Wisdom speaks with a soft voice, which may be why it is so difficult to detect in the debate over President Reagan's plan to cut income-tax rates. Junior Democratic congressmen noisily beard the Treasury secretary. Opposition press aides rack their brains for yet another variant on the voodoo/free-lunch/bumper-sticker/jellybean economics label.
All of this theater is, literally, diverting. The president has endured worse (and better) in the past year, and his good humor is devastating. Reagan is in the White House, and his opponents are not.
But where is the substance of the debate? So far, aside from attempts to redefine the president's tax plan into something it is not, the opposition is divided between the same aging liberal Keynesians who gave us economic chaos-as-usual and a group of conservative Keynesians who share basically the same economic theory. They have yet to discuss the central issue.
Rep. Jim Jones, the able chairman of the House Budget Committee, says that the experience of the Thatcher government holds a warning for Reagan. I agree. Many of us have been saying so for a year and a half now. The lesson is not, however, the danger of doing what Reagan was elected to do but, rather, of failing to do it.
As Jones points out, both Thatcher and Reagan were given a mandate to repudiate the status quo. Both promised to cut tax rates across the board, to restrain spending and to use sound monetary policy to end inflation. Unfortunately, the similarity ends there.
Jones himself admits that the Tory government immediately doubled the value-added tax from 8 percent to 15 percent. It failed to cut income-tax rates equally across the board. Its first budget added a net tax increase to the automatic increases built into the tax code. The first installment of income-tax reduction was delayed, and the second and third phases were scuttled.
The predictable followed. As the economy deteriorated, revenues fell, spending rose and thhe deficit widened beyond expectation. The money supply was ballooned and the inflation rate doubled, before being brought back down, with considerable pain and unemployment, roughly to where it had started. As Jones says, "The result was no stimulation for the economy, no growth, no job creation." There is indeed an urgent warning here: Stick to your guns, Mr. President.
Reagan's opponents have yet to answer his question: "Why is it that when the government spends your money, it's not inflationary, but when you spend it, it is inflationary?" This simple question hammers a list of theses to the door of Congress, concerning the way fiscal policy works and doesn't work.
The first thesis is that fiscal policy, such as a tax cut, does not change aggregate demand. That is, a tax cut does not "inject money into the economy." Naturally, this denies the central premise of Keynsian theory. The Keynesians say a tax cut works by increasing disposable income, which is said to be "multiplied" in the spending process into an increase in aggregate demand and national income.
The problem with this notion is that, if a tax cut increases the disposable income of taxpayers by a dollar, someone else's disposable income is reduced by a dollar -- either the recipients of federal spending (if spending is reduced), or the buyers of federal bonds (if spending is not reduced). Either way, a tax cut does not increase aggregate demand and income.
Here the Keynesians object, "Well, of course the Federal Reserve can negate the demand effects of a tax cut with tight money." This misstates the problem . The tax cut causes no increase in demand to be offset.
If the Federal Reserve buys federal debt (creating new money), then aggregate demand can increase. But the increase is caused by monetary, not fiscal, policy. And the added demand is nominal, not real. Moreover, monetary policy does not require a tax cut, or even a deficit, and monetizing federal debt is poor policy under any circumstances. So much for Keynesian nonsense about tax cuts causing inflation by "overwhelming capacity" with a "tidal wave of demand."
If a tax cut merely shuffles income around and increases federal borrowing, it is a pretty silly exercise. This fact explains the utter futility of past attempts to "stimulate" the economy with spending increases and tax rebates.
The second administration thesis concerns how tax cuts do work. Cutting marginal income tax rates (the tax on additional income) changes economic incentives. Everyone knows that an excise tax on gasoline increases the cost of gasoline compared with other goods and services. It causes people to economize on gasoline. Every tax has some such "excise effect" in raising the relative cost of the taxed good or service.
The individual income tax is simply an excise on working and saving. Of the two uses of time -- work and leisure -- the income tax is levied on work. Of the two uses of income -- saving and consumption -- the income tax is levied only on saving. High marginal income-tax rates force people to economize on additional working and saving, and to pursue more leisure and consumption.
Cutting marginal income-tax rates, as Reagan proposes, increases the incentives to earn more income and to save a larger share of it. Leisure becomes more costly, because it means giving up higher after-tax wages. Consumption becomes more costly, because it means giving up a higher after-tax return on saving.
Obviously, this does not cause "excess consumption." Consumption increases as the economy grows in response to higher incentives, but only as a smaller share of a larger economy. Its growth trails that of production and investment.
It should also be obvious that we can discuss the claim of economist Sam Nakagama and assorted editorialists that President Reagan's income-tax proposal is "an extreme form of Keynsianism" aimed at hugely stimulating demand. The claim is based on the description of the 1964-65 Kennedy marginal income-tax rate cut as a stimulus to demand by liberal Keynesian economist Walter Heller, Kennedy's economic adviser. But according to Heller and Keynesian theory, an increase in federal spending or a tax rebate would have worked just as well. The non-Keynesians in the Kennedy administration insisted on cutting marginal tax rates and on a sound money policy -- as does President Reagan. The record shows that the Kennedy and Andrew Mellon marginal rate reductions worked, while "stimulative" spending and non-marginal tax measures have absymally failed. The Nakagama & Co. argument seems to make sense mostly to conservative Keynesians who would like to see tax cuts for employers but not for employees.
This is not all there is to the tax issue. But until President Reagan's opponents answer his basis theses about economic policy -- or at least produce a single objection to his plan that is not based on Keynesian theory -- there is nothing that can be called a debate. Attempts to redefine the president's program, or to debate Margaret Thatcher, are no substitute.