Fifty years ago Wednesday (Feb. 26), perhaps the most progressive president in history, Lyndon Johnson, signed into law sweeping cuts in income tax rates that had first been proposed by President John F. Kennedy, and which arguably began a process that has led to the growing issue of income inequality in America.
The Kennedy tax cuts began a dramatic change in how Americans think about the income tax, its relationship to economic growth, the obligations of the wealthiest in our society, and how serious a problem we consider the national debt.
Important not only because of its effect at the time, seventeen years later, Kennedy’s tax program was used by President Ronald Reagan to justify his own additional substantial cuts in income tax rates, which further accelerated the gap between rich and poor.
While the results of their tax programs were similar in many ways, Kennedy and Reagan had different reasons for proposing tax rate reductions—and none were necessarily about relieving the wealthy of a large share of their tax burden, though that was a significant practical effect.
When Kennedy took office in January 1961, the highest marginal federal income tax rate was an astonishing 91 percent, a holdover from the high rates first imposed under Herbert Hoover to counter the Great Depression, and even higher rates later, peaking at 94 percent for the highest income earners, to fund World War II.
Despite the high tax rates sustained during the Eisenhower administration, the U.S. economy had grown at a solid average rate of 2 to 3 percent per year and there were few serious discussions about reducing the federal tax burden.
But there was considerable concern that the American economy was underperforming, particularly vis-à-vis the Soviet Union, whose economy was (erroneously) believed to be growing at an astronomical rate of 6 to 10 percent per year.
Viewing almost every issue as he did through the prism of the Cold War, Kennedy asked his economic advisers how the United States could achieve at least an annual 5 percent growth rate to keep pace with the Soviets. The answer from his chief economic adviser, the liberal University of Minnesota economist Walter Heller, was tax cuts—for at that time liberals were arguing for tax cuts while conservatives were opposed, worrying that a tax cut would lead to deficit spending that would trigger inflation.
Kennedy initially sided with the conservatives, for he, too, feared inflation more than unemployment, part of an overall world view that led historian Allen J. Matusow to label Kennedy the “quintessential corporate liberal.”
But Kennedy was eventually persuaded by Heller and others that tax cuts would spur economic growth. Retrospectively, Heller insisted that Kennedy hoped that the ensuing prosperity would free Congress to spend more on social programs aimed at reducing poverty.
Heller acknowledged that Kennedy’s proposal was based, at least partly, on the theory of “supply-side economics,” which argues that in the right circumstances the loss of revenue from tax cuts can be fully or at least partially offset by higher tax revenues from increased economic activity spurred by the tax cut.
Heller argued that the key difference between the Kennedy tax cuts and the Reagan tax cuts was intent; Kennedy, at least according to Heller, wanted to cut taxes to stimulate the economy so he could increase federal spending, while Reagan would have been sorely disappointed had his tax cuts actually generated more federal tax revenue.
Despite Reagan’s apparent embrace of supply-side economics, as Reagan aide Bruce Bartlett has noted, neither Reagan nor any of his close advisers argued that his tax cut would “pay for itself.” Nor did any of them view the promotion of economic growth as the prime consideration behind a tax cut.
Rather, Reagan was candid in hoping a tax cut would lead to a reduction in the size of the federal government. Author Jeff Madrick said Reagan subscribed to conservative economist Milton Friedman’s belief that the only way to reduce federal spending was “to starve the beast.”
Appeals to fiscal discipline had failed to convince the nation to reduce or at least stall the growth in federal spending. Reagan said it was time for a new approach. In a nationally televised speech, Reagan explained, “Well, you know, we can lecture our children about extravagance until we run out of voice and breath. Or we can cure their extravagance by simply reducing the allowance.”
Where Kennedy’s legislation lowered the top marginal rate from 91 to 70 percent and the lowest marginal rate from 20 to 14 percent, Reagan in 1981 proposed reducing the top marginal rate from 70 to 50 percent and the lowest rate from 14 to 12 percent.
Both tax cuts were followed by periods of substantial economic growth. In the two years after Kennedy’s tax cuts took effect, the U.S. economy grew by 17 percent, which prompted federal spending to increase by 13.5 percent. U.S. News & World Report gushed that the tax cuts had “achieved something like magic,” and LBJ was led to believe he could do both “guns and butter,” funding the Vietnam War and the Great Society.
