The Failure Of Republican Economic Policy

Republicans are enamored by "supply-side" economics. Frankly, I have to admit it's a very easy sell. Think about it. "Cutting tax rates stimulates the economy to such a high level that tax revenues increase." However, there are several problems with this theory. The first is Republicans have not implemented the other side of "supply-side economics" -- a corresponding cut in government spending. This has ballooned the federal debt to dangerous levels under their economic stewardship. In addition, the projected increase in government revenues really haven't materialized as projected. In other words, supply-side economics is a great marketing concept, but in reality is a poor national policy.

First, let's get some administrative issues out of the way. I will be using data from the Congressional Budget Office's historical data the Bureau of Economic Analysis, the St. Louis Federal Reserve and the National Bureau of Economic Research

Reagan was the first person to implement supply-side economic policy. According to the NBER, the primary expansion under Reagan's leadership occurred between November 1982 (the fourth quarter of 1982) and July 1990 (the third quarter of 1990). According to the BEA, the median quarterly percentage change in GDP over this period was 3.85 percent. That's a very good number.

But let's look deeper into the numbers. First, there was a mammoth explosion of government debt during this expansion. Here's a chart from the St. Louis Federal Reserve of total government debt outstanding.

In other words, this was financed growth; the U.S. borrowed heavily to achieve this growth rate. The primary reason for this explosion in debt is Reagan never balanced a budget; he continued to increase government spending. Here is a chart of federal revenues and expenditures from the St. Louis Federal Reserve. Notice first the scale on the right side of the chart is lower than the left side of the chart. Then notice that federal receipts were always lower than federal expenditures.

Let's now turn to receipts from personal income taxes. According to the Congressional Budget Office's historical budget data, tax receipts from individuals totaled $297 billion in 1982 and $466.9 billion in 1990. That's an increase of 57.20 percent. Over the same period of time the GDP price deflator increased from 63.866 to 82.053, or an increase of 28.476 percent. In other words, the increase of tax revenue from individuals really isn't that impressive after adjusting for inflation.

Let's stop here and make a few observations.

1.) The overall rate of growth was very good. A 3.85 percent median quarterly rate of GDP growth is a very good number.
2.) But the economy was grown on credit. And the rate of growth in total government debt was very high.
3.) The high growth rate in total government debt outstanding was caused by a continuing increase in government spending at a rate higher than government revenues.
4.) After adjusting for inflation, the growth in receipts in personal income taxes isn't that impressive.

Let's fast-forward to Bush II:

According to the National Bureau of Economic Research, the current expansion started in November 2001. Since then, the median rate of quarterly GDP growth in 2.7 percent and the average (mean) is 2.74 percent. While this isn't the most impressive median GDP growth number we could expect, it certainly isn't the worst either. This falls into the "fair" category.

But like Reagan, the expansion has been grown on credit. Reference the total government debt outstanding chart from above and notice the upward trajectory the chart takes. Here is a report from the Department of the Treasury of the total federal debt outstanding at the end of the last six federal fiscal years:

09/30/2006 8,506,973,899,215.23
09/30/2005 7,932,709,661,723.50
09/30/2004 7,379,052,696,330.32
09/30/2003 6,783,231,062,743.62
09/30/2002 6,228,235,965,597.16
09/30/2001 5,807,463,412,200.06
09/30/2000 5,674,178,209,886.86

The main problem is (again) that federal expenditures have far exceeded federal revenues. Here is the chart of federal revenues and receipts from above. Again notice the hard part of "supply-side" economics is cutting spending. While cutting taxes is easy, cutting spending is hard.

