About Starving Beasts and Supply Side Tax Cuts
I've spent a lot of time in the middle of the "Starve the Beast" and "Supply Side Tax Cut" debates. I formulated the Roth-Kemp tax cut in early 1977 and, after working to scale it back, helped pass it in 1981 as the Republican tax economist on the Senate Budget Committee. I formulated the Earned Income Tax Credit in 1975 and have worked for Democrats too. I hold myself out as a non-partisan Washington economist. My main goal all along has been to improve tax and budget policy. I won't claim much success, but I would offer some observations.
On "Starve the Beast," I vividly recall sitting in the OMB conference room in early 1981 looking at a summary of the budget President Reagan was about to unveil. His tax cuts were no surprise, but the jump in defense spending was so large, we thought it was a typo. Spending cuts were proposed, but they came nowhere near balancing the tax cut. That's where Rosy Scenario came in. Its projection of sharp personal income and business profit increases yielded lots of revenue and a balanced budget a few years out. The tax cuts became law; so did most of the defense increase; but Rosy Scenario didn't pan out. With the exception of the repeal of general revenue sharing with the states, few spending cuts were enacted. Deficits went up sharply. Throughout his administration, President Reagan predicted declining deficits, but they kept rising.
President Reagan and Congress reacted to higher deficits in several ways. First, we raised taxes in 1982 by about one-third of the 1981 tax cuts, mostly by going after business loopholes. Then, in 1983, we "saved" Social Security from going bust with a big payroll tax increase. Benefits were curtailed far in the future, mostly by extending the retirement age. So, today, nearly half of all Americans pay more in Social Security and Medicare taxes than they do in federal income taxes. Third, we enacted Gramm-Rudman-Hollings in 1985 and Gramm-Rudman-Hollings II in 1987 to cap spending growth. That was like padlocking the refrigerator to enforce a diet, but keeping the combination nearby. Spending growth finally leveled off as Mr. Reagan neared the end of this second term, but that happened as much from public outcry over the deficits as it did from any budget enforcement policies.
Presidents Bush 41 and Clinton deserve much credit for making the tough and politically perilous decisions to balance the budget. Old fashioned spending cuts and tax increases enacted in 1990 and in 1993 brought the deficit under control and produced surpluses in FY98, FY99, FY00, and FY01. The historical appendix of the President's Budget shows the numbers.
On "Supply Side Tax Cuts," I agree completely that marginal tax rate cuts and cuts in the taxation of dividends and capital gains stimulate economic growth that generates offsetting revenue. The size of that offset was estimated by the Congressional Budget Office in late 2005 to range from +1% to +22% in the first five years and from -5% to +32% over the next five years. That sounds about right to me. A lot depends upon the ultimate impact of those tax cuts. The same is true of spending. A broad marginal rate cut, or a cut in the double taxation of dividends, has big revenue "feedback," but a special net operating loss carryback for business, as the Senate is about to pass, is just "instant cash," which has little if any "feedback." Also, tax cuts on top of tax cuts have diminishing "feedback" just as tax increases on top of tax increase yield diminishing incremental revenue.
Finally, I haven't found any silver bullets, when it comes to balancing the budget. It takes a lot of hard work and difficult political calculus to get the budget under control. Then it takes a few years for the surpluses to show up, so you don't get much political credit, or worse, like President Bush 41, you get bounced out of office. Short-run political thinking usually dominates in Washington, and that's why surpluses are so rare.