Almost four years ago the Kemp-Roth tax cut became law with brave promises from supply-side economists that wonderful things were going to happen to the U.S. economy.
According to Arthur Laffer, a massive reduction in personal income taxes would produce such strong incentives to work, save and invest that the economy would almost explode with growth. The rapid increase in output and incomes would generate such an increase in tax revenues that all the losses from lowered tax rates would be recovered. Perhaps the economy might grow so rapidly that tax receipts would actually increase.
Even among supply-siders who doubted that quite all of the revenue losses could be recovered, there were confident predictions of more savings, more investment, faster growth and generally good times. The economy's increased capacity to produce was also supposed to make it possible to eliminate inflation without a recession.
It was a lovely vision, and because almost four years have passed since the tax cut was passed, and the rate reductions have long since been fully phased in, it now becomes possible to ask whether the vision has been realized. The answer is that it has not been, and that the supply-side arguments for personal income tax cuts now look rather silly.
Federal budget deficits of almost $200 billion make it obvious that the revenue losses have not been recovered. A recent econometric study by Henry Wallich and Darrel Cohen at the Federal Reserve Board concludes that the tax cuts of 1981 have contributed $115 billion to the current federal deficit, even after allowing for the small tax increases of succeeding years. Prof. Laffer's predictions that revenues would be fully recovered through more rapid economic growth can now be forgotten.
Comparing the performance of the U.S. economy during the three years after the tax cut with its performance during the four years of Jimmy Carter's administration provides little comfort for supply-side economics.
Personal savings rates actually declined slightly (from 6 percent to 5.8 percent) in 1982-84. The total savings rate for the economy fell sharply (from 15.8 percent of gross national product to 13.8 percent) because of massive federal government "dis-saving" in the form of huge budget deficits. Lower tax rates did not produce more savings.
Gross private investment also declined as a share of GNP after the tax cut (from 16.9 percent to 15.1), which hardly suggests an acceleration of capacity growth. There was a tiny increase -- from 11 to 11.2 percent -- in the share of GNP used for fixed nonresidential investment, which is mainly plant and equipment, but even that figure was lower in 1984 than in 1979 or 1980.
There apparently has been an increase in investment in equipment as a share of GNP, but that was caused by the combination of an investment tax credit and Accelerated Cost Recovery rather than personal income-tax cuts. In addition almost all of that growth was in computers, a form of investment that now seems to be flattening out.
Since there was no increase in savings or total investment as a share of GNP, it is not surprising that there was no acceleration of economic growth. Real GNP grew less rapidly in 1982-84 (2.8 percent a year) than in 1977- 80 (3.3 percent a year). Although growth during 1984 was impressive, it has recently slowed, and the economy is now expected to grow by only about 2 percent during 1985. Inflation was reduced dramatically, but at the cost of a deep recession in 1982.
The supply-side revolution has been a flop. Almost four years after the passage of a massive tax cut, there has been a decline in the savings rate, private investment has not increased as a share of GNP, growth of the economy has not accelerated and federal deficits have exploded, largely because of lost tax revenues.
If the promises of supply-side economics have failed so badly, why has the Reagan administration's management of the economy been so popular, and why did President Reagan enjoy such a landslide victory last November? The answer is that the claims of supply-side economics were never central to Reaganomics, and that on the issues about which his supporters really cared, he delivered.
First, people wanted inflation stopped. Price increases of 13.3 percent in 1979 were frightening, and Reagan presided over a sharp deceleration of that inflation. The fact that this was largely the work of a Federal Reserve chairman who was inherited from the Carter years is irrelevant. Reagan was in office when inflation slowed greatly, and he gets the credit.
Second, a large number of Americans wanted their taxes cut, and they didn't care greatly about the quality of arguments used to justify such a cut. For those who viewed April 15 as an annual financial mugging, the operative motto was, "Any port in a storm," and even a silly argument for tax cuts was a good argument.
Finally, many conservatives viewed a tax cut as a way to reduce government revenues and thereby to force Congress to cut spending for a variety of domestic programs. They would have been appalled if Laffer had been correct and Congress had had plenty of money to spend on programs they despised.
Reagan did produce a large tax cut. Many domestic social programs have been cut. And Congress is under constant pressure to eliminate others. With inflation at about 4 percent the real economic goals of the Reagan revolution have been largely realized. Supply-side economics was only a fig leaf designed ve a modest intellectual respectability to a quite different agenda. It can now be viewed as a sideshow on which the curtain can be brought down. Goodbye, supply side.