Peter Ferrara’s Funhouse View of Reaganomics
Peter Ferrara’s May 12 Forbes.com posting entitled “Reaganomics Vs. Obamanomics: Fallacies Offered By The Left” provides a view of reality straight from the funhouse. I don’t believe Ferrara’s a bad economist. But he is a raging partisan, and is perfectly willing to pick and choose information to support a worldview that leans quite far to the right.
Ferrara states that “temporary tax credits… are economically no different from increased government spending.” I’d side with most economists, who would argue that 100 million consumers spending money is economically more efficient than the government doing so; the market is usually better at picking winners and losers than the government. This is hardly radical thought, especially for conservatives.
Ferrara also wrote that “borrowing $200 billion out of the economy to spend $200 billion back into the economy does nothing to promote the economy on net.” Perhaps Ferrara is taking a long-run view here, that over the medium run the drag caused by interest payments on new debt washes out the short-term benefit of increased economic activity caused by deficit spending. This wouldn’t be contrary to economic orthodoxy. But if Ferrara is claiming that the short run impact of deficit spending is nil, he’s running an argument that relies on two premises: (1) that government spending has no more immediate impact in the economy than does private investment, and (2) that government borrowing crowds out equivalent private investment. Point one is arguable I guess, though I think the impact of private investment lags that of private or public consumption. Point two is one of those theoretical crutches that bedevil economists; it sounds good alright, but with the prime rate at 50-year lows, just how much crowding out is there really? The answer is little or none.
Ferrara says that the notion that deficit spending spurs economic activity has been disproven “over and over, in America and around the world, for decades,” so much so that citing examples is unnecessary. His sole data point: since deficits today are high, the economy would be growing dramatically if this were true. This touches on another bedeviling fact of economics – we can’t know what would have happened under different circumstances. Ferrara’s claim incorporates a logical fallacy, that because the economy’s growing slowly, deficit spending must not be very stimulative. He’s ignoring the fact that there’s not a floor of zero growth here; the economy could be contracting. So it’s possible that GDP growth could be negative — could be significantly negative — absent deficit spending. So current deficit spending could be enormously stimulative and achieve only modest growth rates.
Ferrara also says that the “most intellectually coherent argument of the critics is that the Reagan boom was really just the effect of the large deficits.” Strange that he finds this to be less coherent: that the deep recession of the early 1980s and the economy-ravaging impacts of the 1970s inflation provided a historically low point from which to grow. Both capital and labor were at utilization levels not seen since the 1930s, so once inflation uncertainty was reduced the economy was primed for a historic expansion.
These are all pretty minor criticisms. But then we get into Ferrara’s points that are obviously removed from reality.
He says “the Reagan boom was extended to 25 years with the help of other rate cuts.” But since 1991, the top marginal rate has been HIGHER than when Reagan left office; Ferrara conveniently leaves out the 1990 and 1993 tax rate increases. The 28% tax rate on which Ferrara dotes was only in place for 3 of his 25 “Reagan” years. If changing marginal rates is as fundamental to economic growth as Ferrara claims, how did the economy come out of recession in 1991 as the top rate increased to 31%, and how did it continue to grow even as the top rate was increased to 39.6% in 1993?
Ferrara: “[The Bush tax cuts] quickly ended the 2001 recession, despite the contractionary economic impacts of 9/11…” First off, all of the studies I’ve seen have indicated the immediate impact of the 2o01 attacks was between $30B and $110B, or less than 1% of annual GDP, and that there were very little lasting economic impacts. So assigning meaningful contractionary impacts to 9/11/01 is incorrect. Next, about it ending the recession – once again, if the economy is as sensitive to changes in tax policy as Ferrara here claims, how could the 1990 recession have ended less than 6 months after George H.W. Bush signed a tax rate increase into law?
Ferrara: “After the rate cuts were all fully implemented in 2003, the economy created 7.8 million new jobs and the unemployment rate fell from over 6% to 4.4%.” Those are some tasty cherries he’s picking there. Just after the end of his time period, the unemployment rate increased from 4.4% to 7.8% at the end of Bush’s term, and rising. Why assign causality only for the arbitrary period during which unemployment was falling?
“Real economic growth over the next 3 years doubled from the average for the prior 3 years, to 3.5%.” So I take it three years the period over which changes in tax rates matter. Guess what: for the similar period before and after the 1993 tax hike, real economic growth also nearly doubled, from 1.9% to 3.6%. So much for tax rate changes mattering so much to the economy.
“In response to the [Bush] rate cuts, business investment spending, which had declined for 9 straight quarters, reversed and increased 6.7% per quarter.” I find no quarter in history where business investment increased 6.7%, so I’m assuming a mistake. But there are two points of interest. First is the reason for the 9-quarter decline; it was the combination of the 2001 recession and the extended period of overinvestment during the dot-com bubble just ended. Ferrara leaves this obvious analysis out, I presume because it doesn’t help his argument.
