No 'Voodoo' in Dole's Tax Cut
Kennedy- and Reagan-era reductions showed the growth-enhancing power of this type of economic policy
The top economic issue of this year's election will be Bob Dole's tax-cut proposal. Is it a replay of President Reagan's budget-busting "voodoo economics," or a common-sense plan to provide tax relief and more jobs?
"When I was in the movies," Mr. Reagan told the Washington Post in 1981, "I would reach the point each year when, after the second movie, I'd be in the 90 percent bracket, so I wouldn't make any more movies that year. And it wasn't just me. Bogart and Gable and others did the same thing."
Actually, the top marginal income tax rate was 91 percent at that time, and America's home builders and business owners got the same message as the Hollywood stars: Why work and risk capital to build another house or store if the government is going to confiscate 91 percent of your income? The bottom line is that this soak-the-rich tax rate produced more leisure for movie stars and entrepreneurs and more unemployment for carpenters and stage hands.
In the early 1960s and 1980s, Presidents Kennedy and Reagan both faced faltering economies with high jobless rates. Both recognized that high taxes curtail economic growth. To stimulate the economy, Kennedy's tax program reduced the top marginal income tax rate from 91 percent to 70 percent. Under Reagan, the top marginal income tax rate was slashed to 28 percent. The result? Two economic booms.
Following Kennedy's tax cut, annual economic growth jumped to 5.2 percent between 1964 and 1969, more than double today's rates. Reagan's tax cuts were followed by the longest peacetime economic expansion in United States history - November 1982 through July 1990 - enlarging the nation's real income, adjusted for inflation, by one-third, producing 19.3 million jobs and the lowest unemployment rate in nearly 20 years.
"The trickle-down policies of the 1980s," says President Clinton, "benefited the wealthy at the expense of the middle class and the working poor." In fact, the average real income of every group rose each year from 1983 to 1989. Census Bureau data show the real income of the poorest 20 percent of households rose 10.7 percent from 1981 to 1989, after falling 11.6 percent from 1977 to 1981. Among black families, real median income increased 16 percent from 1982 to 1990, after declining 15 percent from 1973 to 1980.
Over the past two decades, it was only during the Reagan years that the real incomes of the poorest 20 percent of families increased. The incomes of these families nose-dived during the Carter years and decreased by 8 percent in the 1990s. America's poverty population, after growing by 7 million in the Carter years and shrinking by 4 million in the Reagan terms, has increased by 6 million since 1989.
The economic record of the past four decades shows that all income groups benefit from pro-growth policies that lower taxes on work, savings, entrepreneurship, and investment. The 2.1 percent annual job growth during the 1980s created 2.12 million jobs per year. From 1989 to 1995, following the Bush and Clinton tax increases, annual job growth plummeted to 1 percent, an average of 1.26 million jobs per year.
To increase growth and jobs, the Dole economic plan calls for $548 billion in tax cuts over six years. The bulk of the plan is a $406 billion across-the-board 15 percent income tax cut and a $75 billion tax credit of $500 per child for low- and middle-income families. For a married couple with two children earning $35,000, federal income taxes will fall by an estimated 52 percent, from $2,715 to $1,308. For a family with two children earning $75,000, the federal tax bite drops from $8,549 to $6,267.
The rest of the plan consists of a $27 billion repeal of the 1993 tax increase on Social Security benefits, $13 billion in capital-gains tax cuts, and $27 billion for education and training initiatives and expanded Individual Retirement Accounts.
To balance the tax cuts, Dole proposes $217 billion in new reductions in government spending, on top of the budget changes approved by Congress in June: $90 billion in administrative cuts, $34 billion from the sale of broadcast frequencies, $47 billion from downsizing the departments of Energy and Commerce, and $46 billion from a 1 percent across-the-board spending decrease in other programs. The balance, $147 billion, comes from projected increased tax revenues, assuming a 3.5 percent annual growth rate in national income - not an overly optimistic projection based on the 5.2 percent and 4.0 percent yearly growth rates that followed the Kennedy and Reagan tax cuts.
The key criticism of Dole's tax-cut program is that it would reduce the government's revenues and explode the deficit. The federal budget deficits of the 1980s, however, were caused by excessive spending, not by a lack of incoming tax revenue. Despite Reagan's lower tax rates, federal tax revenues jumped by one-third in real dollars from 1981 to 1989. The problem was that Congress increased spending by $1.28 for every new tax dollar that flowed into the federal coffers. With the single exception of 1984, spending by Congress each year from 1981 to 1989 exceeded the Reagan budget requests. Due to the "ingenuity of the federal bureaucracy" and the "avarice of Congress," says Martin Anderson, Reagan's 1981-82 economic policy adviser, government spending in the 1980s "managed to outrace the largest increase in federal revenue in US history."
This time, with the public more amenable to government downsizing, a line-item veto, the collapse of the Soviet Union, and a more conservative Congress, that spending binge and deficit scenario is unlikely to repeat itself. What's now more probable is that tax cuts will deliver higher take-home pay, a growing economy, more jobs, less welfare, and a balanced budget.
*Ralph R. Reiland is associate professor of economics at Robert Morris College in Pittsburgh.