by Scott Farris
Economic theory seems to have some parallels to criminal law; intent can be as important as action in identifying which economic philosophy is being put into practice. In pursuing his set of tax cuts, Kennedy believed he was implementing the tenets of the legendary British economist John Maynard Keynes.
Keynes’s basic theory is simple. Government has available to it and should use two tools to help regulate and smooth out the activities of an imperfect market. One tool is monetary policy, which is the regulation of the supply of money through interest rates, availability of credit, and other means. The other is fiscal policy, which is the government’s power to tax and spend. Exactly which tool to use and how it should be used varies with the economic circumstances, but Keynes’s most controversial argument was that during periods of high unemployment, when the economy is clearly underperforming, governments should deliberately run budget deficits (spend more than they take in) to help stimulate economic activity and growth.
Kennedy freely admitted that he knew very little about economics. He had received a “C” in economics at Harvard, and while his campaign biographies stated that he had studied at the London School of Economics under Harold Laski, health problems caused him to withdraw and he never actually attended the school. Once during his presidency, while reminiscing with his friend, journalist Charles Bartlett, about an economics tutor they had shared during prep school, Bartlett asked if Kennedy knew what had happened to the man. “I imagine he jumped out of the window when he heard I was elected,” Kennedy said.
During his 1960 presidential campaign, Kennedy had promised to “get this country moving again,” including economically. The U.S. economy actually had been growing at an average of 2 to 3 percent per year during the 1950s, which seemed like solid growth except that U.S. officials had incorrectly estimated the Soviet Union’s economic growth at an extraordinary rate of 6 to 10 percent per year. Since Kennedy viewed almost everything through the prism of Cold War competition, a growth rate lower than the USSR’s was unacceptable. Kennedy’s initial goal was an annual growth rate in gross domestic product (GDP) of 5 percent, though he later settled for a still ambitious target of 4 percent annual growth.
Kennedy was also concerned about high unemployment. Unemployment rates had been low throughout most of the 1950s until a series of small recessions led to a spike in joblessness that was still at 7 percent during the 1960 campaign. But Kennedy had declined to recommend increased government spending to stimulate the economy and reduce unemployment. The prevailing wisdom was that deficit spending caused inflation, and Kennedy, as Reagan would, considered inflation a far greater worry, economically and politically, than unemployment. Kennedy’s theory was that while unemployment impacted only 7 percent of the workforce at the time, inflation would impact everyone. Kennedy aide Ted Sorensen put it a little more crassly: “If you have seven percent unemployment, you’re getting a grade of 93,” he said. Why take the political risk just “to raise the grade from 93 to 96?”
In addition to ruling out a stimulus package, Kennedy declined to call on the Federal Reserve Board to lower interest rates for fear it would antagonize bankers and worsen the country’s balance of trade by discouraging foreign investment in U.S. Treasury notes and bills. His chief economic advisor, Walter Heller, a University of Minnesota professor and a dedicated Keynesian who believed budget deficits could stimulate the economy, suggested Kennedy consider a $5 billion temporary tax cut.
One of the remarkable things about the generally stellar performance of the American economy during the 1950s was that income tax rates were extraordinarily high. When Kennedy became president, the marginal income tax rate for the highest income earners (those earning more than $200,000 per year) was a staggering 91 percent, a holdover from World War II when income tax rates had soared as high as 94 percent to pay for the war effort. Even the lowest marginal tax rate was 20 percent.
Yet there was strong political resistance against lowering these rates, especially among conservatives, who feared a reduction in revenue without accompanying spending cuts would lead to higher budget deficits. Speaking as a Keynesian, Heller despaired of this “puritan ethic” that was averse to debt, but former President Harry Truman spoke for many Americans when he said, “I am old fashioned. I believe you should pay in more than you spend.”