Neither does the second point: following the 1993 tax increase, the business investment rate increased from 2% per year during the prior three years to 10% per year during the following three. I’ll happily point out that I’m cherry-picking too. However, the bottom line is that a strong correlation between business investment and tax rate changes is not shown in the data.
A couple more specious claims follow:
“Manufacturing output soared to its highest level in 20 years.” Not true – manufacturing output has been on a productivity-driven growth trajectory for decades.
“From 2003 to 2007, the S&P 500 almost doubled.” Again, an impressive display of cherry-picking, with no mention of either the dot-com bubble bursting or the decline that started in 2007. Does Ferrara want the 2001 tax cuts blamed for the subsequent 27% decline in the S&P 500 before the 2003 cuts were enacted? Of course not. How about the 33% drop between the 2001 tax cuts and the end of Bush’s presidency? Nope. And the overall 36% decline during Bush’s two terms? Coincidental, I’m sure.
Which is, of course, the real answer for all of these things. When the Clinton tax increase was signed in August 1993, the S&P 500 was at 450. By July 1997, when the 1997 tax cut started working its way through Congress, the index had doubled. Was the tax increase the cause? Of course not. Just as the Bush tax cuts didn’t cause the 2003-7 bull market.
Which brings me to a basic point: Ferrara is repeatedly and massively overstating the impact of rate cuts on the economy, but says nothing about the impact of rate increases. Why? Because doing so would have invalidated his argument.
Back to Ferrara: “Capital gains tax revenues had doubled by 2005, despite the 25% rate cut! That should not have been a surprise. Capital gains revenues rose sharply after the Gingrich capital gains cuts in 1997.” Again, two obvious contributing factors are ignored by Ferrara. First, the stock market in 2003 had lost as much as 47% from the 2000 high. Capital gains realizations in 2002 were lower than in any year since 1996; the correlation between capital gains realizations and the stock market’s level is strong and obvious — and ignored by Ferrara.
Second, taking gains is clearly influenced by changing tax regimes. If taxes are expected to be higher today than tomorrow, there is an incentive to wait to take gains tomorrow under the lower tax rate. Similarly, if rates are expected to go up in the future, gains are more likely to be realized now, under the lower tax regime. Lowering taxes doesn’t have a large effect on the overall amount of capital gains over time, but they can have a big an impact on WHEN the gains are taken. This is clearly exhibited by the 1986 tax reform, which raised the capital gains tax rate from 20% to 28%. Realizations and tax collections spiked in advance of the increase.
Ferrara: “When President Reagan came to Washington in 1981, the top 1% of income earners paid 17.6% of all income taxes. By 2007, after a quarter century of tax rate cuts under Reaganomics, the top 1% paid 40.4% of all income taxes, close to twice their share of income.” Ferrara implies that the top 1% had a higher tax burden in 2007 than in 1981, which is absolutely untrue; the average income tax burden of the top 1% plummeted from 33.4% in 1981 to 22.5% in 2007. So how did the share of taxes paid by the top 1% increase so dramatically? Because the share of all income captured by the top 1% increased even more, from 8.3% in 1981 to 22.8% in 2007.
Now why do you suppose Ferrara left out that fact?
“That has been erroneously disparaged as the rich getting richer under Reaganomics, when it was just the same income in different forms.” Was Ferrara giggling as he wrote this? As stated above, the share of income going to the top 1% increased 275%. In what way is this NOT the rich getting richer relative to the rest of us?
“At the lower rates, upper income earners did invest and otherwise work to earn more.” Look at these claims logically. Did the rich work more in response to the lower rates? Probably. But isn’t this incremental? The top 1% are kind of by definition at the top of the earnings scale – weren’t they already working their tails off before the rate cuts? How much more capacity for work did they have? As for “investing more,” what does Ferrara think capital owners were doing, keeping money in jars in the back yard? Lowering rates would increase after-tax returns across the board. It might also cause international capital flows. But in reality the impact of incremental rate changes would also be incremental, providing small incentives to move capital from lower-risk to higher-risk options, such as from bonds to stocks.
“Indeed, by 2007 that 40.4% of income taxes paid by the top 1% of income earners was more than the income taxes paid by the bottom 95% combined. “ Omitted is that in 1981, the cumulative earnings of the top 1% was 47% of the cumulative earnings of the bottom 50% of taxpayers; by 2007, this had increased to 186%. This isn’t the rich getting richer?
“Reagan and his Republicans cut taxes sharply for those lower income earners as well… cut federal income tax rates across the board for all taxpayers by 25%… reduced the federal income tax rate for middle and moderate income earners all the way down to 15%… doubled the personal exemption, which benefitted the more moderate income workers the most… adopted a new lower tax bracket for the lowest income workers of 10%… federal income taxes were abolished for the poor and working class, and almost abolished for the middle class. ”
The obvious question: if tax cuts provided incentives to the wealthy strong enough to drive their enormous income growth, why didn’t all of these tax cuts for the middle and lower classes have the same effect?
And why did Ferrara choose to omit so much of the story, if not because his partisan looking glass can’t withstand reality?