ANOTHER research paper. :)

 Yet another, and yes more boring, paper on economics. :)

Research Paper

Jordan Reed

   In today’s political and economic debates, the subject of tax cuts versus government spending is an extremely volatile issue. It is a polarizing agent in the very definition of where political parties stand on method of governance, and not just in America but in many OECD nations as well. Because it is such a representative issue, both sides of the spectrum persist that their economic formula is superior to the others. This mutual persistence makes it often difficult to get a clear concise picture on the better market ideology. Now, due to recent events in the political sphere, the viability and efficacy of tax cuts has been seriously questioned and in some cases discarded entirely. These events have led me to do my research paper upon whether taxes have a negative effect on the economy, and if tax cuts have a revitalizing influence or not.

  To begin, it would be good to quantify just what these two sides represent exactly. There are numerous sects peppered throughout the spectrum, but, in order to streamline the argument, we can recognize two main factions: Keynesian and Chicago School. Each represents a foundation in their respective thought processes. Keynesian economic theory was a theory that arose around the early 20^th century. It was formed by John Maynard Keynes, and it focused on the idea that aggregate demand dominates the prosperity and productivity of an economy. The corollary to this statement is that the government has the responsibility of spending to increase the overall demand of an economy in times of recession.  In opposition to this theory, the Chicago School of Economics purported that the free-market can best distribute resources, and government interference should be as small as possible. Because of this emphasis on less interference, the use of tax cuts became a common pillar of the theory. This focuses primarily on the supply of an economic model, thereby earning this theory the moniker supply-side economics. Now, the trouble comes when these systems are compared. Each situation in which one of these theories was implemented had different variables in the market, different macroeconomic situations, and varying degrees by which the theories were implemented. These influences make large-scale dissection of these policies and their effects difficult, but it is not impossible. At certain times, there have been administrations completely behind a certain economic model, and the administration’s policies included the implementation of many of the factors contained in a specific school of economic thought. By isolating certain choices of policy during this period of implementation and the subsequent results in a cause-and-effect relationship, we can draw conclusions on the overall impact of said policies.

  First, we will observe the effects of implemented Keynesian policies in the Roosevelt administration of 1933-1945. The blame for the depression had fallen heavily upon the Republican Old Order, and this resulted in the rare occurrence when both the legislative and Executive branches of government were ousted. The new economic outlook of this administration was dominated by the New Deal, which relied heavily on the interventionist principles of Keynes’s ideas. Shown in Fig. 1 (Romer 1992:757-784), the national GDP had plummeted through 1929-1932, and, even though the descent had slowed by 1933, the election of the new administration was almost inevitable. The overwhelming election of Roosevelt gave him a definite “mandate of the people” to enact drastic change. This change included such acts as CCC (Civilian Conservation Corps), PWA (Public Works Administration), CWA (Civil Works Administration, and WPA (Works Progress Administration).Using government wages, these programs were used to employ large segments of the jobless population.  In Keynesian principle, the government spent revenue to employ citizens in works, and these public sector employees would increase the aggregate demand in the economy through the public works system. This policy of government mass-employment is lauded by Keynes himself in a letter to President Roosevelt: “public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money. “ (Keynes,1933:2) Fig.2 (Romer 1992:757-784) shows just how many jobs these policies pushed the government to employ. Further examples of Interventionist precedent are scattered throughout this administraton’s terms and policies, but it would not serve to expand our study into these at this time.

  Before weighing and discussing these findings, I would also present an opposing event that illustrates a similar circumstance but has a radically different solution. The election of 1980 serves as a pivotal turning point in the Kenyesian/Chicago School(or neo-classical as it had become called) contention. In veiw of context, the Kenyesian economic structure had become so entrenched that President Nixon was quoted as saying, “We are all Keynesians now” But, in the 1970s there came a period of stagflation, where inflation skyrocketed, growth stagnated, and unemployment remained at a heightened level. This was detrimental to the Kenysian economists, because their policies were so closely tied to the incumbent party. When the stagflation continued, the people overthrew the current administration in the election of 1980, and supply-side economists became the new leading theorists.  One of the keystone programs of the incoming regime was the institution of a supply-side economic model, and a pillar of this model was a massive tax cut to all income brackets. This tax cut was realized in the Economic Recovery Tax Rate of 1981 that entailed a phased-in 23% cut in individual tax rates over 3 years, with the top rate dropped from 70% to 50%. The Reagan administration and Chicago School theorists claimed that the tax cuts would provide growth in the tax base while simeoultaneously enriching the populace. Did it accomplish these things? Were these tax cuts successful in their stated purpose? Statistics from the period show that GDP grew at an annual percentage rate of 3.1 from 1980-1988, real family median income rose 0.8% annualy, and unemployment annualy fell by 0.3%. Even more telling is the fact that each quintile of living’s real income was raised by at least 5%. (Moore) Looking at these statistics, it would seem reasonable to at least make a superficial claim that tax cuts do indeed have a postive effect on the economy. The problem with this line of thinking is it doesn’t lay rest the basic question of whether tax cuts or government spending are more effective. After all, these two methodologies of governance are mutually exclusive. One represents government intervention during recession while the other focuses on minimal government interferance.

