Wednesday, August 4, 2010

Reich's flawed history.

In a recent column advocating higher tax rates on the wealthy, Keynesian former Labor Secretary Robert Reich wrote:
Unfortunately for supply-siders, history has proven them wrong again and again. During almost three decades spanning 1951 to 1980, when America's top marginal tax rate was between 70 and 92 percent, the nation's average annual growth was 3.7 percent. But between 1983 and start of the Great Recession, when the top rate was far lower -- ranging between 35 and 39 percent -- the economy grew an average of just 3 percent per year. Supply-siders are fond of claiming that Ronald Reagan's 1981 cuts caused the 1980s economic boom. In fact, that boom followed Reagan's 1982 tax increase. The 1990s boom likewise was not the result of a tax cut; it came in the wake of Bill Clinton's 1993 tax increase.
A few points in response.

First, and most crucially, the post-war period before 1971 was blessed with a generally well-maintained dollar exchange rate versus gold, and a global system of fixed exchange rates among major currencies. This meant stable prices, low interest rates, and international trade unencumbered by currency fluctuation. This arrangement, the equivalent of a single world currency, was a huge benefit across the globe, freeing the U.S. to export heavily to rebuilding nations such as Japan and Germany. These nations, it should be noted, grew rapidly due to sound money and their own deep tax rate cuts.

Second, the highest U.S. tax rates applied to relatively few earners, and loopholes were plentiful for top earners.

Third, the 1950s were less than prosperous, as taxes and inflation crept up. According to Brian Domitrovic's
Econoclasts, that decade had no less than three recessions.

Fourth, the 1960s were boom years, thanks to JFK's public re-commitment to a stable dollar/gold price and a major tax rate cut.

And fifth, the real growth of the economy during the 1970s was a paltry 1.8 percent, with the Dow losing ground in real terms and inflation rising due to President Nixon's decision to float the dollar. Significant growth between 1971-1982 can only be found in nominal, i.e. inflationary, terms.

Regarding the Reagan Boom, Reich is also off base. The 1981 Reagan tax cuts were phased in, taking full effect in 1983, so their impact was delayed.

More importantly, from 1981-82, the U.S. was in a nasty deflation as President Reagan's strong dollar rhetoric, combined with Fed Chairman Paul Volcker's tight money policy, caused the greenback's value to surge. Gold fell from a record $850 in 1980 to $300 two years later, oil plunged, and dollar debtors were crushed.

When Volcker was forced
by a pending Mexican debt default to add liquidity to the cash-starved economy in summer 1982, the dollar fell, gold jumped, and the Reagan Boom took off. The Dow and bond markets surged, GDP rose, interest rates declined, and economic health was restored. Reagan's relatively minor 1982 tax increase -- though a mistake -- was not enough to diminish the positive impact of newly sound money and large marginal tax rate cuts. The boom was extended by 1986's additional tax rate cuts, though that year's capital gains tax increase was unhelpful.

Finally, President Clinton's 1993 income tax increase occurred more than a year into an economic expansion, and the post-recession growth rate was sub-standard as a result. Supply-side initiatives such as 1994's NAFTA helped improve growth, as did Clinton's willingness to maintain a sound dollar.
But the real economic surge of the Clinton years started in 1996, as markets got wind of a major capital gains tax cut to come. In response, investment soared, the markets boomed, and revenues flooded into the treasury.


  1. It annoys me when people re-write history by using misleading statistics. To use average growth rates over a period of several decades while ignoring EVERY factor except tax rates is enormously misleading. Anyone who lived through the 60's and seventies saw how money expansion caused nominal (not real) income increases with subsequent bracket creep and the stagnation it brought. Any economic analysis that ignores disincentives to work and invest is simply worthless.

  2. One point about the tax increase of 1982. People like Mario Cuomo and now Reich have been saying for years that this got the 1980s boom going. The argument (as you can see above) is that once Reagan made some move in the direction of "fiscal sanity," the economy felt comfortable once again with booming.

    Funny thing is, these people are right -- but don't realize why. The "TEFRA" tax increase of 1982 was mainly a levy on phones and the airlines. All the while it was being prepared, however, there were whispers that it would cancel the big forthcoming income tax cuts that had been scheduled the year before. So when the bill was finalized in the summer of 1982 without the recission of those tax cuts, you bet the economy exhaled for the next 8 years. TEFRA guranteed the Reagan tax cuts, Robert Reich.

    As for the phones and the airlines, they were just at the moment finalizing arrangements with the feds to be very much freed of regulation. They volunteered for tax increases as a sign of good faith in that process. The TEFRA tax increases were a quid pro quo -- we'll concede to taxes on our products in exchange for a very serious governmental departure in our business sphere. Would anyone care to notice what happened to telecom (not to mention the nation's ability to communicate) after the Ma Bell breakup in 1984? The story of TEFRA is not of tax increases; rather it is of the guaranteeing of the epic cuts of the 1981 law and of the forthcoming success of another plank of Reaganomics, deregulation.

  3. An additional couple of good points on Reich, courtesy of Brian D:

    [Reich] makes a major blooper in saying that the top tax rate 1983-2007 ranged between 35 and 39%. Of course that range was 50% and 28%.

    Likewise his growth calculations are off. Any way you slice it, the biggest gap between his cherry-picked runs of 1951-1980 and 1983-2007 is 0.3%, not 0.7%, as he has it.

  4. ONe thing for sure Brian and Sean, when you call it like it is, supplyside economics again as was experimented with under Bush, everyone is going to run like hell away from it. Best to keep it all disguised as a tea party where the bad guys are taxing the ordinary people to death. That's a popular notion that will always be accepted by the common ordinary joe on the street. Never let them know what supplyside tax cuts really are and who the are 'really' for.

    Don't ever, ever let them get the idea that your agenda is 4 or 8 more years of Bush in order to give supplyside economics a fair chance.

  5. Anonymous,
    I've addressed your points previously: