The only question now is, will it work?
The United States has plunged into a bold economic experiment and nobody knows what happens next. If taxes are cut and civilian government expenditures reduced, the theory is that there will be an increase in private investment. This will stimulate industry; more goods will bring prices down and make jobs; it will also reduce the cost of federal unemployment insurance and similar welfare expenditures; thus the ultimate happy result will be a balanced budget.
Ronald Reagan put it to the nation from the White House, July 27, with charts beside him:
"Our economic package is a closely knit, carefully constructed plan to . . . put our nation back on the road to prosperity." He added, "starting next year the deficits will get smaller until, in just a few years, the budget can be balanced . . ."
I have watched Washington a long time and could hardly believe that a new President could get such a complex program through Congress. But he did it. Mr. Reagan boasts that the administration received "95 percent" of what it sought. Will it work? We certainly must hope so.
Wall Street isn't certain. Bonds and stocks have fallen. Many factors could affect the outcome, some of them irrelevant. Looked at with the technical detachment of the student it would be a shame not to see this bold application of "supply side" economics tested on its merits. It began with a measure introduced simultaneously by Sen. William V. Roth (R) of Delaware and Rep. Jack F. Kemp (R) of New York in 1977: a bill that hardly anybody took seriously at the time. They wanted a three-year average income tax cut of about 33 percent, plus a slash in business taxes. It became known as the "Kemp-Roth" bill and Republicans flirted with it in the 1978 mid-term election. Many people thought it woudl then fade out. But on the steps of the Capitol, June 25, 1980, GOP Senate and House leaders unanimously pledged support to a revised version (a one-year, 10 percent across-the-board tax cut for individuals, and faster write-offs of plant and equipment for business). Candidate Ronald Reagan adopted it. He wanted additional 10 percent cuts in individual income taxes in each of the next two years. The package evolved and expanded, with bidding for votes in Congress, and further tax advantages to business. However, essential Kemp-Roth theory remained: cut taxes and investors would put the money to work making goods. Tax cuts would pay for themselves. Congress passed it.
There are signs now of a little reaction. Business Week dryly notes that the federal deficit for the fiscal year that begins next October will be at least $ 20 billion higher than the original hopeful estimate of $42.5 billion. The administration figures have been rosy all along: now "a somewhat more realistic note is creeping into government arithmetic," the magazine notes.
One important theory remains to be tested. Writing for the conservative American Enterprise Institute, two economists, Herbert Stein and Murray F. Foss, question the Kemp-Roth assumption that people who get tax benefits will substantially increase their savings and investment. It seems that an economist named Edward F. Denison in the 1950s formulated what is known as "Denison's Law:" the ratio of private saving to overall production (GNP), he said, remains fairly constant, high taxes or low taxes. This was true of the postwar period when tax rates were steep and in the 1929 period when they were low. Will the old law apply now? Messrs. Stein and Foss think it will, contrary to the Kemp-Roth thesis. They question whether a rush of new investment will follow the forthcoming tax cuts. But this is a postulate on which a great structure of theory has been based. Messrs. Stein and Foss offer charts and statistics ("Taxes and Savings" from the AEI Economist, July 1981). They are restrained. But they flash a red light, rather late in the game perhaps: "There seems little prospect that the cut in taxes will yield the personal savings rates projected by the administration" (4.9 percent and 5.3 percent respectively in GNP in 1984 and 1986), they say. This is an important assumption of the Kemp-Roth program.
The authors, who lean to the orthodox economic view, politely add that this doesn't mean that the great Reagan program won't work. Their observations, they say, "are only meant to indicate how great is the ignorance about this critical element in the government's economic strategy." They caution, "We should be prepared for the possibility that the policy will not yield all the expected results on the schedule now described."
Wall Street's doubts of the Reagan program have been sharply expressed in the past week. Basic assumptions are now being tested.