Should Candidates (and Voters) Be More Optimistic?

Justified Optimism

Maybe Not

In a recent Washington Post opinion piece, Jonathan Capehart praises President Obama's optimism about America's future, optimism the President recently expressed in his final state of the union address. Capehart also analogizes President Obama's optimism to that expressed by President Ronald Reagan in the latter's 1989 farewell address.  In that address, President Reagan referred to America as a "shining city on a hill" that was, at the end of his administration, "more free, more prosperous, more secure and happier than it was eight years ago." Capehart also chastises the current field of Republican presidential candidates for rejecting such optimism. According to Capehart, these candidates repeatedly invoke Reagan, but "bombard us with gloom, doom and defeatism."

Capehart is certainly correct that both President Obama and President Reagan struck optimistic tones as their administrations came to a close.  He is also correct that many Republican candidates for President seem anything but optimistic about the nation's current trajectory.  At the same time, Capehart does not mention the fact that most Americas do not seem to share President Obama's optimism. For instance, two thirds of Americans believe the nation is "on the wrong track," compared to 55 percent early in President Obama's first term.  (Go here for these data.)  Only one third of Americans believe that today's children will be better off than their parents.  (See here.)  The rate of new business formation is near a 30 year low. Capehart does not consider the possibility that glum Republican presidential candidates are simply reflecting the mood of the people --- Republicans, Democrats and Independents --- they hope will elect them.

Of course it may be that the American people are simply unduly pessimistic about what the future holds for this country. However, a little reflection, informed by recent economic history, suggests that there is significantly less reason for optimism about the nation's economic future than there was when Reagan delivered his farewell address in 1989.  While President Reagan left his successor a booming economy resulting in robust job creation, President Obama's successor will inherit a tepid economic recovery which has left millions of Americans behind and with little or no prospect of improvement.

Like President Obama, President Reagan inherited a deteriorating economy.  When Reagan took office in January, 1981, the prime interest rate had just hit 21.5 percent, inflation was running over 13 percent, and unemployment was 7.5 percent, on its way to 10.8 percent in December, 1982.

Like President Obama, who proposed an economic stimulus package that Congress would later pass, President Reagan proposed a package of tax cuts also designed to stimulate the economy, and Congressman Jack Kemp led the Congressional efforts to enact Reagan's proposals.  (To his credit, President Obama would later award Kemp the Medal of Freedom.)   The plan, which cut tax rates for all Americans, was similar in design and rationale to that offered by President John F. Kennedy in 1962.  As previously explained on this blog, President Kennedy sold his plan as an effort to stimulate economic growth, reduce unemployment, and, ultimately, eliminate the short run budget deficit that such cuts would produce.   As President Kennedy explained in a December, 1982 speech to the Economic Club of New York:

"The purpose of cutting taxes is not to incur a budget deficit, but to achieve the more prosperous, expanding economy which can bring about a budget surplus."

Congress enacted President Reagan's proposed tax cuts in the summer of 1981.  While a portion of the cuts took effect immediately, most were phased in over the next three years.  His administration also accelerated the pace of deregulation. What followed was a veritable economic boom.  While the economy contracted in 1982, a recovery started in November of that year.  Over the six year period 1983 through 1988, the American economy grew at an annual rate of 4.6 percent on average.  (See here)  During the same period, total employment increased from 88,993,000 in January, 1983 to 106,906,000 on December 1, 1988, a 20.1 percent net increase. (See here).

The economy has not experienced a similar boom under President Obama, despite passage of his stimulus package.  The economy contracted during 2009 and began a recovery in the summer of 2009. Over the six year period of 2010 through 2014, GDP grew an average of 2.2 percent, less than half the rate during the Reagan boom, with annual growth never exceeding 2.4 percent.   During the same period, total employment grew from 129,717,000 in January, 2010 to 143,242,000 in December, 2014, a 10.3 percent net increase.  (See the sources cited in the prior paragraph for these data.)

