Good article by Larry Kudlow on Reaganomics.
Hard to believe, but taxes were that high just 25 years ago:
“When Reagan moved to implement his tax-cutting policies in 1981, he was severely criticized for favoring the rich and decimating U.S. financial solvency. Democratic candidates on the campaign trail are echoing those very same criticisms today. But Reagan was unmoved by partisan attacks 20 years ago. He first lowered top marginal personal tax rates to 50 percent from 70 percent, making the rate reduction fully effective in 1983. He next lowered corporate tax rates to 34 percent from 48 percent. Then, in 1986, in a second tranche of tax reform, the Gipper reduced the personal rate for individual incomes all the way to 28 percent.”
I remember him saying: “The moment it started working, they stopped calling it reaganomics” Hahaha. The Gipper is just All Right!
God bless the Gipper.
Nothing has changed. If you lower the cost of capital associated with economic development-through taxation, interest rates, or discount rate assumptions- you WILL get more of the activity. Memo to the DNC: your candidates are recommending one version or another of INCREASING the cost of capital associated with economic growth, thus you are ASSURED that there will be less of it. You can shroud your arguments with class warfare, “pay their fair share”, and other sound bytes masquerading as fiscal discipline, but you cannot repeal laws of capital flight. JFK knew it, as did Reagan. Strauss is having an impact with the GWB administration, too bad that the Donks are financial illiterates.
Miguel – Reagan always seem to get less credit than he deserves.
Rahul – God Bless the Gipper indeed.
Hightower – I wish the government would just leave us alone.
My experience with economic is EXTREMELY limited, but aren’t there economic consequences to a large deficit too? Deficit spending is usually thought to raise the price of capital, too, by causing higher interest rates. That hasn’t happened yet, but it happened during the mid 80’s before Reagan started to bring the deficit back under control. Wasn’t that the essence of the IMF’s complaint a few weeks ago with US fiscal policy?
I like how Reagan cut taxes, and indeed it led to economic expansion. Inflation often go hand in hand with expansion simply because people are making more money, so they’re in essence “bidding up” prices with their increased disposable income. There’s always a balancing act to find a good balance between inflation and expansion.
I think with Reagan, US treasuries hit almost 18-20% interest rates due to the high cost of capital. Pretty good returns for government debt.
B of P,
Blind leading the blind here, but as far as I understand it the deficit isn’t so bad. Sure you’re hearing NOTHING but doom and gloom- “record high deficts- WE’RE ALL GOING TO DIE” chicken little talk out of the media. But as a percentage of our GDP it isn’t that high. Very manageable right now. Why isn’t there headlines screaming RECORD HIGH PRICES FOR BUBLE GUM! We are paying more for gum now than ever before- WE’RE ALL GOING TO DIE!
THe IMF also cried about deficits with Reagan. And as a percentage of the GDP it was much worse then than it is now.
Still, there is reason to worry. But cutting taxes and expanding the current deficit with additional spending, as the dems propose, is not the answer.
The deficit isn’t the problem. The problem is the high level of government spending and the (unavoidable) fact that much of this spending is unproductive. Deficits and debt are only problems if the economy isn’t growing enough to cover them.
Look at it this way. In one scenario there is private spending and govt spending and a deficit. In another scenario there is the same total level of private and govt spending, but govt spends a greater proportion of the total because taxes are increased to balance the budget. In which scenario is total output likely to be bigger? That’s the real question, and I think the answer is pretty clear.
Politically, deficits can actually be good to the extent they discourage additional spending by govt. Unfortunately, nowadays very little seems to discourage additional govt spending.
Goverment debt clearly increases the cost of capital.
Y(Ip) = C + I + G
Production(A function of private investment and other stuff, but not government spending)= Private consumption + Investment + Government spending (Ignoring imports and exports)
I = Y(Ip) – C – G
Investment = Production less consumption less government spending.
Thus, with any increase in government spending, investment, and likley production will both go down.
I = Ig + Ip
Investment = Investment in government debt + Investment in private stuff.
As the defecit grows, Ig goes up, thus as G rises in the absence of increased tax revenue or decreased consumption, Ip goes down. Since production is a function of Ip (Private investment), increased government defecit leads to decreased production.
Understood on the last point. But I submit that the deficit is a red herring. At 5% of GDP, it’s not an overly worrisome number, at least from a historic standpoint. In previous wartime experience, it’s run at a materially higher figure. Military spending soared in the 80s, deficits ensued, and the economy roared back from the “malaise” (Jimmy Carter’s words) of the 70s as Reagan pushed for reduced tax rates (which is not synonomous with tax receipts). Grow your way out of the deficit. Taxing your way out assumes static behavior on the behalf of the citizenry, and assumptions are the mother of all _____-ups.
Hipocrite,
-This theory is not confirmed by evidence. Interest rates, which are an index of the cost of capital, are not well correlated with govt deficits. And whatever effects govt borrowing has on interest rates are apparently dwarfed by the effects of economic activity. Economic expansion is what drives up interest rates and vice versa.
-The cost of capital is not really the issue here. The issue is how much the govt spends and how it finances that spending. The govt can run a deficit and make up the shortfall by borrowing, or it can make up the shortfall by printing money, or it can take more private income in the form of taxes. The first option is least bad. The second option leads to disaster. The third option reduces availability of capital to the most productive parts of the economy, meaning that productivity and overall growth will likely suffer. (And no, the most productive businesses, which are typically high-risk ventures when they are starting out and have greatest need for capital, will not necessarily be able to borrow the capital that they need. For this purpose we have equity markets, and higher taxes means less funds for investors to use to buy stakes in promising new ventures.)
