The tale of three recessions

In early 1961, the first year of President Kennedy’s administration, Time magazine reported, “More alarming to builders, who are accustomed to a recession pickup as cheaper mortgage money becomes available to home buyers, housing has stayed down.” ¹  Then, as now, the country was in ten month recession characterized by a housing decline. ²  Unemployment was 7% and the Federal debt 50% of GDP. 

According to economist Herbert Stein, the stock market fell sharply the following year. ³  To grow the economy, Kennedy first proposed raising government expenditures, but was blocked by Congress.  Ah, the good ol’ days!

Analyzing his options to boost the economy, Kennedy observed at the Economic Club of New York, December 1962, “In the past, this could be done in part by the increased use of credit and monetary tools, but our balance of payments situation today places limits on our use of those tools for expansion.

“It could also be done by increasing federal expenditures more rapidly than necessary, but such a course would soon demoralize both the government and our economy.  If government is to retain the confidence of the people, it must not spend more than can be justified on grounds of national need or spent with maximum efficiency.

“The final and best means of strengthening demand among consumers and business is to reduce the burden on private income and the deterrents to private initiative which are imposed by our present tax system … it is a paradoxical truth that tax rates are too high today and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now.”  ⁴

This powerful realization elucidated a fundamental truth of economics: give incentives to people and they work harder, save more, and invest wisely.  As a result, counter-intuitively, tax revenues increase.

The Kennedy tax cuts started with a reduction of business taxes and a relaxation of depreciation rules, because Kennedy recognized they “increase incentives and the availability of investment capital.”  The bulk of the cuts, passed in 1964 after his tragic death, were in personal rates.  Before the cuts, the marginal rate—the tax paid on the last dollar a person earns—could only be described as repressive.  The top rate was 91%.  The lowest rate, 20%, applied between $0 and only $2,000 (equivalent to $14,000 today).  The middle class paid between 30% and 60% of their income to Washington. ⁵

Kennedy reduced the top rate to 70% and all brackets received cuts between 16% and 43%.⁶  Although other factors contributed, GDP grew 4.8% per year on average from 1961 to 1970, up from an average 2.6% per year for the nine prior years 1952 - 1960.  What is more, the Federal debt dropped to 36% of GDP through 1970, even as we built up defenses for the Cold War and Vietnam, because, as Kennedy predicted, tax revenues paradoxically increased with lower marginal rates.

The recession that President Reagan inherited in 1981 was remarkably similar to that assumed by Kennedy: six months of recession in 1980 followed by 16 months when unemployment rose to 9.7% in 1982. ⁷  Reagan had the added problem of dealing with 13% inflation and an energy crisis.  While others before him were wearing sweaters, tuning down thermostats, and talking about rationing energy, Reagan, understanding the nature of free markets, simply lifted the 1973 price controls on oil within days of taking office, which had the propitious effect of increasing supply and ending the crisis.  With Reagan’s support, the Federal Reserve under Paul Volcker brought inflation to just 3% by 1982 by tightening the money supply.

The dramatic successful conclusions of these two crises allowed Reagan to turn his attention to growing the economy.  Like Kennedy, he cut the top marginal tax rate from 70% to 50% in 1981.  Unemployment dropped through 6% during the next four years and tax revenues doubled throughout the 1980’s ⁸ as did GDP. ⁹  In 1986, Reagan signed a tax simplification law that cut the top marginal rate again to 33% and created only four brackets, which continued the economic boom.

Analyzing the effects of the Reagan program 14 years later, the Joint Economic Committee (JEC) of Congress concluded, “High marginal tax rates discourage work effort, saving, and investment, and promote tax avoidance and tax evasion…. The economic benefits of ERTA [Economic Recovery Tax Act of 1981, the first round of Reagan tax cuts] were summarized by President Clinton's Council of Economic Advisers in 1994: ‘It is undeniable that the sharp reduction in taxes in the early 1980s was a strong impetus to economic growth.’ " ¹⁰

What about the objection that tax cuts benefit only the rich?  The JEC said, “The share of the income tax burden borne by the top 10 percent of taxpayers increased from 48.0 percent in 1981 to 57.2 percent in 1988.”

In our present recession, unemployment is ironically where it was in 1983.  Since the Reagan years, the marginal rates have crept up to just under 40% under President Clinton, as the chart below shows¹¹, and down slightly to 35% under President Bush—still higher than the Reagan years.

In contrast to Kennedy and Reagan, President Obama and Congress are considering raising marginal rates and capital gains taxes, while toying with tax surcharges and other ways of taxation.  Like a pilot who is taught to push a stalling aircraft’s stick down when instinct tells him to pull it up, they should put faith in the Kennedy paradox.  May they find succor to push on the stick in the words of Patrick Henry, "I have but one lamp by which my feet are guided, and that is the lamp of experience. I know no way of judging of the future but by the past."

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[1] “Business: Housing Troubles?” Time, 24 Feb. 1961 http://www.time.com/time/magazine/article/0,9171,828814,00.html

[2] “Business Cycle Expansions and Contractions”, The National Bureau of Economic Research, http://www.nber.org/cycles.html

[3] Stein, Herbert. “Why JFK Cut Taxes” The Wall Street Journal, 30 May 1996 http://www.msjc.edu/econ/jfk022502.htm

[4] Kennedy, John F.  “Address to the Economic Club of New York.” 14 December 1962 http://www.americanrhetoric.com/speeches/jfkeconomicclubaddress.html

[5] “U.S. Federal Individual Income Tax Rates History, 1913-2009.” Tax Foundation, http://www.taxfoundation.org/publications/show/151.html

[6] Robbins, Gary & Aldona. “Tax Policy & the 1960s: Another Look At the Kennedy Tax Cuts.” Institute for Policy Innovation, http://www.ipi.org/IPI%5CIPIPublications.nsf/PublicationLookupFullTextPDF/D363A0E54E2E40AB862567ED00213FCA/$File/kennedy.pdf?OpenElement

[7] “Employment status of the civilian noninstitutional population, 1940 to date”, Bureau of Labor Statistics, ftp://ftp.bls.gov/pub/special.requests/lf/aat1.txt

[8] “Tax Revenues Nearly Doubled During 1980s.” The Heritage Foundation http://www.heritage.org/Research/Taxes/images/bg1086c10.gif

[9] “Real Gross Domestic Product, Chained Dollars”  Bureau of Economic Analysis http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=6&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=1980&LastYear=1999&3Place=N&Update=Update&JavaBox=no#Mid

[10] “The Reagan Tax Cuts: Lessons for Tax Reform.” Joint Economic Committee, Congress of the United States, April 1996, http://crab.rutgers.edu/~mchugh/taxes/The%20Reagan%20Tax%20Cuts%20Lessons%20for%20Tax%20Reform.htm

[11] “Maximum Income Tax Rates.” The Heritage Foundation http://www.heritage.org/Research/Taxes/images/bg1086c2.gif