EH.net is owned and operated by the Economic History Association
with the support of other sponsoring organizations.

The Kennedy-Johnson Tax Cut: A Revisionist History

Author(s):Prachowny, Martin F. J.
Reviewer(s):Vedder, Richard K.

Published by EH.NET (October 2000)

Martin F. J. Prachowny, The Kennedy-Johnson Tax Cut: A Revisionist

History. Cheltenham, UK and Northampton, MA: Edward Elgar Publishing,

2000. ix + 227 pp. $80 (cloth), ISBN 1-84064-417-6.

Reviewed by Richard K. Vedder, Department of Economics, Ohio University.

The conventional wisdom regarding modern American macroeconomic history is

that after the Keynesian Revolution of the 1930s, business cycles were largely

tamed, in part because of the intelligent use of fiscal policy. Scholars point

to the Kennedy-Johnson tax cut of 1964-65, which, we are told, turned a

sluggish economy into a vibrant and rapidly expanding one, setting off the

longest boom in American history to that time.

Martin Prachowny challenges that wisdom in his interesting and valuable

account of the Kennedy-Johnson tax cut, writing what he calls a “revisionist

history.” Yet the revisionism is a different form than I would have predicted

ex ante. I expected an account arguing that the Keynesian paradigm was faulty,

perhaps using a New Classical perspective that emphasizes the role that the

tax cut had in the genesis of the stagflation of the 1970s. Rather, Prachowny

finds not much inherently wrong in the Keynesian theoretical approach, but

much wrong in its implementation. The villains in this account are Walter

Heller, Gardner Ackley, and Arthur Okun, the chairmen of the Council of

Economic Advisers (CEA) of the era. The problem was not that they were

Keynesian, Prachowny argues, but that they were not Keynesian enough.

Prachowny suggests that the sins of this triad of economists were many. First

of all, he argues that they were not using the full array of Keynesian

theoretical tools to analyze the economy. They used a rather simple

multiplier-accelerator model, instead of the IS-LM approach that was

universally used in the intermediate macro theory books of the time. As a

consequence, they tended to ignore the interest rate and monetary dimensions

of their expansionist programs. Crowding out is not acknowledged as a

potential issue. The problem was sometimes even more basic: “the simple truth

is that Heller did not understand the operation of the accelerator” (p.68), a

hallmark of Keynesian cyclical analysis of that era. Moreover, while Okun

(approvingly in Prachowny’s view) championed the idea of measuring and

targeting the gap between actual and potential GNP, thus introducing some

supply side considerations into the analysis, the CEA inconsistently tried to

eliminate the output gap, and sometimes dishonestly or incompetently measured

it (Prachowny goes into some tedious econometric overkill to demonstrate that

point). Moreover, its sensitivity to supply side effects of stabilization

policy was wanting.

Moreover, the CEA was not always intellectually honest, sometimes suppressing

truth and hard analysis in order to accommodate some political problem.

Prachowny shows that at one point Ackley seemed to advocate lying (or at least

suppressing the perceived truth) about the forecasted GNP, even though this

would “not completely fool many outside experts” (p. 197). The notion that the

Council was a group of objective experts, who gave the president and public

the unvarnished truth as they saw it, is a fantasy. Speaking of Heller’s

perception of his job, Prachowny noted “there was no inconsistency between

being a partisan advocate of efficiency and a partisan Democrat” (pp.

180-181).

Even more sinful, the Council was intellectually inconsistent, fighting hard

in 1962 and 1963 for a tax cut to eliminate an output gap, but vacillating and

fudging forecasts so as to avoid vigorously prompting a tax increase when

aggregate demand overheated by 1966 or 1967. Bowing to political pressures

(e.g., opposition to a tax increase by Lyndon Johnson and Wilbur Mills), they

pushed wage-price guideposts and started bashing businessmen, implementing

fine-tuning and mindless intervention to an absurd degree. Thus, in February

1966, Gardner Ackley devoted considerable effort to rolling back an increase

in shoe prices, and argued that the U.S. “should . . . proceed to draw up an

export restriction order” (p. 122). In Prachowny’s view, inflation was

mounting because the government would not dampen aggregate demand, yet the

nation’s leading policy economist was advocating trade restrictions to deal

with the problem! Had Shakespeare been alive, he might sensibly have advocated

shooting the economists instead of the lawyers. The fiasco of failing to deal

at a macro level with excessive aggregate demand set the stage for inflation

and later stagflation.

Prachowny says that the CEA did not take advantage of modern advances in

Keynesian economics, such as the development of IS-LM analysis. One can argue

that they ignored non-Keynesian insights as well. Milton Friedman and Anna

Schwartz had written their Monetary History of the United States before

the tax cut was approved, and the early Keynesian notion that “money does not

matter” (which seemed, roughly, to be the Heller view) was under serious

attack. We were within a few years of reading new insights of Friedman,

Phelps, Lucas and others. Why did not some of the brainpower at the Council

anticipate the problems that demand stimulus would cause in the long run?

