Previewing President Obama's announcement of his fiscal year 2011 budget plan, Fox News provided a platform to Art Laffer, a member of President Reagan's Economic Policy Advisory Board,* to offer dubious claims about tax cuts. Laffer claimed that in fiscal 2011, "all of the Bush tax cuts expire," ignoring that President Obama's budget plan allows those cuts to expire only for those making more than $250,000 per year, and asserted that the recession in the early 1980s occurred because President Reagan delayed the implementation of his tax cuts and ended due to those cuts, a claim disputed by many economists who instead cite changes to interest rates.
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From the February 1 edition of Fox News' America's Newsroom:
LAFFER: What's happening, Bill, is that at the end of 2010, the beginning of 2011, all of the Bush tax cuts expire, plus there are lots of other tax increases coming. They're raising the highest personal marginal income tax rate from 35 to 39.6. They're raising the capital gains tax, the dividend tax, the inheritance tax, and payroll taxes. Now, if you know that they're going to raise taxes next year, what do you do this year? You accelerate all the income you possibly can into this year, and then when 2011 comes, you're going to literally fall off the cliff. It's the exact opposite of the mistake Reagan made in 1981 by delaying tax cuts, and that caused a recession in '81, '82, and the biggest boom ever in '83, '84.
Obama's budget calls for maintaining Bush tax cuts for those making $250,000 or less
Budget includes $3 trillion to continue cuts for most through 2020. In his message accompanying the fiscal 2011 budget proposal, Obama stated, "the Budget eliminates the Bush tax cuts for those making more than $250,000 a year and devotes those resources instead to reducing the deficit." The budget includes $135 billion in fiscal 2011 and $3.097 trillion form 2011-2020 to "Continue the 2001 and 2003 tax cuts."
"Other tax increases" Laffer cites are actually part of the Bush tax cuts. While Laffer stated that "all of the Bush tax cuts expire, plus there are lots of other tax increases coming" in fiscal 2011, most of the "other tax increases" he cited -- increases to the top personal marginal income tax rate and the capital gains, dividend, and inheritance tax -- are due to the sunsetting of the 2001 and 2003 Bush tax cuts.
Bush tax cuts are set to expire because of legislation passed in 2001 and 2003 under GOP Congress. The Republican-controlled Congress passed the Economic Growth And Tax Relief Reconciliation Act Of 2001 on May 26, 2001, with a provision sunsetting the tax cuts on December 31, 2010, causing the tax rates to return to their previous levels on that date. President Bush signed the bill on June 7, 2001. The Republican-controlled Congress also included sunset provisions when it passed the Jobs And Growth Tax Relief Reconciliation Act Of 2003 on May 23, 2003. Bush signed the 2003 tax cut on May 28, 2003.
Economists dispute Laffer's link between Reagan tax cuts and recession
CBO: 1982 recession "brought on by monetary restriction," interest rate drop "permitted the recovery to begin." An August 1983 Congressional Budget Office report, titled "The Economic and Budget Outlook: An Update," concluded:
The Economy At Mid-1983
Recovery started in December 1982 from the deepest postwar recession, the second of two since 1980. Both recessions were brought on by monetary restriction aimed at bringing inflation under control. Lower interest rates after mid-1982 permitted the recovery to begin. Real GNP grew at a 2.6 percent annual rate in the first quarter and at an 8.7 percent annual rate in the second quarter of 1983.
The report also concluded: "A dramatic decline in inflation, a fall in interest rates from levels that were extraordinarily high to levels that are merely high, and the stock market boom have contributed to the improvement in economic conditions."
Reagan official Mussa links interest rate changes to recession recovery. Michael Mussa, a member of Reagan's Council of Economic Advisers, in an essay for American Economic Policy in the 1980s (University of Chicago Press, 1995), wrote that a "consequence" of the Federal Reserve's "very tight monetary policy" in the early 1980s led to a "deep and prolonged recession":
The second and ultimately successful effort to combat inflation during the 1980s really began, appropriately enough, on 4 November 1980 -- two years after the dollar stabilization crisis of 1978 and on the day that Ronald Wilson Reagan was elected president of the United States. For twenty-one months, until August 1982, the Federal Reserve would consistently pursue a very tight monetary policy. As a consequence of this effort, the inflation rate would be driven down from 12.4 percent during 1980 to 3.9 percent during 1982. The U.S. economy would also be pushed into a deep a prolonged recession during which real GDP would fall absolutely by 3.3 percent and the unemployment rate would rise to a postwar peak of 10.8 percent.
Mussa also wrote that when the Federal Reserve cut the discount rate a half percentage point on July 20, 1982, it "signal[ed] the beginning of what would become a four-and-a-half-year period of quite rapid monetary expansion. During this period, interest rates, both short and long term, would be driven significantly lower, and the U.S. economy would substantially recover from the devastation of both inflation and recession."
Krugman: Fed "turned the economy around" by reducing interest rates. In a January 14, 2008, Rolling Stone article headlined "Letter to Obama," Nobel laureate Paul Krugman wrote:
Compare the situation right now with the one back in the 1980s, when [Paul] Volcker [then chairman of the Federal Reserve] turned the economy around. All the Fed had to do back then was print a bunch of dollars (OK, it actually credited the money to the accounts of private banks, but it amounts to the same thing) and then use those dollars to buy up U.S. government debt. This drove interest rates down: When Volcker decided that the economy needed a pick-me-up, he was quickly able to drive the interest rate on Treasury bills from 13 percent down to eight percent. Lower interest rates on government debt, in turn, quickly drove down rates on mortgages and business borrowing. People started spending again, and within a few months the economy had gone from slump to boom. Economists call this process -- from the Fed's decision to print more money to the resulting pickup in spending, jobs and incomes -- the "monetary transmission mechanism." And in the 1980s that mechanism worked just fine.
Interest rate movement tracks economists' statements. The recession to which Laffer referred began in July 1981 and ended in November 1982. The federal funds rate peaked at 20 percent in late May 1981 and dropped to 9.5 percent by mid-October 1982, while the discount rate peaked at 14 percent in early May 1981 and dropped to 9.5 percent in mid-October 1982.
Correction: Originally, this item incorrectly identified Art Laffer as President Reagan's budget director. We regret the error.