March 23, 2005,
Four years ago, with the U.S. economy stuck in recession, partisans condemned the Bush administration’s stated policy that tax cuts would put the economy back on track. Alan Greenspan, however, did not join the partisan chorus. In July 2001, the Federal Reserve chairman testified that “demand should be assisted going forward by the effects of the tax cut.” He was right. The 2001 recession was one of the mildest in postwar history, with the significant Bush tax cuts of 2003 generating what many are calling a bonafide economic boom.
Earlier this month, Greenspan again went to bat for the fiscal stimulus of tax cuts. He described the 1986 Reagan tax reform as “exemplary.” The 1986 measure, he observed, “is widely regarded as having been the most successful of the post-war era.”
What we heard was Greenspan at his supply-side best. He went on to say that “A defining feature of the 1986 reform was the broadening of the tax base and the lowering of tax rates, and it is widely believed that these changes enhanced economic efficiency. High tax rates (whether the base is income or consumption) exacerbate the distortions that taxes invariably create.” Economists, he added, “have disagreed about the size of the efficiency gains that might be achieved from a broader base and lower rates, but there can be little doubt regarding their positive effect.”
The response from Democratic partisans was telling. Following Greenspan’s comments, Senate Minority Leader Harry Reid referred to the chairman as “one of the biggest political hacks we have here in Washington.” A “hack,” one is to presume, is a Fed official who speaks from the supply-side. But Greenspan is hardly the first to do so. Fed economists have stood by the idea of lowering tax rates to stimulate growth in work that dates to the 1980s. And the work itself has often shown how supply-side theories are nothing new, and can be traced back centuries.
In October 1980, the St. Louis Fed even co-sponsored a conference called “The Supply-Side Effects of Economic Policy.” The event featured a paper by NRO Financial contributor Victor Canto, Douglas Joines, and Arthur Laffer that argued for the Laffer Curve an intuitive model which shows how tax rates “initially increase government revenue up to some revenue maximizing tax rate but decrease tax revenue beyond this point.”
Many Fed essays during this period explored how supply-side thought is rooted in neo-classical economics. John A. Tatom, in “We Are All Supply-Siders Now!” (St. Louis, May 1981), wrote that
Supply-side economics is growth- and efficiency-oriented. It covers the entire range of economic decisions: what gets produced, how, for whom, and how fast production and consumption possibilities expand. The supply-side approach is not novel in economic analysis. Indeed, it has been the core of economic analysis since the first systematic analysis of scarcity and aggregate supply, Adam Smith’s pioneering Inquiry into the Nature and Causes of the Wealth of Nations, was published over 200 years ago.
The Atlanta Fed delivered “Supply-Side Effects of Fiscal Policy: Some Historical Persepctives” in February 1981. The paper, by Robert E. Keleher and William P. Orzechowski, “responds to suggestions that the supply-side view is a novel, untested theory by showing that the approach actually represents a return to classical principles of public finance, developed and implemented in the 19th century.”
In January 1982, the same regional Fed bank published “Historical Origins of Supply-Side Economics.” The paper argued that while supply-side theory was being “Dismissed by academic critics as ‘quackery’ and ‘snake-oil economics,’” that it in fact represents “a return to the dominant orthodox strain of public finance analysis which originated with the attacks of [David] Hume, the Physiocrats, Adam Smith, and others on mercantilism.”
That same year, the Atlanta Fed hosted a “Supply-Side Conference” that “attracted a large group to hear Milton Friedman, Martin Feldstein” and others “debate the theoretical and practical validity of the supply-side approach.” A useful 297-page report was published.
One of the Fed’s top historical scholars is Thomas M. Humphrey of the Richmond bank. In a 1992 essay, Humphrey discussed the tax theorems of French economist Jules Dupuit (1804-1866), pointing out that they were Laffer-like in their in methodology and implications:
Dupuit’s third theorem posits an inverted U-shaped or Laffer-curve relationship between tax rates and tax revenue. Like Arthur Laffer in the 1980s, Dupuit in 1844 saw tax revenues rising from zero with small increases in the rate, reaching a maximum … then falling with further rate increases, and eventually returning to zero when the rate becomes prohibitive. This rate-revenue relationship together with his second tax theorem led him to conclude ‘that the yield of a tax is no measure of the loss which it causes society to suffer.’ For the same yield can be obtained from two different rates entailing markedly different deadweight losses.A more recent example of how our Federal Reserve banks have long taken the supply-side seriously came in 2000 when the Atlanta Fed published “The Shifty Laffer Curve,” by Zsolt Becsi. Becsi noted how “most analyses of the Laffer curve occur in a static framework that has proved inadequate.” Instead, Becsi developed a model to analyze “the long-run effects of tax policies.” He observed,
It turns out that how the government spends its tax revenues on consumption, investment, or transfers is important for understanding the Laffer curve. In fact, a different Laffer curve is associated with the different ways revenues are spent, and it is important to know which curve one is operating on when designing tax policies.
The truth is, some at the Fed have taken “hack” economics seriously for more than two decades. Better to be a supply-side hack and be right, than a name-calling partisan who gets it wrong time and time again.
Greg Kaza is executive director of the Arkansas Policy Foundation, an economic research organization based in Little Rock.