Let's look at tax revenues to see how they have responded. First, remember that Bush first cut taxes in 2001 and again in 2003. So let's go back to the first tax cut to see what happened from that point forward. According to the Congressional Budget Office's Historical Budget Data, total revenue from individual taxpayers was $994 billion in 2001 and $1.043 trillion in 2006. Since the fourth quarter of 2001, the GDP price deflator has increased from 103.1221 to 117.003 (this was the price deflator in the third quarter of 2006 when the federal government's fiscal year ends). This is an overall increase of 13.46 percent. In short, after adjusting for inflation, the overall increase in tax revenues from 2001 when the first tax cutting began is nothing to write home about.

Republican commentators usually start their analysis from 2003. First, note the tax revenues decreased from $994 billion in 2001 to $793.7 billion in 2003. This is hardly the result the Republicans predicted for the 2001 tax cuts. However tax revenues increased from $793.7 billion in the 2003 to 1.043.9 trillion in 2006. This is an increase of 31.52 percent. The GDP price deflator in the third quarter of 2003 was 106.616 and was 117.003 in the third quarter of 2006, or an increase of 9.74 percent. So using 2003 as the starting point we can see that total tax revenues have increased, but again not as impressively as Republican pundits like to think.

Notice we can draw the same conclusions for Bush II that we can for Reagan:

5.) The overall rate of growth was fair. A 2.7 percent median quarterly rate of GDP growth is decent, but not great..
6.) But the economy was grown on credit. And the rate of growth in total government debt was very high.
7.) The high growth rate in total government debt outstanding was caused by a continuing increase in government spending at a rate higher than government revenues.
8.) After adjusting for inflation, the growth in receipts in personal income taxes isn't that impressive.

First, let's note the growth in tax revenues from individuals after adjusting for inflation is good, but not the result the Republican commentators promised. In addition, look at the CBO historical budget tables for other expansion and you'll see tax revenues grew at similar or higher rates during economic expansions. This leads to the conclusion that growing individual tax revenues is as much a function of overall economic growth as it is of overall tax rates.

Secondly, while I would agree that cutting marginal tax rates from a high level to a lower level is probably going to be stimulate the economy, smaller cuts clearly aren't the amazing panacea the Republicans advertise them to be. As an example, I do think that Kennedy's cuts were clearly a cause for the 1960s economic expansion. But arguing that a small cut from 40 percent to 37 percent is the greatest thing since sliced bread is overselling the idea.

At this point we get into a discussion about the underlying policy about the appropriate use of government debt: when to use it, how much to use when we use it and when to pay it down. The bottom line is economic growth from the last two great supply-side experiments has been financed by using government debt. Neither Reagan nor Bush meaningfully cut government spending, largely because that's the hard part of supply-side economics. Both used government debt to finance the shortfalls between government spending and revenue. None of this debt has been paid-off, and probably won't be in our lifetime.

Regarding government debt, I would argue the following. Government debt should be used sparingly. In times of an economic slowdown deficit spending is warranted to mitigate the negative effect of a slowing economy. But when the economy is doing well, the government should work to pay-off its debt. This will allow the government to engage in deficit spending when the next recession happens. This overall idea is hard politically, which is why it's probably not done.

In essence, the U.S. is faced with a policy decision -- how to finance growth. Do we pay as we go, or pawn off the cost of growth on future generations? I would argue that paying as we go does not propose a radical or anti-growth situation because the 1990s demonstrated that increasing taxes on upper-income taxpayers dies not thwart growth. In addition, we balanced budgets in the 1990s and it did not thwart growth. In short, paying for growth as we go is the sane and sensible answer. And it's one the Democrats need to embrace.

Comments

[nikto]

If we don't overturn NAFTA, then HUGO CHAVEZ will have to do it for us.

If that's what it takes, then so be it.

[johnnyhempseed]

Excellant analysis Hale,Socialism for the rich,Corporate welfare,screw the ,middle class and working poor ,outsource the military and the government,outsource the I.R.S. while spending borrowed Asian money like a drunken sailor in port for the weekend.Isn't that "Voodoo economics" on steroids? If they monetise the dept any more the Dollar is burnt toast.Thanks for "Bonddads" excellant posts,you have made economics much more understanable. peace

[peterg76]

Supply-side economics has *never* worked in the real world. It has always been based entirely on people spending money that doesn't exist. And if you could do that, it wouldn't matter what economic policy you had.

