Recession Prevention: Keynes Was Right
Macroeconomics, Fiscal Policy, U.S. Economy, Monetary Policy, American Recovery and Reinvestment Plan

January 28, 2008 —
Once upon a time, economic downturns were looked on as inevitable. Or incurable. Or even a morally justified, righteous cleansing of an economy burdened by the sins of excess. One result of this thinking was the policy mistakes that contributed to the Depression. One of the few good developments to come out of this experience was perhaps the most important economic breakthrough in the 20th century: John Maynard Keynes’ 1936 book, “The General Theory of Employment, Interest, and Money.” Keynes pointed out that in a downturn, an economy simultaneously has idle factories, unemployed workers and too little spending. This creates the possibility of a virtuous circle: Getting people to spend more will put the factories back to work, staffed by the previously unemployed workers. Put another way, in the short run, when the economy is operating below its potential, expanding demand can create supply.

This Keynesian perspective is now standard textbook economics, taught in virtually every introductory economics course. The textbooks teach that policymakers have two tools at their disposal to counteract a downturn. One is monetary policy, which can lower interest rates to encourage consumers and businesses to borrow more and use the money for spending on consumer durables, housing, factories or equipment. The second tool is fiscal policy, which can temporarily increase government spending or cut taxes — again with the goal of raising consumption or investment.

Economists generally prefer that fighting business cycles be left to monetary policymakers because they do not trust the president and Congress to get it right. One fear is that the glacial political process will fiddle and haggle until well after the recession has passed, thus destabilizing the economy and contributing to higher inflation. Another fear is that in an election year, the president and Congress will try to push the economy beyond its capacity, again triggering inflation with little economic benefit. But neither of these arguments is grounded in any fundamental insight; they are just based on a presumption about the political system.

But this time, the presumption about the political system appears to be wrong. The economy appears to be slipping into a potentially serious downturn. The Federal Reserve has cut rates by 1.75%, but lags in the effect of monetary policy mean that much of the benefit of these rate cuts will not be felt until 2009. Fortunately, Congress and the president appear set to fill in some of the gap before 2009. It is likely that in May, June and July the U.S. Treasury will mail out $100 billion worth of checks to working households. If past experience is any guide, at least $50 billion of these funds will be spent — which together with multiplier effects will add about 3% to the annualized growth rate in the third quarter of this year. If extended unemployment insurance or food stamp increases are added to he final package, as demanded by many in the Senate, the macroeconomic benefits would be somewhat larger.

We will eventually need to pay back this money, but an extra year of lower unemployment and higher output will put us in a better position to do so. That is the paradox of economics in a downturn. Normally, the only way to grow the economy is the old-fashioned way: delaying gratification through reduced deficits and increased savings to encourage more investment. But in a downturn, these steps would just compound the problem and worsen the vicious circle of rising unemployment, underutilized capacity and falling consumption. Perhaps we should be thankful that the substantive economic need for a bit of immediate gratification happens to have fallen in an election year.

http://www.brookings.edu/opinions/2008/0128_recession_prevention_furman.aspx

And the primary requirement in supply side is that when the tax rate is lower, every dollar of income must be taxed at those rates. You can’t have rules which allow corporations that SELL products in the United States avoid taxes on that income by keeping the profits OUTSIDE of the United States.

Which is why supply side does not work. Because in practice its proponents have never raised taxes to levels high enough to deal with all the exceptions to the rules and the tens of thousands of deductions that allow those with the largest incomes to avoid paying taxes even at those lower rates

Supply side says two types of taxation are bad for government revenues. The closer the top income tax rate comes to 100 percent, the lower the revenues, and the closer it come to zero, the lower the revenues.

If the top tax rate is insufficient to prevent government deficits, it does not meet the standard for supply side theory either.

Theoretically the OPTIMAL income tax rate is fifty percent. Top rate that is. But in reality, the rate can be anything between 0 and 100 percent, as long as that rate pays for everything the government does.

And this excludes programs that are paid for by taxes other than income taxes, like Social Security and Medicare, which have their own dedicated taxes, and which produce a surplus. That is they now take in more than go out.

When you remove Social Security and Medicare from the mix, because of their separate dedicated taxation, at the rates Reagan initially lowered taxes to, there was not enough revenue to pay for governments “non discretionary” spending. Which according to supply side, is not good. Reagans rates went below what is necessary to pay for government programs, even with the large cuts he made in many other disrcretionary programs. That is to say, Reagans tax cuts left the goverment with not enough revenue to even pay for his defense budget, so he started raising other taxes, payroll taxes, to create a surplus he could draw on, gasoline taxes, etc.

David Stockman ended up quitting as Reagans OMB advisor, because he simply did not want to be blamed for the exploding deficit that was created by Reagan tax cuts and increased spending in non discretionary areas.

