What great debate
Yes, I believe that MY civil liberties have not been violated although the gov't has the ability to do so. I am saying that I doubt my telephone is being wiretapped, etc.
Yes I agree, great debate...
I agree in theory but can you name a time in history when tax cuts caused inflation?
Well, since you asked...
The conventional wisdom regarding modern American macroeconomic history is that after the Keynesian Revolution of the 1930s, business cycles were largely tamed, in part because of the intelligent use of fiscal policy. Scholars point to the Kennedy-Johnson tax cut of 1964-65, which, we are told, turned a sluggish economy into a vibrant and rapidly expanding one, setting off the longest boom in American history to that time.
Martin Prachowny challenges that wisdom in his interesting and valuable account of the Kennedy-Johnson tax cut, writing what he calls a "revisionist history." Yet the revisionism is a different form than I would have predicted ex ante. I expected an account arguing that the Keynesian paradigm was faulty, perhaps using a New Classical perspective that emphasizes the role that the tax cut had in the genesis of the stagflation of the 1970s. Rather, Prachowny finds not much inherently wrong in the Keynesian theoretical approach, but much wrong in its implementation. The villains in this account are Walter Heller, Gardner Ackley, and Arthur Okun, the chairmen of the Council of Economic Advisers (CEA) of the era. The problem was not that they were Keynesian, Prachowny argues, but that they were not Keynesian enough.
Prachowny suggests that the sins of this triad of economists were many. First of all, he argues that they were not using the full array of Keynesian theoretical tools to analyze the economy. They used a rather simple multiplier-accelerator model, instead of the IS-LM approach that was universally used in the intermediate macro theory books of the time. As a consequence, they tended to ignore the interest rate and monetary dimensions of their expansionist programs. Crowding out is not acknowledged as a potential issue. The problem was sometimes even more basic: "the simple truth is that Heller did not understand the operation of the accelerator" (p.68), a hallmark of Keynesian cyclical analysis of that era. Moreover, while Okun (approvingly in Prachowny's view) championed the idea of measuring and targeting the gap between actual and potential GNP, thus introducing some supply side considerations into the analysis, the CEA inconsistently tried to eliminate the output gap, and sometimes dishonestly or incompetently measured it (Prachowny goes into some tedious econometric overkill to demonstrate that point). Moreover, its sensitivity to supply side effects of stabilization policy was wanting.
Moreover, the CEA was not always intellectually honest, sometimes suppressing truth and hard analysis in order to accommodate some political problem. Prachowny shows that at one point Ackley seemed to advocate lying (or at least suppressing the perceived truth) about the forecasted GNP, even though this would "not completely fool many outside experts" (p. 197). The notion that the Council was a group of objective experts, who gave the president and public the unvarnished truth as they saw it, is a fantasy. Speaking of Heller's perception of his job, Prachowny noted "there was no inconsistency between being a partisan advocate of efficiency and a partisan Democrat" (pp. 180-181).
Even more sinful, the Council was intellectually inconsistent, fighting hard in 1962 and 1963 for a tax cut to eliminate an output gap, but vacillating and fudging forecasts so as to avoid vigorously prompting a tax increase when aggregate demand overheated by 1966 or 1967. Bowing to political pressures (e.g., opposition to a tax increase by Lyndon Johnson and Wilbur Mills), they pushed wage-price guideposts and started bashing businessmen, implementing fine-tuning and mindless intervention to an absurd degree. Thus, in February 1966, Gardner Ackley devoted considerable effort to rolling back an increase in shoe prices, and argued that the U.S. "should . . . proceed to draw up an export restriction order" (p. 122). In Prachowny's view, inflation was mounting because the government would not dampen aggregate demand, yet the nation's leading policy economist was advocating trade restrictions to deal with the problem! Had Shakespeare been alive, he might sensibly have advocated shooting the economists instead of the lawyers. The fiasco of failing to deal at a macro level with excessive aggregate demand set the stage for inflation and later stagflation.
Prachowny says that the CEA did not take advantage of modern advances in Keynesian economics, such as the development of IS-LM analysis. One can argue that they ignored non-Keynesian insights as well. Milton Friedman and Anna Schwartz had written their Monetary History of the United States before the tax cut was approved, and the early Keynesian notion that "money does not matter" (which seemed, roughly, to be the Heller view) was under serious attack. We were within a few years of reading new insights of Friedman, Phelps, Lucas and others. Why did not some of the brainpower at the Council anticipate the problems that demand stimulus would cause in the long run? Among the Council's members were future Nobel laureate James Tobin. Other future Nobel winners, like Robert Solow, were informal advisors. Eccentric, but probably correct, Ludwig von Mises almost perfectly anticipated the Phillips Curve and its ultimate demise in the forward to his new edition of the Theory of Money and Credit, published in 1953. If one wants to indict the Council on its economics, one does not have to limit oneself to its lack of sophistication regarding the Keynesian model.
