(This item originally appeared at Forbes.com on October 21, 2016.)
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?