If I want to make 700.000 a year and the tax rate is 30 percent and each employee brings in 100,000 dollars of profit beyond the cost of running the business, all I need is ten employees. But if the tax rate is 60 percent and each employee makes the same 100,000 dollars a year, to extract 700,000 a year for my own personal income, I need 20 employees to make that personal nut for myself.

The results never came close to measuring up to the supply-side rhetoric. For starters, the tax cuts busted the federal budget. The federal deficit ballooned from 2.7% of GDP in 1980 to 6% of GDP in 1983, the largest peacetime deficit in history, and was still 5% of GDP in 1986. Tax revenues did pick up, especially after the 1983 payroll tax increase kicked in, reducing the deficit somewhat. Still, tax revenues grew far more slowly over than the 1980s business cycle (2.5% from 1979 to 1989) than they did in the 1990s business cycle (4.1% from 1989 to 2000).
The tax cuts came in 1981, Reagan’s first year in office. The administration’s plan slashed corporate and individual income tax rates, with the biggest cut in the top rate. The Reagan team promised that their tax cuts would jolt the economy back to life because, as the Wall Street Journal’s editors put it, “high taxes interfere with natural human creativity and drive.” And the true believers went so far as to suggest that the economy would grow fast enough that tax revenues would actually rise, making the tax cuts painless.

The results never came close to measuring up to the supply-side rhetoric. For starters, the tax cuts busted the federal budget. The federal deficit ballooned from 2.7% of GDP in 1980 to 6% of GDP in 1983, the largest peacetime deficit in history, and was still 5% of GDP in 1986. Tax revenues did pick up, especially after the 1983 payroll tax increase kicked in, reducing the deficit somewhat. Still, tax revenues grew far more slowly over than the 1980s business cycle (2.5% from 1979 to 1989) than they did in the 1990s business cycle (4.1% from 1989 to 2000).

http://www.thirdworldtraveler.com/Ronald_Reagan/Ronald_Reagan_Legacy.html

http://www.thirdworldtraveler.com/Ronald_Reagan/Ronald_Reagan_Legacy.html

Nor did the claim that tax cuts would encourage work effort, savings, and investment, the central premise of Reaganomics, hold up. When mainstream economists, such as Barry Bosworth and Gary Burtless of the Brookings Institution, checked out the effects of the 1981 tax cut, they found that something quite different had happened. After the tax cut, men didn’t work much more at all; although women did work longer hours, their earnings failed to improve. And relative to the size of the economy, net investment declined and savings plummeted. The Economic Policy Institute, a labor-funded think tank, reports that the annual increase in real investment in the 1980s business cycle (2.5% per year) was less than half of that during the 1990s business cycle (5.9% per year).
Worse yet, most low-income taxpayers missed out on the Reagan tax cuts. The bottom 40% of households paid out more of their income in federal taxes in 1988 than they had in 1980. Increases in the payroll taxes that finance Social Security and Medicare, which made up a far higher portion of their federal tax bill than income taxes, swamped what little benefit these taxpayers received from lower income tax rates. For the richest 1%, on the other hand, the Reagan tax cuts were pure elixir. This group saw their effective federal tax rate drop from 34.6% to 29.7%, according to a recent study conducted by the Congressional Budget Office. As these numbers suggest, Reagan left a far less progressive federal tax code than he found.

The bottom 50 percent of workers ALL saw their taxes increase because they moved up from the bottom 10 percent bracket, to the new lowest bracket 15 percent. If they were making 10,000 a year, they were taxed 1,000 dollars the year BEFORE Reagans tax cuts, and 1,500 the year after they went into effect. Plus Reagan REMOVED every little deduction that a lower income person could take. Removed Credit Card interest, removed the 400 dollar charitable contribution tax credit. If you were working class or poor and you made 400 dollars worth of charitable donations, money or in kind, you could take a tax credit. Reagan removed that. The average person making the median income saw their taxes increase. Those making a bit more ended up having to send a check to the IRS. A single person, with nothing but the standard deduction. making about 18,000 a year back then, had to send a check for about 240 dollars to the government, above and beyond what was taken from their payroll for income taxes if they filed the 1040 A form.

While Carter was president, in his last 18 months, economists kept predicting a recession, but it never came. It did not hit until well into the end of Reagans first year and as economists recorded at the time, was the result of Reagan policies.

The difference between Obama’s Telepromter use, and George W. Bush’s, was that Obama can actually read something more complex than “The Very Hungry Caterpillar”

When Laura Bush, embarrased by her husbands lack of literary awareness, established a reading program for him, she chose some very good books, but they were very short ones, like Camus’ “The Stranger”. He shortly gave up on the reading program.

I detect a bit of jealousy with or without the teleprompter Pres Obama is a great orator MAYBE John McCain should have used the teleprompter during his campaign INSTEAD of walking into it like an old senile man walking aimlessly in the dark (remember that?)

Let Go of teleprompter Dead Reagan and the dying GOP.