When all is said in done, however, Prachowny's book is a welcome addition to the literature on American fiscal policy history. It adds importantly to the work of individuals like the late Herbert Stein and the self-congratulatory writings of participants in the policy-making arena. Prachowny despairs over the politicization of policy recommendations of economists, but to students of public choice his laments are totally predictable.
The Prachowny book is not the last word, however, on this subject. It is not a comprehensive analysis of the Kennedy-Johnson tax cut, but rather an economist's attempt to analyze the actions of fellow economists who were influential in making policy. The book virtually ignores the discussions between Lyndon Johnson and his other advisers, the role played by the Treasury, Commerce Department, Budget Bureau, Congress, special interest groups and the like. Making economic policy is like making sausage -- it is not pretty. Prachowny expresses horror at this, particularly at it relates to the CEA, but the problem did not start with Walter Heller or end with him. Indeed, as a longtime consultant to a congressional committee myself, I think the problem is far larger than he imagines. Indeed, the problems of timing fiscal policy, of the probability of special interest manipulation of results, etc., increase the case for a rules approach to macro policy, arguably on both the fiscal and monetary sides.
Perhaps some of the alleged failings of the CEA during this period should fall more on others largely ignored in Prachowny's account. Even if the CEA had behaved perfectly it might not have been able to alter policy that much: its power was finite. While House Ways and Means chair Wilbur Mills gets some mention in this book, there is very little on the political dynamics that went into the tax cut and the laterdecision to engage an income tax surcharge. There is no mention of Henry Fowler (LBJ's Treasury Secretary) or Everett Dirksen (prominent Republican senator) or dozens of other influential political leaders who played a role in shaping fiscal policy during this era. There is no mention of a fascinating phone conversation that Lyndon Johnson had with Heller the day after Kennedy's assassination inviting him, in effect, to fudge revenue estimates (as recounted in Michael Beschloss's editing of the Johnson White House tapes). In short, much of the richness of the story about policy changes of the era is lost in the Prachowny recounting, with its emphasis on the arcane details of forecasting, model building, and econometric estimations.
The Prachowny book, however, has stimulated me to offer a rather different revisionist account, which some scholar might wish to develop or challenge. At the time that the Kennedy-Johnson tax cut was approved in February 1964, the unemployment rate was 5.4 percent, below the annual average for any of the previous six years and 1.2 percentage points lower than when Kennedy took office. If Robert Gordon is right, unemployment was pretty close to its natural rate. The economy had been growing faster than its long run average rate (of about 3.5 percent annual output growth). For example, real GDP rose over 5 percent annually over the two years 1962 and 1963, significantly reducing any potential output gap. In the five quarters including the enactment of the tax increase and the year preceding, real GDP rose at annual rate varying between 2.9 and 9.2 percent a quarter, with the median growth rate being 5.3 percent. In short, there was no dire need to stimulate aggregate demand: the self-correcting properties of the market were working nicely to eliminate the last residue of the 1960 recession.
Yet 1964 was an election year, and LBJ was a masterful political animal. Johnson wanted to revitalize the New Deal coalition, and a tax cut would help give him the power to do it. The economy really did not really need a tax cut from a cyclical perspective, but it needed it to meet LBJ's political objectives, and the economy (and Kennedy's assassination) provided the cover. Heller, Okun and Ackley were partisan Democrats wanting to help the cause. Whether out of partisan enthusiasm for a liberal Democratic agenda or out of economic ignorance or both, they went all the way with LBJ. To be sure, the administration economists, with their obsession with aggregate demand, probably underestimated the supply side effects of the tax cut, as total income tax (individual and corporation) revenues rose over 20 percent from fiscal year 1963 (the last pre-tax cut year) to fiscal year 1966 (the first year with the cut fully implemented).
The Laffer curve dimensions of the tax cut were realized beyond their fondest dreams. Yet the extraordinary increase on the demand side from the Vietnam War and Great Society programs led to rising inflation, and ultimately to the higher inflationary expectations, wage increases and soaring interest rates that ultimately led to the stagnation of the 1970s. The budget deficit problem was not a result of a failure of tax revenues to grow, but rather entirely the consequence of an extraordinary growth in expenditures that went to fight what ultimately turned out to be two highly unproductive wars, the War on Poverty and the Vietnam War.
Enough of my own speculation. The important point is that Prachowny has provided a valuable addition to the literature, one well researched and documented. Its faults are ones of omission rather than commission, and his retelling of this era stimulates us to await a more comprehensive retelling of the fiscal experiences of the Sixties.
Reviewed by Richard K. Vedder, Department of Economics, Ohio University.
Which by the way we are fighting these same two senarios today !!
The War on Poverty and the War's in the Middle East...