Supply-side economics is really a religion, and an ineffective, self-destructive one at that.

[Novista]

Gold over $700/oz. Yeah. Won't help you gold bugs when the meltdown continues, the banks are closed to prevent a run and you can't get at the safety deposit box.

And maybe by the time they open, Bu$hCo will confiscate private gold (mostly) like FDR did in 1933. Would that have counted as voodoo economics? A neat trick, $20.67 to the sheeple and then set the official price at $35.

Wall St. needs eased credit? Isn't that why we're in strife now?! What was that definition of insanity ...

[joebaggadonuts]

Bondad,

The facts you lay out are the soft underbelly of the Administration and its Enablers in Congress. If folks keep them in mind when they go to the polls the R's don't stand a chance (assuming we get Diebold and its friends to properly count the votes). However, the fact is that they have some 25% who will not ever change their POV, and another 25% who will succumb to their finger pointing about family values and killing fetuses, despite the fact that most of these creeps have family values inconsistent with the public and don't give a rip about life in the womb or anywhere else if it's not theirs or making them money.

I too hope that stark facts will wake folks up, but the evidence is not in.

Thanks again for your continued efforts.

joeb.

[magen]

RepubliCON economic policy--

Anything that helps midlle class Americans--Cut funding

Anything that increases corporate profits or promotes war--Fund with billions of taxpayer dollars.

[procrustes]

CRIME OF THE CENTURY

Why would a bank grant a mortgage to someone not even remotely qualified? Someone who, unless their meager income jumps by a factor of two in two years is certain to be unable to service the debt? (This ain"t the crime, hang on a bit.)

Why? Because it"s very profitable.

Nuts, you say? How can creating sure fire loan defaults be profitable? Easy, sell the mortgage to someone else at a rate so discounted that it appears to be a steal.

But, but...if only one percent is made on the deal, how can that be good business? Well, do it once month for twelve months and you"re turning a cool 12% profit on nearly zero risk.

Okay, but this is everyday scoundrel stuff"how"d big banks get sucked in by a tinhorn scam like this, you ask.

WE"RE GETTING CLOSE TO THE REALLY SLICK CRIME.

Some "solid" investment bank buys up a whole bunch of these loans and in the magic that allows banks to book loans as assets this paper is used as collateral to issue bonds.

AND HERRREES THE STING:

A major bond rating agency, say like Moodys, say"s "Geeze, this is paper issued by Bear Stearns, or Goldman Sachs, or somebody like that, and grant the bonds AAA top quality rating, investment grade, rock solid for the ages even though they know the bonds are based on pure crappola. The bonds sell for top dollar.

This crime dwarfs Enron, and don"t think for one minute that our international banking friends stuck with these bonds will forget.

A whole bunch of people should go to jail for a very long time, but they won"t. A whole bunch of people will lose their homes, instead.

[mrcontinental]

They won't forget, or forgive. And when we fall, and we will, NO ONE will come to our aid.

[daniel155]

Well the author is of course right. Spending should be cut but realistically that is not going to happen. No matter which party is in power, spending never gets cut in realistic terms.

Even if we had some leaders that are serious about cutting spending there are so many entitlements, for example Social Security payments, that there is relatively little discretionary spending that could be subject to being cut.

The only way spending will be cut is for both sides to agree on some type of across the board spending cut. This was tried in the 1980s with the Gramm-Rudman-Hollings bill. It did not work because courts struck down parts of it and Congress found ways to get around the other parts.

So the only game in town to reduce deficits is using tax or fiscal policy. This can be done by raising taxes and running the risk that revenue will decrease because of the negative economic aspects of raising taxes.

