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Recovery Under Truman
After V-J Day in 1945, the Democratic liberals made a pitch to keep the high nominal tax rates up to pre-war levels, along with an end to tax write-offs, of course. Liberals warned that unemployment would go to 10 million unless the Government taxed and spent on social desirables. But taxes were cut sharply. President Truman wisely liquidated war contracts on the word of the contractors instead of harassing them with tax audits. And recovery ensued.
As in Mellon’s day, the lower tax rates produced expanded revenues, and the Republicans, led by Sen. Robert A. Taft of Ohio, demanded another tax cut. The Keynesian economists, who by this time dominated both the academic community and Washington policy makers, predicted a worsening of inflation if the Taft tax cut of $5 billion were enacted. It was enacted in 1948, over Truman’s veto, and inflation came to a halt. The Keynesians to this day have explanations of why the tax cut should have produced a rampant inflation.
The Korean War upset Republican plans to cut taxes again in 1950, but in the tradition of Herbert Hoover, Dwight Eisenhower shot Santa Claus in January 1953. As in 1931, the GOP forgot Mellon’s advice and sought to balance the budget, hoping to end the deficits of the Korean War years. The Republican chairman of the House Ways and Means Committee, Daniel Reed, introduced H.R. 1, a general tax-reduction bill, but Eisenhower’s economic advisers argued that it would be fiscally irresponsible, and Ike asked Reed to withdraw the bill. In the 1958 recession , Eisenhower again stoically rejected calls for a tax cut by members of his won party.
Economic Role Reversal
As a result, there were eight years of Eisenhower economic stagnation. In 1953, as in 1931, the GOP brain trust insisted the tax cut would mean a deficit. The deficit would have to be financed with Treasury bond sales. And these sales would “crowd out” private borrowers from the capital market. In 1974 Treasury Secretary Simon made the same arguments in inveighing against tax cuts.
Ignoring these kinds of arguments, Presidents Kennedy and Johnson got the economy moving again by slashing taxes $20 billion between 1962 and 1965, doing the job the GOP Santa Claus should have done.
But as business expanded and the tax base grew, the Democrats spent the increased revenues that poured into the Treasury. The Great Society programs of 1965 through 1968 were financed by these tax cuts. So was the increased spending for the Vietnam War. The Democrats realized that the Republicans would never call for a tax cut unless the Federal budget were in surplus, so they engineered their spending programs in a way that would guarantee spending would always outrun revenues.
Republicans Play Scrooge
The typical Great Society legislation that passed in 1965 and 1966 called for spending a few dollars the first year, $1 million or so the second year, and $1 billion in the third. The Democrats were spending anticipated revenues. Throughout the period, Republicans continued to play Scrooge, carping against increased spending without ever offering the obvious alternative to tax reduction. Even with a Republican back in the White House in 1969, it was the Democrats who pushed tax reduction in the face of continuing deficits. In 1969 and in 1971, tax cuts were put through over Republican budget concerns. After both, the economy expanded and revenue increased.
In learning how to play both Santa Clauses, the Democratic majorities in Congress grow larger and larger. They can alternate between increased spending and occasional tax cuts and take credit at the polls for both. The economy suffers, though, because the Democrats do not fulfill both roles with equal zest. They spend with exuberance and cut tax rates only when in doing so they can redistribute income from the middle and upper incomes to the less affluent. Americans, discouraged by ever-increasing tax rates, work less and invest less, devoting more time to leisure and a higher portion of their income to current consumption. Because middle- and upper-income Americans are the most productive (an engineer produces more than a ditch digger), taxing them the most has the effect of reducing economic output.
Tax Cuts—Timidity
Until President Ford in January 1975 timidly proposed a tax cut of sorts (three-quarters of his $16 billion package was a rebate on 1974 taxes, not incentives for new production), the Republicans had gone 22 years without proposing the kind of reduction President Eisenhower rejected in 1953 upon the advice of his Hooverlike advisers.
Both President Ford and Ronald Reagan are inching toward the Mellon approach. Still, they each insist in one way or another that tax reduction be bound to spending cuts. This is an improvement on the straightforward demand that the Spending Santa be shot. But as the Two-Santa Claus Theory holds that the Republicans should concentrate on tax-rate reduction. As they succeed in expanding incentives to produce, they will move the economy back to full employment and thereby reduce social pressures for public spending. Just as an increase in Government spending inevitably means taxes must be raised, a cut in tax rates—by expanding the private sector—will diminish the relative size of the public sector.
All the United States needs now to prosper is a Coolidge in the White House, a Mellon at Treasury, and GOP tax-cutting St. Nick.