Kennedy believed a majority of Congress shared Truman’s view. While Democrats held a 262 to 173 advantage in the House, 101 Democrats were from the South and could be counted on to side with conservative Republicans on most domestic issues. In fact, Kennedy himself had shared Truman’s view. As a congressman he was a deficit hawk, opposing Republican proposed tax cuts and Democratic proposed spending increases as leading to potentially “dangerous” deficits that might limit the nation’s ability to wage war, if it came to that. Congressman Kennedy had called the federal government the “great Leviathan,” had once proposed a 10 percent across-the-board budget cut, and had said, “I do not see how we can go on carrying a deficit every year.”
As he weighed his advisors’ call for tax relief, Kennedy contemplated the non sequitur of proposing massive tax cuts after having called on the American people, in his inaugural address and other speeches, to sacrifice for the good of the nation. Kennedy had asked Americans what they could do for their country, and it did not seem right that the first answer was to pay less taxes.
During the Berlin crisis, Kennedy had actually considered adding a 1 percent surcharge on all income tax rates to raise $2.5 billion and rally public opinion for the defense of Berlin. Heller, Paul Samuelson, and Kennedy’s other economic advisors talked the president out of it, warning that a war scare could spur inflation. One of the most liberal economists Kennedy knew, Seymour Harris, told him, “Mr. President, any rise of taxes at the beginning of a recovery would be disastrous.”
Continuing to press Kennedy on the tax cut, Heller cited “chronic slack” in the economy, and he claimed that an appropriately timed and targeted tax cut could generate an additional $30 billion in economic activity without triggering higher inflation.
Kennedy realized he needed to do something but was still reluctant to proceed. He wanted to win favor with the business community, and because he believed most businessmen were essentially conservative, he worried they also would be unreceptive to a tax cut absent a corresponding spending cut.
As the “quintessential corporate liberal,” a label applied by historian Allen J. Matusow, Kennedy remained baffled that business reflexively supported Republicans over Democrats when Democratic administrations often presided over periods of greater prosperity than Republican ones. Business distrust of Democratic presidents was, as Robert Kennedy said, “one of the facts of life,” but that was not going to prevent JFK from trying to win them over. As he told one group of businessmen, “far from being natural enemies, government and business are necessary allies.”
Kennedy’s first timid foray into improving the economy was a proposed 7 percent investment tax credit, which brought a collective yawn from the business community; what business wanted was more liberal depreciation allowances. One of Kennedy’s problems was that he simply found economic policy—in truth, most domestic policy—boring. It did not hold his attention. After the excitement of the Bay of Pigs crisis, Kennedy told Nixon, “It really is true that foreign affairs is the only important issue for a president to handle, isn’t it? I mean, who gives a shit if the minimum wage is $1.15 or $1.25 in comparison to something like this?”
Unsurprisingly, it took a crisis—or at least a crisis as far as Kennedy was concerned—to get him focused on economic issues. The showdown over steel prices in April 1962, while resolved in Kennedy’s favor, was shortly followed by the biggest one-day drop in the stock market since 1929. To win back business support, Kennedy approved the new accelerated-depreciation guidelines business had sought, which represented an annual corporate tax cut of nearly 10 percent, or $2.5 billion.
He also finally acceded to Heller’s and others’ request that he propose a $10 billion income tax cut, which would reduce the top marginal rate from 91 percent to 70 percent, the lowest marginal rate from 20 percent to 14 percent, and the tax rate on capital gains from 25 percent to 19.5 percent. Kennedy’s only demand was that the tax cuts in no instance create a budget deficit larger than $12.4 billion, which had been the peacetime record under Eisenhower. That meant phasing in the tax cuts over several years, diluting their potential impact. Still, Heller predicted a $10 billion tax cut would generate the additional $30 billion in economic activity that he had promised.
Keynesian theory appealed to Kennedy because Keynes was not a radical who advocated major reforms to the capitalist system; rather, Keynes argued only that the existing system could be made more efficient. Kennedy had argued that the great ideological battles were over; now it was a matter of finding technical solutions to the world’s problems.