In the first year after Reagan’s tax cuts took effect, economic growth actually declined by nearly two percent, but in each year of Reagan’s second term the economy grew by an average of roughly four percent per year. Reagan and his fellow conservatives credited this growth to the tax rate reductions—just as had those who supported the Kennedy tax cuts.
The degree to which the ensuing economic growth could be credited to either of the tax cuts is still hotly debated among economists. The 1960s and 1980s were also periods of technological advances and increased government spending, especially on defense. Reagan also benefited from monetary policies, which he supported, that greatly reduced the inflation that had burdened the economy in the late 1970s and early 1980s. These were all critical factors, too, but the perception that tax reductions almost automatically trigger economic growth became embedded in the public consciousness.
If Heller accurately portrayed Kennedy’s rationale for the tax cuts, then it did indeed lead to increase domestic spending. But if Reagan’s goal in cutting taxes was reduced federal spending, he failed. Not a single major federal agency or program was eliminated during his administration.
Because domestic spending was not abated, because defense spending increased, and because the tax cuts did not pay for themselves, deficit spending worsened, as Kennedy, conservatives, and others had worried they would. Reagan had said a balanced budget was his goal, but he was unwilling to sacrifice spending on defense to achieve it.
In 1961, Kennedy’s first year in office, the federal deficit was just more than $3 billion; by 1968, LBJ’s last year and three years after Kennedy’s tax cuts took full effect, the federal deficit was $25 billion. Of course, these numbers were dwarfed during the Reagan era. In 1981, Reagan’s first year in office, the government ran a $78 billion deficit but by 1983 the annual deficit topped $200 billion and stayed near or above that amount throughout Reagan’s presidency.
Yet, because public opinion credited the tax cuts with economic growth (and because everybody personally enjoys paying fewer taxes), the public outcry was muted.
Increased American comfort with deficit spending led former Vice President Dick Cheney to proclaim that Reagan had proved, with Kennedy and LBJ’s prior example, that “deficits don’t matter,” at least politically. Heller had bragged that the great achievement of Kennedy’s tax cuts was that he had “banished’ the idea that public debt was “burden on our grandchildren.”
Worry over debt, of course, has not been banished in many quarters, but it does appear that the Kennedy and Reagan tax cuts combined have had the very significant result of creating a new sense of what is an appropriate or fair tax rate, especially for the wealthy.
This was highlighted during the bitter debate two years ago when, at President Barack Obama’s behest, the top marginal rate for those individuals earning more than $400,000 per year was raised from 35 to 39.6 percent. This rather small 4.6 percent gap was conflated by antagonists on both sides as the difference between creeping socialism and unfettered capitalist greed.
Forgotten was that Republican President Herbert Hoover approved a top income tax rate of 63 percent on those making more than $1 million per year to help the government deal with the Great Depression, and that the Republican President Dwight Eisenhower made no serious effort to lower that top 91 percent marginal tax rate that had existed throughout the 1950s.
Such rates today would be automatically dismissed as confiscatory, while conservatives, now lacking the caution of their forbearers, appear to argue that tax cuts are always good for the economy.
They always seem to be good for the wealthy. By the end of Reagan’s two terms, taxes on the middle fifth of income earners had been cut by 0.7 percent and many low wage earners had actually seen their taxes increase because of a Reagan-sponsored increase in the payroll tax to fund Social Security. The top 10 percent of income earners, meanwhile, had had their taxes cut 3.3 percent, while taxes fell 8.1 percent for the notorious top one percent.
Kennedy had also been warned that his tax cuts would benefit the rich at the expense of the poor and middle class. Liberal economist Leon Keyserling complained at the time that 45 percent of the Kennedy/LBJ tax cuts went to the wealthiest 12 percent of Americans. Keyserling warned that income inequality would result in a sluggish economy because too many consumers would have too little purchasing power.
In 1983, during the worst of the Reagan recession and before the economy rebounded, a 1983 Gallup survey found that 70 percent of Americans agreed with the statement, “Reagan represents the rich rather than the average Americans.”
Yet, while middle class Americans seem to understand that their economic interests have been harmed over the past several decades, there is no sense that they believe that income tax rates have played a role in their worsening condition.
Perhaps this is because both parties—first Democrats under Kennedy and Johnson and then Republicans under Reagan—embraced dramatic reductions in income tax rates, especially for the wealthy, and then credited those tax cuts for subsequent economic growth. This change in how Americans now view the income tax, their faith that tax cuts spur the economy, and the growing disparity in income was a bipartisan effort.