In short, the rate of economic growth during the Reagan recovery was more than double the rate for Obama recovery.  Moreover, the rate of employment growth during the six years of the Reagan recovery was more than 60 percent higher than the rate during the first six years of the Obama recovery.  Nor is there any indication that the Obama recovery is picking up steam, with 2015 growth predicted to be a disappointing 2.5 percent.  (By contrast the economy grew 3.7 percent in 1989.)  It is little wonder that many Americans are pessimistic about the nation's economic future.  Even former President Bill Clinton recently expressed his view that, if elected, former Secretary of State Hillary Rodham Clinton would "do what needs to be done now to restore prosperity."  Like former President Clinton, many Americans are old enough to recognize robust economic growth when they see it, and they know this is not it.

Of course, GDP and employment growth are not the only indicators of national well-being.  A nation might choose policies that alleviate poverty or result in a more equitable distribution of income, even if such polices cause somewhat smaller economic growth.  However, there is no indication that slower growth has bought us greater equality or lower poverty.  Poverty rates are higher than when President Obama took office and lower than 1989, when President Reagan left office.  (See page 12 of this report.)  Income inequality is by many accounts on the rise.  The Reagan boom brought greater wealth and less poverty; the Obama recovery has been disappointing by comparison.

None of this is to condone the sort of pessimism that Capehart claims to see in today's crop of Republican candidates.  In 1980 then-citizen Reagan believed the country was moving in the wrong direction but was nonetheless optimistic about America's future.  In particular, he had faith in the power of free markets and individual initiative and a plan for unleashing both to serve the common good.  With the help of Congress, his administration implemented that plan, and the rest is (economic) history.  Hopefully one of the current presidential candidates will follow Reagan's example and articulate an optimistic vision for the nation's future coupled with a workable plan for making that vision a reality.

Conservatives Embracing Science, While the Left Balks

Accepts Science 

Ditto

Rejects Science/Thinks He Knows Better

Senator Marco Rubio (R-Florida) and Pat Robertson, both pictured above, have made news recently, both embracing the scientific consensus that the earth is 4.5 Billion years old.   As Senator Rubio, a Roman Catholic,   put it:  "Science says (the earth) is about 4.5 billion years old.  My faith teaches that's not inconsistent. . . . God created the heavens and the earth, and science has given us insight into when he did it and how he did it."   Mr. Robertson, a Southern Baptist and the Chancellor of Regent University, put things this way:

"Bishop Ussher [who opined that the Earth was created in 4004 BC] wasn't inspired by the Lord when he said that it all [creation of the Earth and Man] took 6,000 years. It just didn't. You go back in time, you've got radiocarbon dating. You got all these things and you've got the carcasses of dinosaurs frozen in time out in the Dakotas.  They're out there. So, there was a time when these giant reptiles were on the Earth and it was before the time of the Bible. So, don't try and cover it up and make like everything was 6,000 years. That's not the Bible."

Mr. Robertson's remarks won the praise of national luminary "Bill Nye the Science Guy," who expressed hope that Mr. Robertson would continue to press his view on the age of the Earth.  Previously Mr. Nye had argued that the belief that the Earth is 6,000 years old "threatens science."

Unfortunately, some public officials still reject basic scientific teachings.  For instance, as previously explained on this blog, President Obama's repeated claim that tax cuts caused the recent "Great Recession" contradicts basic economic science of the sort taught to thousands of college freshmen each year in the United States and around the world.  More recently, Vice President Biden (pictured above) joined the anti-science chorus, claiming, again contrary to basic economic science, that tax cuts and increased spending during the G.W. Bush Administration caused the Great Recession.  Here's what the Vice President said, during his debate with Congressman Paul Ryan.  According to the Vice President:

"And, by the way, they [Republicans] talk about this Great Recession [of 2008-2009] as if it fell out of the sky, like, 'Oh, my goodness, where did it come from?' It came from this man [Congressman Ryan] voting to put two wars on a credit card, to at the same time put a prescription drug benefit on the credit card, a trillion-dollar tax cut for the very wealthy. I was there. I voted against them. I said, no, we can’t afford that."