To Kennedy’s delight, the tax cut was well received by business. In selling his tax reform in a 1962 speech to the Economic Club in New York, Kennedy argued, “The current tax system siphons out of the private economy too large a share of personal and business purchasing power . . . it reduces the financial incentives for personal effort, investment, and risk-taking.”
Those remarks, downright “Reaganesque,” have since caused considerable heartache among generations of liberals who object to Kennedy being used to justify subsequent tax cuts. Conservatives have embraced those words and Kennedy’s tax cuts to argue that the iconic Democratic president was an early advocate of “supply-side economics,” a theory more closely associated with Reagan that argues that when tax rates are too high, it actually deprives governments of tax revenue because it depresses economic activity, while in some circumstances tax cuts can so stimulate economic growth that governments will end up collecting nearly the same amount of tax revenue under lower rates. A few even argue that tax cuts can “pay for themselves.”
In advocating for his tax cut proposal, Kennedy did argue that while cutting taxes might “temporarily” increase the federal budget deficit, the increased economic activity generated by the tax cuts would “prevent the even greater budget deficit that a lagging economy would otherwise surely produce.” Heller himself addressed the question of whether Kennedy was advocating supply-side economics in a 1981 article written while Reagan’s tax rate reduction proposal—which the president said was inspired by Kennedy’s tax cuts—was being debated in Congress
“We did not use the catchphrase ‘supply-side economics,’ but that’s exactly what it was,” Heller said. He even once claimed in congressional testimony that the Kennedy tax cut had indeed paid for itself by spurring additional economic growth that led to higher revenues. Heller recanted that statement in a later article, saying that the idea that tax cuts pay for themselves was “bizarre . . . [and] is unfortunately not supported by the statistical evidence.” In the very same article, Heller acknowledged that the Kennedy tax cut stimulated enough economic activity and put enough people back to work that it broadened “the tax base—not full enough to pay for itself, but enough to cut the revenue loss very significantly.”
Heller was not endorsing the Reagan tax cut in 1981. He noted several key differences in the economic conditions the two presidents had faced, and that Reagan was proposing rates lower than Kennedy would have supported. But the main difference between the Kennedy tax cut and the Reagan tax cut, Heller said, was the purpose for which they were intended.
The goal of the Kennedy tax cut was to improve the economy to such a degree that Congress would be open to increased appropriations for other programs Kennedy wished to expand or initiate. “As later events proved, the surest path to more adequate financing for government programs was, paradoxically, through tax reduction,” Heller said. A healthier, more robust economy created “a more sympathetic attitude toward expansion of social programs.” Heller quoted a conversation he had eleven days before Kennedy’s assassination in which the president said, ‘First we’ll get your tax cut, and then we’ll get my expenditure program.’” Based on faith that the tax cut would help the economy as planned, Heller remembered, Kennedy also assured him he would propose an antipoverty program in 1964.
Kennedy, of course, did not get the opportunity to outline what that antipoverty program might look like, nor was his package of tax cuts headed toward easy passage in Congress at the time of his death. Like most of Kennedy’s domestic program, including his proposal of health insurance for the aged and federal aid for education, the tax cuts were languishing in Congress at the time of his assassination. Lyndon Johnson, however, saw to it that the tax cuts, along with civil rights legislation, would be the top legislative priorities enacted to memorialize the slain president.
LBJ assured Heller he was fully on board with the tax cuts and accepted the need for deficit spending to give the economy a boost. He was no knee-jerk conservative, Johnson assured Heller. “If you looked at my record,” he said, “you would know that I’m a Roosevelt New Dealer. As a matter of fact, to tell the truth, John F. Kennedy was a little too conservative to suit my taste.” To appease Senate Finance Committee Chairman senator Harry Byrd of Virginia, Johnson, wheeling and dealing with Congress in ways completely foreign to Kennedy, agreed to a $1 billion budget cut as a condition for approval of the tax cuts so that the federal budget could symbolically stay below $100 billion. “Now you can tell your friends that you forced the president of the United States to reduce the budget before you let him have his tax cut,” Johnson told Byrd. The tax cuts were approved in February 1964.