  To solve the problems above, we must examine the factors and evidence in each case, and define what would constitute a “successful” policy. For my paper, I am constituting a successful policy as one that spurs the economy to greater GDP than it would have experianced otherwise .

    First, we examine the New Deal example. Did the Keynsian method work? Upon first glance the evidence seems convincing. The GDP skyrocketed from 58 billion in 1933 to nearly 130 billion in 1941. This is one area where we must understand the intricacies of the historical context. Part of that enormous increase in GDP can be partly attributed to the energizing effect of America’s entrance into World  War 2. For this reason, it would be more informative to study the economic evidence of pre-WW2. With this in mind we can now see that the GDP jumped to approximately 90 billion in 1938. This 32 billion increase over five years is spectacular in any circumstance, but the claim that the rapid growth was caused by the fiscal  policies of FDR has been questioned in recent studies. Economist Christina Roma put forth a study that the government spending of the New Deal had less of an effect on the growth of GDP. She proves this through the use of an algorithm that incorporates the recessions and revoverys of previous instances. The simulation allows one to see approximately what the GDP growth would have been without the fiscal policy of 1933. (see fig. 3). (Romer) By looking at this chart that the Keynsian policies employed had nearly no effect on the growth. In the limited scope of this example, we can derive that a policy of government spending to increase demand is flawed, but it should be repeated that the diverse variables comprising the different markets must be taken into account in any conclusion.

  Of course, it is does nothing to quell a controversy if one policy is proven flawed but the other is not tested for its own authenticity. We now study the Reagan period of economic policy, and the Chicago School methodology brought with it. Applying the same litmus test we used on the New Deal policies, did Reagan’s tax cuts spur growth? We see in figure 4 that the growth during the Reagan administration was the second largest post WW2. In addition, A broad view showed that the growth came after two consequtive falls in growth. More than that, it could be implied that the economic stagflation would not have recovered without some major change, and that change was this change in economic policy.

  Viewing all the presented evidenc e, a few conclusions can be drawn from them. First, in the examples listed we see the weakness of Keynsian policies. It should be remembered that though they didn’t have an effect in these instances, but there are numerous studies that present further evidence on the different facets of the economy. What is proven in this paper is that the Keynsian ideology does not particularly contribute to the overall growth of GDP.

  Another conclusion that could be drawn is that, while interventionistism does not work, tax cuts have a pro-growth effect on the overall  economy. Because the measurement of success being gauged was GDP, that was the targeted statistic, but there are numerous other statistics, unemployment and real family income just for starters, that show a favorable change due to tax cuts and Chicago School policies.

  The final conclusion is that, while these issues have become a defining point of alliegiance in politics of the modern day , tax cuts and government spending are in themselves not complete economic policies. Just as there are numerous variables and nuances in a market, there is an equal amount of complexity in any economic plan. Tax cuts versus government spending really illustrates the difference in the way of approaching an economic  plan to solve a problem.

 

Works Cited

Keynes, John. "AN OPEN LETTER TO PRESIDENT ROOSEVELT." 16 December 1933.

Moore, William A. Niskanen and Stephen. "Supply-Side Tax Cuts and the Truth about the Reagan Economic Record." 22 October 1996. Cato Institute. Web. 25 November 2012.

Romer, Christina D. "What Ended the Great Depression?" The Journal of Economic History 52.4 (1992): 757-784. Web. 25 November 2012. <http://www.jstor.org.dbsearch.fredonia.edu:2048/stable/2123226?seq=11>.

Figure 1

Figure 2Fig. 3

Fig. 4