THE QUESTIONS, so far, have been a good deal more interesting than the answers as Congress begins its examination of President Reagan's tax cut. The House Ways and Means Committee opened its hearings in an atmosphere that was not hostile but certainly skeptical. The responses from the secretary of the Treasury, Donald Regan, were less than reassuring. He is having trouble making the crucial connections in the argument for his tax program. At this early stage of the debate, it appears that the congressional Democrats are strongly inclined to accept, at least in general, the president's cuts in the budget. But they are preparing to challenge his tax bill on grounds that it is too big and too dangerously inflationary.
The administration's case for those three successive annual reductions in the personal income tax rates fillows this logic: If people's taxes are cut, they will 1) save more, leading to 2) higher investment, which in turns means 3) rising productivity and therefore 4) increased prosperity and lower inflation. The Democrats in the Ways and Means Committee have begun to challenge each link in that chain of cause-and-effect.
The administration has contributed to its own vulnerability by its extremely optimistic predictions of the response at each stage. Secretary Regan thought it was dreadfully rude of a young New York congressman, Thomas Downey, to describe his economic assumptions as "hallucinogenic." But would it be wrong to describe them as another triumph of hope over experience?
The administration is defending itself mainly by citing the enormous burst of growth, prosperity and high employment that followed a big tax cut in 1964 under President Johnson. That's a very odd posture for this administration to adopt. It came to power amidst a chorus of denunciations of the Keynesian policies of its predecessors, which, the victorious Republicans claimed, was responsible for a decade of stagnant productivity and intolerable inflation. But that 1964 tax bill was widely known, at least until this winter, as the Great Keynesian Tax Cut, the classic success of that school.
Ironies aside, what guidance does the 1964 tax cut offer to policy in 1981? It was a huge cut -- dropping, incidentally, the top rate from 91 percent to the present 70 percent. But it came at a time when, unlike the present moment, the economy was already expanding fast. Productivity rose sharply in the year of the tax cut, but it fell thereafter through the rest of the decade. What should you make of that? Higher productivity -- which means output that rises in relation to the number of people working -- is important, since otherwise wage increases are inflationary. As for inflation, it remained low through 1964 but began to rise ominously in late 1965. That was largely the impact of the buildup for the Vietnam War. But there's a certain parallel with the present situation, since the Reagan administration's plans for military spending are already sending inflationary tremors through the economy.
One lesson of 1964 is that a big tax cut can certainly raise the savings rate, but it will also raise spending -- a lot. It will lower unemployment, just as the Keynesian theorists promised, but it doesn't necessarily do anything for productivity. The 1964 case says that a tax cut can keep a boom going but, combined with a rapid increase in military appropriations, it raises an obvious danger of more inflation.
There's a reasonable case for a tax cut this year. But it isn't the case that the administration is making. Nor is it a case for the three years of large personal tax reductions that the administration is urging.