By Hale Stewart
Republicans are enamored by “supply-side” economics. Frankly, I have to admit it’s a very easy sell. Think about it. “Cutting tax rates stimulates the economy to such a high level that tax revenues increase.” However, there are several problems with this theory. The first is Republicans have not implemented the other side of “supply-side economics” — a corresponding cut in government spending. This has ballooned the federal debt to dangerous levels under their economic stewardship. In addition, the projected increase in government revenues really haven’t materialized as projected. In other words, supply-side economics is a great marketing concept, but in reality is a poor national policy.
First, let’s get some administrative issues out of the way. I will be using data from the Congressional Budget Office’s historical data the Bureau of Economic Analysis, the St. Louis Federal Reserve and the National Bureau of Economic Research
Reagan was the first person to implement supply-side economic policy. According to the NBER, the primary expansion under Reagan’s leadership occurred between November 1982 (the fourth quarter of 1982) and July 1990 (the third quarter of 1990). According to the BEA, the median quarterly percentage change in GDP over this period was 3.85 percent. That’s a very good number.
But let’s look deeper into the numbers. First, there was a mammoth explosion of government debt during this expansion. Here’s a chart from the St. Louis Federal Reserve of total government debt outstanding.
In other words, this was financed growth; the U.S. borrowed heavily to achieve this growth rate. The primary reason for this explosion in debt is Reagan never balanced a budget; he continued to increase government spending. Here is a chart of federal revenues and expenditures from the St. Louis Federal Reserve. Notice first the scale on the right side of the chart is lower than the left side of the chart. Then notice that federal receipts were always lower than federal expenditures.
Let’s now turn to receipts from personal income taxes. According to the Congressional Budget Office’s historical budget data, tax receipts from individuals totaled $297 billion in 1982 and $466.9 billion in 1990. That’s an increase of 57.20 percent. Over the same period of time the GDP price deflator increased from 63.866 to 82.053, or an increase of 28.476 percent. In other words, the increase of tax revenue from individuals really isn’t that impressive after adjusting for inflation.
Let’s stop here and make a few observations.
1) The overall rate of growth was very good. A 3.85 percent median quarterly rate of GDP growth is a very good number. 2) But the economy was grown on credit. And the rate of growth in total government debt was very high. 3) The high growth rate in total government debt outstanding was caused by a continuing increase in government spending at a rate higher than government revenues. 4) After adjusting for inflation, the growth in receipts in personal income taxes isn’t that impressive.
Let’s fast-forward to Bush II:
According to the National Bureau of Economic Research, the current expansion started in November 2001. Since then, the median rate of quarterly GDP growth in 2.7 percent and the average (mean) is 2.74 percent. While this isn’t the most impressive median GDP growth number we could expect, it certainly isn’t the worst either. This falls into the “fair” category.
But like Reagan, the expansion has been grown on credit. Reference the total government debt outstanding chart from above and notice the upward trajectory the chart takes. Here is a report from the Department of the Treasury of the total federal debt outstanding at the end of the last six federal fiscal years:
The main problem is (again) that federal expenditures have far exceeded federal revenues. Here is the chart of federal revenues and receipts from above. Again notice the hard part of “supply-side” economics is cutting spending. While cutting taxes is easy, cutting spending is hard.
Let’s look at tax revenues to see how they have responded. First, remember that Bush first cut taxes in 2001 and again in 2003. So let’s go back to the first tax cut to see what happened from that point forward. According to the Congressional Budget Office’s Historical Budget Data, total revenue from individual taxpayers was $994 billion in 2001 and $1.043 trillion in 2006. Since the fourth quarter of 2001, the GDP price deflator has increased from 103.1221 to 117.003 (this was the price deflator in the third quarter of 2006 when the federal government’s fiscal year ends). This is an overall increase of 13.46 percent. In short, after adjusting for inflation, the overall increase in tax revenues from 2001 when the first tax cutting began is nothing to write home about.
Republican commentators usually start their analysis from 2003. First, note the tax revenues decreased from $994 billion in 2001 to $793.7 billion in 2003. This is hardly the result the Republicans predicted for the 2001 tax cuts. However tax revenues increased from $793.7 billion in the 2003 to 1.043.9 trillion in 2006. This is an increase of 31.52 percent. The GDP price deflator in the third quarter of 2003 was 106.616 and was 117.003 in the third quarter of 2006, or an increase of 9.74 percent. So using 2003 as the starting point we can see that total tax revenues have increased, but again not as impressively as Republican pundits like to think.
Notice we can draw the same conclusions for Bush II that we can for Reagan:
5) The overall rate of growth was fair. A 2.7 percent median quarterly rate of GDP growth is decent, but not great. 6)But the economy was grown on credit. And the rate of growth in total government debt was very high. 7) The high growth rate in total government debt outstanding was caused by a continuing increase in government spending at a rate higher than government revenues. 8) After adjusting for inflation, the growth in receipts in personal income taxes isn’t that impressive.
First, let’s note the growth in tax revenues from individuals after adjusting for inflation is good, but not the result the Republican commentators promised. In addition, look at the CBO historical budget tables for other expansion and you’ll see tax revenues grew at similar or higher rates during economic expansions. This leads to the conclusion that growing individual tax revenues is as much a function of overall economic growth as it is of overall tax rates.
Secondly, while I would agree that cutting marginal tax rates from a high level to a lower level is probably going to be stimulate the economy, smaller cuts clearly aren’t the amazing panacea the Republicans advertise them to be. As an example, I do think that Kennedy’s cuts were clearly a cause for the 1960s economic expansion. But arguing that a small cut from 40 percent to 37 percent is the greatest thing since sliced bread is overselling the idea.
At this point we get into a discussion about the underlying policy about the appropriate use of government debt: when to use it, how much to use when we use it and when to pay it down. The bottom line is economic growth from the last two great supply-side experiments has been financed by using government debt. Neither Reagan nor Bush meaningfully cut government spending, largely because that’s the hard part of supply-side economics. Both used government debt to finance the shortfalls between government spending and revenue. None of this debt has been paid-off, and probably won’t be in our lifetime.
Regarding government debt, I would argue the following. Government debt should be used sparingly. In times of an economic slowdown deficit spending is warranted to mitigate the negative effect of a slowing economy. But when the economy is doing well, the government should work to pay-off its debt. This will allow the government to engage in deficit spending when the next recession happens. This overall idea is hard politically, which is why it’s probably not done.
In essence, the U.S. is faced with a policy decision — how to finance growth. Do we pay as we go, or pawn off the cost of growth on future generations? I would argue that paying as we go does not propose a radical or anti-growth situation because the 1990s demonstrated that increasing taxes on upper-income taxpayers dies not thwart growth. In addition, we balanced budgets in the 1990s and it did not thwart growth. In short, paying for growth as we go is the sane and sensible answer. And it’s one the Democrats need to embrace.