-BTW, not all govt spending is a bad investment. For example, military spending that contributed to the fall of the Soviet empire was an excellent investment, making possible higher economic productivity in the future by helping to eliminate large regular costs for defense and freeing a lot of able people for more-productive work.
2002 Total fixed investment was 1,565 billion dollars.
400 billion dollars is 25% of this number.
Remember, the deficit does not have a substantial impact on production, rather on investment.
No theory in what I posted, merely identity maths. I know that it’s policy here not to have a strong academic understanding of economic principals, but the argument you are presenting is that the effect of decreased investment does not have as substantial an impact on production as the increased consumptive demand does, which is fine, as far as it goes. Ironic, isn’t it, that the Reganites are now demand-siders, don’t you think?
Finally, it is inherently disengenuous to segregate borrowing via equity markets from interest rates. As you probably know, the required return on equity goes up lockstep with the required return on riskless assets.
Hipocrite wrote:
Remember, the question I addressed was: What are the real alternatives and costs of “reducing the deficit”? The main alternatives are govt borrowing and tax increases, of which borrowing is less costly and less economically disruptive. (Cutting govt spending is another alternative, but that should be obvious.) If deficit reduction means “paying down the deficit” — i.e., increasing taxes or not refunding surpluses, which is the same thing — then there will indeed be a substantial, and negative, effect on investment and hence, ultimately, production.
The fact that a statement appears in a textbook as an accounting definition does not make it empirically valid as a description of economic and political behavior. It’s circular and meaningless unless you connect your statement to evidence. You have not done so, merely repeated assertions, and when challenged you dodge by claiming the assertions aren’t theory. I agree that they are not theory, and they are not evidence either, so what’s your point?
Is Greenspan an “economic principal”? I think I understand him. But I am afraid you misunderstand my argument, the gist of which is that govt deficits per se are not a big problem, if a problem at all, and that most of the cures are worse than the disease.
It’s disingenuous for me to frame an issue differently than you do? I guess I’d better apologize. But seriously, you are still missing the point. If govt increases taxes (or keeps a surplus — again, this is the same thing) to pay down low-rate debt, less capital will be available in the economy to invest in high-return ventures. To make a personal comparison, it’s like using scarce funds to pay off your 6% home mortgage, rather than plowing them back into your profitable business and earning a 15% compounded return. It’s a bad deal.
Another way of thinking about this is that tax revenues are extracted largely from successful companies/individuals, thus reducing the return on capital. Borrowing increases the cost of capital, which puts presure on the weakest companies (and most heavily leveraged ones if they have a lot of short term debt) by chipping away at the smaller margin between their operating profit and cost of capital.
In both cases, the government is increasing its share of available capital – but the effect on the economy can be very different depending on where the capital is pulled from.
Jonathan, don’t bother. Hipocrite is the kind of character for whom theory proves or disproves facts, not the other way around. If a theory, as he understands it, says facts cannot happen, then they never occurred. You are wrong. Simple as that. If academic theory says something, facts and evidence are irrelevant. People who argue on facts are “idiots”. And if you call things “spillovers” or “economic side-effects” instead of “externalities”, you’re an idiot too. See the ‘Green Quagmire’ thread and Lambert’s blog.
Or simply, one of his first statements : “I know that it’s policy here not to have a strong academic understanding of economic principals”. Smell the pedantic arrogance, the academic self-conceit and the wilful dismissal of anything connected to the real world. If you don’t have an “academic understanding” of a given topic, how can you possibly talk about it ? You heretic miscreant you.
Reality is irrelevant. Evidence is irrelevant. History is for morons. Theory precedes facts. Or “identity maths”, which is academic slang for “bullshit”.
I like Don’s quote:
“Those who can, do. Those who can’t, teach. And those who can’t teach, teach economics.”
He is certainly modest, considering the impressive scope of his knowledge.
Don? Yes. One of the smartest people I know.
I was referring to our friend Hipo.
Ha. Yes, academia…
Nito, indeed. It’s when you know self-taught guys like Luskin you realize how positively irrelevant some of the parasite academic types are. Which would actually explain their condescending frustration, I guess…
As my grandfather – another self-taught type who made his fortune without “academic understanding” – used to say, culture and knowledge are like butter on a piece of bread. The less you have, the more you spread it.
Jonathan, yes. And he knows he’s modest, too. :)
“Is Greenspan an “economic principal”? I think I understand him. ”
I loved this one. Remember, “your princi_pal_ is your _pal_”
And then, there was the Simpson’s Episode where Skinner is fired and replaced by Ned Flanders, who says he will put the ‘pal’ back in ‘principal’.
The short answer is that historically not only have interest rates not risen when deficits have risen, they generally tend to move in the opposite direction. This is because the same things that cause deficits to increase(decreasing economic growth leading to lower receipts and higher automatic spending) also tend to lower interest rates.
In pure theory an increase in the deficit should produce some microscopic increase in interest rates. But this is an “all things being equal” proposition, of which all things never are equal. Even assuming that cutting taxes were the sole reason for the deficit (it isn’t) the increase in the capital base should exactly offset the decrease in the capital base needed to borrow the money. Simple math. It’s a wash. But, since that money doesn’t have to be removed form the capital base in the first place (at great cost) and the fact that borrowing the money only costs pennies on the dollar, the capital base is larger for it. Thus on balance interest rates shuld be lower, not higher. History bears this out.
Of course the deficit isn’t the real problem, it’s government spending. Diverting money form productive activity to less productiive government activity is the biggest detriment to economic growth, regardless of whether the budget is in deficit or surplus.
This is why we went into recession at the end of 2000 and why we are still in a slow growth phase: The government, whether in surplus from 1998-2001 or in deficit in from 2002 on is removing too much of the productiive capacity from the private sector to support economic growth and job growth at the level that we all want.