Like President Obama's claim about tax cuts, Vice President Biden's claim that deficit spending caused the recent recession is economic nonsense, akin to a claim that the Earth is flat or the center of the Universe.  Just as there is a scientific consensus that the Earth is 4.5 Billion years old, there is a longstanding scientific consensus that increasing the deficit, whether by tax cuts, increased spending or both will stimulate aggregate demand, increase employment and increase the nation's real economic output.  See e.g. N. Gregory Mankiw, Macroeconomics, 296 (7th Edition 2010) (explaining how tax cuts increase the budget deficit and thus aggregate demand and national output); Rudiger Dornbusch and Stanley Fischer, Macroeconomics, 73-83, 401-11 (2d Edition 1981) (explaining how tax cuts and spending increases can increase aggregate demand and thus national output).  The only exception is for cases in which the economy is already at full employment.  In such cases, deficit spending cannot increase output but can only result in inflation.  However, so far as I know, no one contends that the economy was at full employment when, say, Congress enacted the so-called Bush tax cuts in 2001.  In the same way, the economy was at less than full employment when President Kennedy proposed across-the-board tax cuts in an effort to "get the economy moving again."

Of course, there are other reasons to oppose budget deficits and the resulting increase in the national debt.  For instance, government borrowing to encourage consumption can crowd out private investment, thereby partly (but only partly) offsetting any resulting increase in national output.  A nation could decide to forgo higher GDP in the short run in the hopes that, in the longer run, increased private investment will increase national productivity and thus potential national output.  But it bears emphasis that this argument against increased deficits assumes that such deficits increase national output, contrary to Vice President Biden's assertion.

Oddly the economics profession has been relatively silent in the face of this Administration's rejection of basic economic science.  To be sure, hundreds of economists endorsed Mitt Romney in the recent general election.  Six of these individuals were past recipients of the Nobel Prize in Economic Science.  However, so far as I know, no such economist has called out President Obama or Vice President Biden for their rejection of basic science.  This is surprising, because the rejection of economic science can have serious real world consequences for millions of ordinary Americans.  (Imagine if, instead, the President and Vice President claimed that vaccinations do not work or that smoking does not harm your health.  Surely the relevant scientific professionals would (properly) be up in arms.)

Perhaps the economics profession needs its own "Bill Nye the Science Guy" to shame public figures who reject basic economic science. 

President Obama's Rejection of Economic Science

Thought the Earth was Flat

Thinks Tax Cuts Slow the Economy

Embraced Economic Science for the Common Good

A recent survey (discussed here) finds that Conservatives are losing faith in Science.    Remarks by President Obama in Iowa earlier this week (reported here by USA Today) suggest that he, too, has abandoned some basic tenents of science, in this case, economic science.  In particular, the President accused Republicans of clinging to policies that would, in his words "double down on some of the policies that didn't work and got us into this mess in the first place."  According to the report in USA Today, the President "cit[ed] in particular proposed tax cuts for the wealthy" as examples of such policies that caused the current downturn and would, if maintained prevent recovery.  The "tax cuts for the wealthy," of course, referred to the 2001 across-the-board reduction in tax rates advocated by President Bush and passed by Congress.

Perhaps USA Today has mis-reported the President's remarks.  If not, the President has apparently decided the repudiate basic science.    There is simply no plausible economic theory or evidence supporting the President's claim that tax cuts for the wealthy or  tax cuts for anyone else, result in an economic downturn.  On the contrary, tax cuts put more money in the pockets of consumers, including rich consumers, who in turn spend a portion of this new wealth, thereby increasing aggregate demand and national output.   See N. Gregory Mankiw, Macroeconomics, 296 (7th Edition 2010) (explaining how tax cuts increase aggregate demand and thus increase national output).   This result is a basic scientific fact, taught annually to thousands of college freshmen annually across the country.  Indeed, the nation's unemployment rate remained below 5.0 percent for all 24 months in 2006-2007, compared to a peak of 5.7 percent the year Congress enacted the tax cuts the President Obama has decried.  (Of course, there were other sources of fiscal stimulus during the first term of the Bush Administration, including increased military spending, such that the tax cuts were not the sole source of economic stimulus.) There is only one circumstance in which tax cuts will not increase output and employment, namely, when the economy is already at full employment.  While tax cuts (or spending increases) will increase aggregate demand in these circumstances, national output will remain the same, because society is already employing all of its resources in their highest-valued uses, with the result that national output is at its maximum.  No one argues that the current economy is at or near full employment.

