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Larry Kudlow and Brian Domitrovic have teamed to up deliver a fantastic
account of the Kennedy tax reform of 1964 – all the more relevant today, as
we once again need leaders who can “get the economy moving again,” as Kennedy
promised in the 1960 election. If you have never heard the tale before, you
are in for a treat. Apparently, many have not, for the title of their book is
JFK
and the Reagan Revolution: A Secret History of American Prosperity. And
if you have – I described the JFK tax cut briefly in Gold:
the Once and Future Money (2007) – you are going to savor all the
delicious details that Kudlow and Domitrovic have mustered of this wonderful
moment in U.S. history. This one goes on your must-read list.
While we generally remember the 1950s as a time of economic good health – as
indeed it was, compared to what we have become used
to since 1971 – it was actually rather mediocre compared to the
astonishing performance of the German or Japanese economies of the time, or
the U.S. expansion of the late 1960s. Faced with four debilitating recessions
in eleven years, Kennedy focused on creating 5% real GDP growth in his 1960
election campaign.
But how? Following the advice of Paul Samuelson, he assembled the leading
lights of academia, who told him that he needed easy money and spending
projects to take care of the unemployment (the solution John Maynard Keynes
had recommended in 1936) and high taxes to prevent inflation. His Treasury
Secretary Douglas Dillon, however, was a wealthy Wall Street businessman wise
to the workings of the real economy, and also a Republican. Dillon supported
the extensive research of the little-known Stanley Surrey, a member of the
faculty of the Harvard Law School – not, it should be noted, an “economist,”
although he was later called “the greatest tax scholar of his generation,”
with twenty books to his credit.
Surrey argued that the 91% top income tax rate of the time was a “phantom
rate” that nobody paid: as inevitably happens wherever high nominal rates are
found, lobbyists had been hired to punch extensive loopholes in the tax code.
Lower rates, he argued, would change incentives and produce more growth.
Kennedy actually experimented with the advice of his academics, before
disregarding them for the path shown by Dillon and Surrey. The result was a tax
reform that lowered the top rate to 70% and all other rates proportionally;
and the best economic boom of the 1950s and 1960s.
The first Reagan tax reform of 1982 was basically an exact copy of Kennedy’s
1964 tax cut. This was deliberate, to help raise the needed support in the
Democrat-controlled Congress. A substantial number of Democrats used to
understand that the first and best thing to be done for the middle- and
below-middle classes was to create the private-sector economic growth that
could lead to rising employment and wages. In 1982, the first Reagan tax
reform bill split both parties, 103 to 89 among Republicans and 123 to 118
among Democrats. The top income tax rate fell to 50%, again with proportional
reductions in all tax brackets.
As Kudlow and Domitrovic recall, Reagan’s 1986 tax reform, which lowered the
top Federal income tax rate to 28%, passed the Senate with a vote of 97-3.
Edward Kennedy, Joe Biden, Paul Sarbanes, Chris Dodd, Al Gore Jr. and John
Kerry all voted for it. The plan for the tax reform had actually been hatched
in the House Ways and Means committee in 1985, led by Democrats Dan
Rostenkowski, Richard Gephardt and Bill Bradley.
Today, Democrats (including, apparently, the Kennedy family itself) refuse
the idea that Kennedy and Reagan were following the same playbook; or that
Democrats voted for all three tax reforms in large numbers. Kennedy’s
academic economists, who gave completely opposite advice and were then
brushed aside, later claimed to be the source of the plan.
None of Kennedy’s successors embraced his breakthrough insights: both the
Democrat Lyndon Johnson and the Republican Richard Nixon raised taxes and
attempted to deal with the recessionary consequences with easy money—the Paul
Samuelson/James Tobin playbook. Republican Gerald Ford and Democrat Jimmy
Carter didn’t do much better. By that time, tax increases were coming about
automatically via inflationary “bracket creep.” This was understood at the
time, and not exactly opposed by the political elites. An “accommodative”
Federal Reserve was expected to keep the U.S. out of recession; the result
was stagflationary collapse.
Things have moved on since then. Flat tax reforms, which would lower the top
income tax rate to sub-20% levels while eliminating 90%+ of the tax code,
take Surrey’s original insights to an idealized state. The results would be
awesome. How do we know this? Because over thirty governments worldwide have
already implemented “flat tax” reforms since 2000, with universally
fantastic results. The biggest beneficiaries are those who don’t pay
taxes at all: unemployment is still tax-free. A strong private economy is the
only reliable source of job creation.
As Kudlow and Domitrovic relate, the Kennedy success was not just about tax
reform. It was a “policy mix;” in particular, a rejection of the academics’
“easy money” strategy, in favor of a strong and stable currency. “Strong
and stable” means a gold standard. Kennedy was a defender of the Bretton
Woods gold standard of his time; Reagan wanted to bring it back. The most
successful governments of the Bretton Woods era, Germany and Japan, also
embraced a hard-money strategy, defending stable exchange rates with the
dollar, and thus to gold. Britain and France tried to boost their laggard
economies with “easy money” tricks; the result was periodic currency devaluations.
Indeed, it was Richard Nixon’s easy-money plan that finally ended the world
gold standard in 1971, and ushered in a decade of “stagflation” as the
kickoff for over four decades of floating-fiat chaos. Nixon followed Milton
Friedman’s monetary advice: in particular, a nominal GDP target of 9% in
1972, to be achieved with the Federal Reserve’s printing press. The goal was
achieved: 9.8% in 1972. The dollar fell nearly to half its prior value in the
process. Friedman’s intellectual grandchildren today want to systematize
Nixon’s Big Idea in the form of a mechanistic “nominal GDP targeting” system,
albeit one with – as suits today’s low expectations – a
nominal GDP target of perhaps 3.65%.
Kennedy’s hard-money/tax-cut strategy produced nominal GDP growth of 9.6% in
1966, without any “easy money” or consequent devaluation of the gold-linked
dollar. This was good, but much more was possible. Japan, which had cut taxes
every year since 1950, had nominal GDP growth of 18.4% in 1968 – with a
strong and stable gold-based yen. Between 1950 and 1970, Japan’s tax revenue
increased by sixteen times, thus funding the expansion of a broad swath of
welfare benefits that nobody needed because unemployment was vanishingly
small. (The official rate for 1968 was 1.2%.) And what if Japan had enacted a
Steve Forbes-style flat tax in 1964? Even more amazing things would have
happened.
Stanley Surrey, the brains behind the Kennedy tax cut, had actually been in
Japan in 1949-1950, to reform Japan’s tax code. In 1949-1950, the Japanese
government not only reduced the top income tax rate to 55% from 85%, it
eliminated an excess profits tax, reduced corporate taxes, eliminated a
national sales tax, banned all government bond issuance and repegged the
hyperinflationary yen to gold.
This is the power of the Magic
Formula: Low
Taxes and Stable
Money, the “policy mix” that Kennedy discovered, as did Andrew Mellon
before him and Ronald Reagan afterwards. We don’t really have to “discover”
it anymore, just put it to use; it lies idle, waiting for someone to come
along who actually wants to make America great again.
I hope that we will see more books of this caliber from Brian
Domitrovic. The legions of Ph.D-wielding mediocrities populating
universities all seem to want to be the next Paul Samuelson. Also: are there
any other geniuses hiding in the faculty of Harvard Law?
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