To Heller’s delight, the economy grew at a rate of 6.5 percent and unemployment dropped to 4.1 percent by 1965. Heller was particularly pleased that at lower average tax rates, a two-year 17 percent increase in the gross national product allowed federal spending to increase by 13.5 percent. U.S. News & World Report said the tax cut “achieved something like magic,” while Time magazine headlined a story, We Are All Keynesians Now.
But not everyone agreed with Heller that the tax cuts should get credit for the ensuing economic growth. Conservative free-market economist Milton Friedman argued the economy was instead stimulated by a decision made by the Federal Reserve Board to lower interest rates and loosen the money supply months before the tax cuts were approved. Others suggested the economic boom of the 1960s was fueled primarily by increased defense spending—an argument Heller specifically rejected. Until the escalation of the Vietnam War in 1966, defense spending was actually shrinking as a percentage of GDP, Heller argued, adding that the massive expenditures associated with Vietnam overheated the economy and drove up the inflation rate, which caused a new set of economic problems. Friedman, of course, took a different view, arguing that the lower interest rates that had loosened the money supply had spurred inflation.
Liberal economists also questioned the results achieved by the Kennedy tax cut. James Tobin, who served with Heller on the Council of Economic Advisors until he returned to Yale in 1962, argued that Kennedy’s tax cuts had betrayed traditional liberalism. While a temporary tax cut could be justified to stimulate the economy, Tobin said, when the reduced rates were made permanent they ensured that consumption would be favored over investment, which was a bad strategy for long-term growth. Kennedy advisor John Kenneth Galbraith, then serving as ambassador to India, also fretted that government needed the revenues lost to tax cuts to make necessary public sector investments in infrastructure and education that would ensure the nation’s long-term economic health. And Leon Keyserling, who had been a key advisor to Truman, argued that Kennedy’s tax cuts simply weren’t equitable, since the richest 12 percent of Americans received 45 percent of the tax cut benefit. Keyserling said income inequality was already a key reason for the sluggishness of the U.S. economy; too many consumers had too little purchasing power, and the tax cuts made that inequality worse. All these arguments would reappear in 1981, when Reagan proposed h
is own tax relief.
The great achievement of the 1960s’ tax cuts, Heller said, was that Kennedy “banished . . . the beliefs that deficits in a weak economy were instruments of the devil and that public debt was a ‘burden on our grandchildren.’” Heller was wrong to use the word banished, but Reagan’s tax cuts were further evidence that Americans had indeed crossed some sort of Rubicon in their attitudes toward debt. When President George W. Bush proposed further tax cuts in 2002, Vice President Dick Cheney argued the cuts could be justified in part because “Reagan proved deficits don’t matter.”
There is a myth that Reagan so fully subscribed to supply-side economics that he genuinely expected his tax cuts would yield increased revenues to the federal government because they would stimulate such a giant boost in economic activity. Bruce Bartlett, a domestic policy advisor to Reagan, said, “No one in the Reagan administration ever claimed that his 1981 tax cut could pay for itself or that it did.” A thorough analysis of the impact of the Reagan tax cuts by economist Lawrence Lindsey concluded, “Behavioral and macroeconomic effects of the 1981 tax cut, resulting from both supply-side and demand-side effects, recouped about a third of the static revenue loss.”
Reagan would likely have been disappointed had his tax cuts generated more tax revenue, for that would have encouraged more federal spending. If Kennedy had hoped his tax cuts would so improve the national economy that it would trigger spending on new or expanded federal programs, Reagan was hoping for the opposite result: He hoped less revenue would mean less government. “No doubt at the back of Reagan’s mind was [Milton] Friedman’s advice to starve the beast; tax cuts would eventually force government to contract,” wrote Jeff Madrick, author of The Age of Greed.