.2 percent from 10.4 percent.

If the Reagan supply-side recovery had in reality been good old demand stimulation of the pump-priming variety, inflation should have risen. But this, as we have seen, was not what happened.

It is difficult to attribute all of the reduction in the level of inflation and interest rates to the traditional view of monetary policy.

Growth in M-1, a measure of the money supply that includes currency in circulation, travelers checks and checking deposits at financial institutions, was exceptionally high during the 1983-84 period, averaging 7.8-percent rate.

In 1979, the last time inflation accelerated to double digits, the same measure of the money supply grew by some 7.2 percent.

Rapid money growth is seen by traditionalists as leading to a higher inflation rate and interest rates, in addition to a weaker economy.

The Federal Reserve does deserve much of the credit for lower inflation, interest rates and stronger dollar. The Fed’s success, however, was not based on austerity.

The Fed changed its policy to targeting prices. This fundamental policy change allows rapid money growth to coexist with lower inflation, lower rates of interest and an expanding economy.

All this means there should be no more stagflation.

Federal budget deficits are a lot larger than I ever thought they would be, especially given the economic growth experienced in the past two and a half years.

But I should point out that the NIPA deficit (a seasonally adjusted Commerce Department measure) peaked in the fourth quarter of 1982, just before the actual tax cuts, and was $43.1 billion lower, in the first quarter of 198 than the fourth quarter of 1982.

State and local surpluses have risen a substantial $20.8 billion during the first quarter of the year.

After adjusting for inflation, tax revenues for fiscal 1985 exceeded the Reagan administration’s optimistic forecast of January 1983 by $30.5 billion…

Defense spending is also $25.6 billion less than had been projected back in January 1983. Both tax revenues and defense spending reduced the deficit by $56.1 billion. What could possibly have gone wrong?

Congress has literally gone on a spending spree in non-defense items. It exceeded the generous projections of January 1983 by a staggering $77.8 billion.

As Mr. Reagan said, Congress has spent like drunken sailors, the difference being that drunken sailors usually spend their own money. By contrast, Congress always spends other people’s.

Quite frankly, my miscalculation on the federal budget deficit was due to my overly generous perception that Congress would live up to its appointed role.

The solution to the federal budget problem must also include spending restraints. Tax cuts alone are not enough to cut the deficit.