Or it can be done by cutting taxes to stimulate the economy and running the risk that the increase in revenue will not be enough to offset increase in spending which is almost built into the budget.

I cry in my beer with the author about high spending but real spending cuts are not going to happen regardless of whether the Republicans or Democrats are in power.

[daniel155]

Correction: spending never gets cut in real terms. Not realistic

[radmul]

You are using facts to make your argument. The free market is an article of faith and no amount of evidence will change the minds of these true believers. We are after all, "kicking Ass", in Iraq.

[CharlesMac]

Thank you for the properly researched, analyzed, and organized presentation. I'm tired of making argument about the state of economy by saying "An economy overfueled by debt sucks".

Now I have the correct words.

[FreeLibertarian]

Libertarians are the only real alternative to the tax and spend Democrats and their allies, the borrow and spend Republicans.

[deZerTomB]

Good point, if reducing taxes increases revenue then zero taxes should result in infinite revenue. Basic math. Because of the nature of politics and election cycles, politicians tend to implement policies that result in feel good short term results at a cost that is not realized until far in the future when that politician is long gone.

Also, do any of these debt figures include the costs of the war?

[daniel155]

The inverse of that is that if raising taxes raises revenue then raising the tax rate to one-hundred percent would produce more revenue.

Not as simple as you think.

[ChristianEcon.com]

"The inverse of that is that if raising taxes raises revenue then raising the tax rate to one-hundred percent would produce more revenue."

Why wouldn't it? You're under the mistaken ideological assumption that government can't spend efficiently to maximize growth.

[leftLibertarian]

The state always helps the Capitalist Class, just watch Wall Street crying so that the Fed will help them.

[olephart]

Speaking of which, did you see Cramer on CNBC blaming Bernanke for not shoveling money into the brokerages to bail their crooked asses out? After 10 years of no hike in the minimum wage, millions losing their health insurance, wage stagnation and CEO pay rising to 364 times that of the average worker when the market they created goes bust they want WELFARE!

[opines]

The Fed is supposed to be independent, apart from partisan politics with a mandate to implement sound fiscal policy.

Lowering interest rates will further weaken the dollar and will add helium to inflationary trending.

With Wall Street demanding eased credit and the MSM giving face time to pro-business shills, e.g., Larry Kudlow, the supposedly independent Fed is likely to cave, providing a bailout for selected debt riddled corporations.

To justify such an inflationary step, the business shills are making the preposterous claim that inflation is under control.

Not in the breadbasket of the middle class where food prices are skyrocketing. Not just in food, but in all industries affected by fuel costs.

What they really mean is that in their judgment the inflationary result is preferable to allowing poorly run corporations to fail, which would shake the stock market.

But the danger of runaway inflation is very real and far more dangerous to the economy than the failure of debt-drenched corporations.

The public must demand to know how the rate of inflation is derived. What items are in the basket?

Runaway inflation is a system ender. Bankrupt corporationscan be survived.

[Bluetiger]

As always your work is well thought out, well researched and a pleasure to read.

But now we need a the same for "Bubble Up". A set of good logical reasons for an economic policy that with a balanced budget feeding money into the bottom of the economic strata will cause a stable and well run economy that will appeal to the fiscal conservatives as well as the social actives.

The best way to combat magic is to make magic back. We have heard about trickle down so much it is stale. Give us something with a lot of neat sound bites that meets the needs of today. We need this because when a new president takes over he will need a robust economy so we can work our way out of the mess that Bush has given us. We need this or in four years these guys will be back.

[RogerHWerner]

Why are we still talking about this? Obviously, because some of our leaders continue to buy into the supply side myth. I would have thought that serious discussion of supply side economics would have ended with Reagan's massive deficits. What's so hard to understand: It doesn't work. It promises something for nothing and reality usually doesn't work that way.

[cuddletuffy]

well said.

[daniel155]

We are talking about this because tax policy is an important issue.