The President's rejection of scientific fact and theory in this context is particularly odd.   After all, the centerpiece of the President's economic recovery program entailed a so-called "Stimulus Package" of nearly $800 Billion (discussed previously on this blog), spread out over five years, a portion of which included tax cuts.  The logic of the stimulus package depends upon the very same economic models establishing that tax cuts, even tax cuts for the rich, stimulate aggregate demand and national output.

It is also noteworthy that President Obama's attitude toward economic science stands in stark contrast to the approach taken by President Kennedy, pictured above with Dr. Walter Heller, who chaired the Council of Economic Advisors during the Kennedy Administration.  As previously explained on this blog, President Kennedy advocated across-the-board tax cuts as a means of "getting America moving again," the theme of his 1960 presidential campaign.  In so doing, he followed the advice of Heller and others who understood that across-the-board tax cuts would stimulate the economy, not get us into a "mess" as President Obama now claims.

Of course, across-the-board tax cuts are not the only means of stimulating the economy.  The national government could also rely upon spending increases and/or an expansive monetary policy.  Moreover, the government could reduce taxes for lower income and middle income workers.  Nonetheless, any claim that extending such cuts to "the rich" will cause an economic downturn is akin to the claim, by Thales of Miletus, pictured abouve, that the earth is flat.

Should Misleading Charts Accompany All Discussions of the Debt Ceiling?

Probably Not "Incoherent"

Useless Visual Aid

In a recent blog post, James Fallows, national correspondent for the Atlantic Monthly, asserts that one cannot both be concerned with structural budget deficits and simultaneously support the across the board tax cuts that President Bush convinced Congress to adopt early in his Administration. Fallows' main argument is a picture --- a chart, reproduced above, which originated in a recent opinion piece in the New York Times. The chart purports to quantify how various policy changes supported by Presidents Bush and Obama, respectively, have increased spending by the National Government and/or deprived the National Government of revenue it supposedly would have received. Among other things, Fallows claims that the chart "demonstrates the utter incoherence of being very concerned about the structural federal deficit but ruling out of consideration the policy that was the single largest contributor to that deficit, namely the Bush-era tax cuts." (emphasis in the original).

Fallows' assertion is unconvincing, to say the least. Here's why.

1. The chart inexplicably omits over $500 Billion --- the forgone revenue attributable to the two year extension of the Bush tax cuts to which President Obama agreed after the 2008 mid-term elections. (See this story.) Indeed, President Obama's own former director of the Office and Management and Budget, Peter Orzag, advocated such an extension shortly after he left the Administration. Fallows does not explain why we should ignore this forgone revenue.

2. The chart is also misleading in a more fundamental sense. In short, the chart is a gerrymandered portrayal of factors that drive spending, revenue and thus the deficit and resulting debt. In particular, the chart focuses exclusively on the fiscal impact of new programs adopted during the Bush and Obama administrations, respectively. Thus, the chart entirely ignores the cost of existing programs, adopted during previous administrations which, taken together, cost far more than the various programs and tax cuts portrayed in the chart. Indeed, according to one source, the National Government spent $28 Trillion in 2002-2010 alone. During 2002-2009, Fallows claims, the Bush tax cuts deprived the National Government of $1.8 Trillion in revenue, a figure that rises to about $2 Trillion if one includes the forgone revenue attributable to the cuts which Congress extended, with President Obama's agreement, after the 2010 mid-term elections. Thus, the Bush tax cuts equal a whopping 7.1 percent of the expenditures by the National Government during the period in question and are hardly the driving force in the current budget deficit, projected to reach $1.5 Trillion, or 10 percent of GDP, in 2011.

3. The chart ignores all sorts of tax deductions and loopholes, adopted before 2002, that, like the Bush-era tax cuts, deprive the National Government of revenue. Examples include the home mortgage interest deduction (including the deduction for second homes) and the tax exemption for employer-provided health insurance. (The former reduces annual tax revenue by $100 Billion per year.) Inclusion of these potential sources of revenue in the Fallows/New York Times Chart would reduce even further the apparent contribution of the Bush-era tax cuts to the deficit.

4. Finally, the chart and any arguments based upon it ignore entirely the long run link between structural deficits and economic growth (or lack thereof), a link emphasized by John F. Kennedy in his 1962 speech to the Economic Club of New York. As explained in an earlier post on this blog, JFK argued that across the board tax cuts during an economic downturn were the best way to encourage investment, work effort and economic growth and thereby, in the longer run, reduce the budget deficit. In JFK's own words:


"The purpose of cutting taxes now is not to incur a budget deficit, but to achieve the more prosperous, expanding economy which can bring about a budget surplus."

Of course, JFK did not believe that tax cuts alone would ultimately lead to a budget surplus. He also advocated spending restraint, arguing that reliance on government expenditures to stimulate the economy would "demoralize our government and the economy" and that government should not "spend more than can be justified on grounds of national need or spent with maximum efficiency."

In short, like Ronald Reagan two decades later, JFK believed that low tax rates were a precondition for economic growth and that tax cuts and spending increases had quite different impacts on the deficit over the longer run. Moreover, both Presidents advocated policies that helped innaugurate lengthy economic expansions and economic growth. Most Americans would gladly embrace the sort of "incoherence" that resulted in such strong and sustained economic growth and resulting job creation and economic opportunity.

John F. Kennedy, Radical Supply-Sider?

In an August 2, 2010 Op-Ed "Soak the Rich Catch-22" published in the Wall Street Jounal, Arthur Laffer argues that a tax increase on the wealthy will reduce the tax revenue received from such individuals and, other things being equal, increase the federal budget deficit. The Op-ed follows a May WSJ column by Laffer on tax policy in various states, entitled "Soak the Rich, Lose the Rich." Laffer argues that the wealthy, which he defines as individuals in the top 1 percent of the income distribution, can more readily take those steps necessary to alter their activities and income so as to avoid the incidence of income taxes.

As Laffer puts it:

"The highest tax bracket income earners, when compared with people in lower tax brackets, are far more capable of changing their taxable income by hiring lawyers, accountants, deferred income specialists and the like. They can change the location, timing, composition and volume of income to avoid taxation."

Laffer also warns that those who call for higher taxes at this moment in history are repeating the mistakes of Herbert Hoover and Franklin Roosevelt, each of whom signed large income taxes into law in the early 1930s, increases that Laffer claims first precipitated and then deepened and legthened the Great Depression.

To support his claim that raising taxes on the rich will result in lower revenues, Laffer points to data showing that, after REDUCTIONS in tax rates on the rich, tax receipts from the rich rose. For instance, between 1978 and 2007 (the last year from which Laffer has data), taxes paid by the rich rose from 1.7 percent of GDP to 3.3 percent of GDP. (It should be noted that GDP rose significantly during this period. Thus, the size of the pie increased, and so did the portion of the pie that the "rich" paid in taxes.) During the same period, Laffer notes, the share of taxes paid by those individuals in th lower 95 percent of the income distribution fell, from 5.4 percent of GDP to 3.2 percent of GDP.

It should be noted that there may be alternative explanations for these data. For instance, it may be that, from 1978 until 2007, the wealthiest's pre-tax share of overall GDP rose, thus explaining the increase in tax receipts from the wealthy as a share of GDP. Note, however, that this increase in pre-tax share of GDP would reflect in increase in the productivity of the wealthy relative to other earners, an increase that Laffer might explain by the reduction in tax rates that led the wealthy to work, save and invest more than they had under prior tax rates. Others may attribute this increase in productivity to other factors or claim that productivity had nothing to do with the wealthy claiming a larger share of GDP.

Here, though, is what really caught this blogger's eye.

Laffer begins his editorial with a quote from the January, 1963 Economic Report of the President, published by John F. Kennedy.

"Tax reduction thus sets off a process that can bring gains for everyone, gains won by marshalling resources that would otherwise stand idle --- workers without jobs and farm and factory capacity without markets. Yet many taxpayers seemed prepared to deny the nation the fruits of tax reduction because they question the financial soundness of reducing taxes when the federal budget is already in deficit. Let me make clear why, in today's economy, fiscal prudence and responsibility call for tax reduction even if it temporarily enlarged the federal deficit --- why reducing taxes is the best way open to us to increase revenues." Like the Arthur Laffers of today, President Kennedy argued that, over the longer run, cutting taxes will actually result in increased government revenues.

Now of course, President Kennedy likely did not pen the words that appeared in his economic report. That task probably fell to Walter Heller, also pictured above, who chaired President Kennedy's Council of Economic Advisors at the time. Heller was a highly respected macroeconomist from the University of Minnesota, hardly a hotbed of laissez faire. Note, however, that Heller was echoing what President Kennedy himself had said just a month earlier, in his famous speech to the Economic Club of New York. There the President made the case for an "across the board, top to bottom" reduction in income tax rates as well as corporate tax rates, as a means of stimulating the economy. At the time, the unemployment rate was 5.5 percent.

In so doing, President Kennedy sounded a lot like Professor Laffer.

"In short it is a paradoxical truth that tax rates are too high today and tax revenues are too low, and the soundest way to raise the revenues in the long run is to cut the rates now. The experience of a number of European countries and Japan have borne this out. This country's own experience with tax reduction in 1954 has borne this out. And the reason is that only full employment can balance the budget, and tax reduction can pave the way to that employment. The purpose of cutting taxes now is not to incur a budget deficit, but to achieve the more prosperous, expanding economy which can bring about a budget surplus."

It should be noted that there are a couple of possible distinctions between Professor Laffer's position, on the one hand, and that taken by President Kennedy, on the other. That is, Laffer emphasizes the ability of individuals to shift income from one place to another --- both spatially and temporally --- an ability that prevents tax increases from raising revenue. President Kennedy's emphasis was more Keynesian, that is, he claimed that tax cuts would enhance private consumption and investment, thereby enhancing aggregate demand and increasing real output, given that the economy was operating below full employment. Of course, the conventional Keynesian story includes an INCREASE in the full employment budget deficit, an increase that stimulates consumption and investment. Kennedy does not fully explain n how, given his Keynesian logic, deficits will, as he claims, turn into surpluses, except to say that such tax cuts will lead to increased prosperity and thus to a balanced budget. However, he does claim that wealthy Americans who receive a tax break will "hereby be encouraged to undetake additional efforts and enabled to invest more capital." This is pure supply-side reasoning, as such "additional efforts" and investing of "more capital" manifest themselves as shifts in the aggregate supply curve that thereby increase real output (and reduce prices). In so doing, he seems to distance himself from the traditional Keynesian approach, which assumes away such supply-side effects to focus only on the demand side. Perhaps he also had in mind the possibility that relaxed monetary policy would provide a separate source of stimulus and thereby boost GDP sufficiently to lead to a balanced budget.

One final note. True Keynesians believe that, when it comes to stimulating the economy, increased spending will, if anything, be more potent than tax cuts. After all, individuals who receive a tax cut, particularly those who are well off, may choose to save the additional income the government allows them to retain instead of spending it. The Keynesian model assumes that such savings will be completely unproductive, even if the additional savings drive down interest rates, because the economic downturn will reduce the return from private investments. (Moreover, consumers may spend the proceeds of a tax cut on imports, thus stimulating the economies of other countries.) Outright spending, by contrast, will stimulate the economy "by definition," as the government purchases goods or services directly from its citizens. Nonetheless, Keenedy's speech to the New York Economic Club rejected additional spending as a remedy for recession, arguing that "such a course would soon demoralize both our government and the economy." "If the government is to retain the confidence of the people," he continued "it must not spend more than can be justified on grounds of national need or spent with maximum efficiency." In short, President Kennedy rejected a big government spending approach to stimulating the economy.

In sum, while President Kennedy may not have been a pure, "true believing" supply sider, he did incorporate certain aspects of supply side thinking in his macroeconomic policy, as part of an overall synthesis of Keynesian and supply-side principles.