Among the Council’s members were future Nobel laureate James Tobin. Other

future Nobel winners, like Robert Solow, were informal advisors. Eccentric,

but probably correct, Ludwig von Mises almost perfectly anticipated the

Phillips Curve and its ultimate demise in the forward to his new edition of

the Theory of Money and Credit, published in 1953. If one wants to

indict the Council on its economics, one does not have to limit oneself to its

lack of sophistication regarding the Keynesian model.

When all is said in done, however, Prachowny’s book is a welcome addition to

the literature on American fiscal policy history. It adds importantly to the

work of individuals like the late Herbert Stein and the self-congratulatory

writings of participants in the policy-making arena. Prachowny despairs over

the politicization of policy recommendations of economists, but to students of

public choice his laments are totally predictable.

The Prachowny book is not the last word, however, on this subject. It is not a

comprehensive analysis of the Kennedy-Johnson tax cut, but rather an

economist’s attempt to analyze the actions of fellow economists who were

influential in making policy. The book virtually ignores the discussions

between Lyndon Johnson and his other advisers, the role played by the

Treasury, Commerce Department, Budget Bureau, Congress, special interest

groups and the like. Making economic policy is like making sausage — it is

not pretty. Prachowny expresses horror at this, particularly at it relates to

the CEA, but the problem did not start with Walter Heller or end with him.

Indeed, as a longtime consultant to a congressional committee myself, I think

the problem is far larger than he imagines. Indeed, the problems of timing

fiscal policy, of the probability of special interest manipulation of results,

etc., increase the case for a rules approach to macro policy, arguably on both

the fiscal and monetary sides.

Perhaps some of the alleged failings of the CEA during this period should fall

more on others largely ignored in Prachowny’s account. Even if the CEA had

behaved perfectly it might not have been able to alter policy that much: its

power was finite. While House Ways and Means chair Wilbur Mills gets some

mention in this book, there is very little on the political dynamics that went

into the tax cut and the laterdecision to engage an income tax surcharge.

There is no mention of Henry Fowler (LBJ’s Treasury Secretary) or Everett

Dirksen (prominent Republican senator) or dozens of other influential

political leaders who played a role in shaping fiscal policy during this era.

There is no mention of a fascinating phone conversation that Lyndon Johnson

had with Heller the day after Kennedy’s assassination inviting him, in effect,

to fudge revenue estimates (as recounted in Michael Beschloss’s editing of the

Johnson White House tapes). In short, much of the richness of the story about

policy changes of the era is lost in the Prachowny recounting, with its

emphasis on the arcane details of forecasting, model building, and econometric

estimations.

The Prachowny book, however, has stimulated me to offer a rather different

revisionist account, which some scholar might wish to develop or challenge. At

the time that the Kennedy-Johnson tax cut was approved in February 1964, the

unemployment rate was 5.4 percent, below the annual average for any of the

previous six years and 1.2 percentage points lower than when Kennedy took

office. If Robert Gordon is right, unemployment was pretty close to its

natural rate. The economy had been growing faster than its long run average

rate (of about 3.5 percent annual output growth). For example, real GDP rose

over 5 percent annually over the two years 1962 and 1963, significantly

reducing any potential output gap. In the five quarters including the

enactment of the tax increase and the year preceding, real GDP rose at annual

rate varying between 2.9 and 9.2 percent a quarter, with the median growth

rate being 5.3 percent. In short, there was no dire need to stimulate

aggregate demand: the self-correcting properties of the market were working

nicely to eliminate the last residue of the 1960 recession.

Yet 1964 was an election year, and LBJ was a masterful political animal.

Johnson wanted to revitalize the New Deal coalition, and a tax cut would help

give him the power to do it. The economy really did not really need a tax cut

from a cyclical perspective, but it needed it to meet LBJ’s political

objectives, and the economy (and Kennedy’s assassination) provided the cover.

Heller, Okun and Ackley were partisan Democrats wanting to help the cause.

Whether out of partisan enthusiasm for a liberal Democratic agenda or out of

economic ignorance or both, they went all the way with LBJ. To be sure, the

administration economists, with their obsession with aggregate demand,

probably underestimated the supply side effects of the tax cut, as total

income tax (individual and corporation) revenues rose over 20 percent from

fiscal year 1963 (the last pre-tax cut year) to fiscal year 1966 (the first

year with the cut fully implemented). The Laffer curve dimensions of the tax

cut were realized beyond their fondest dreams. Yet the extraordinary increase

on the demand side from the Vietnam War and Great Society programs led to

rising inflation, and ultimately to the higher inflationary expectations, wage

increases and soaring interest rates that ultimately led to the stagnation of

the 1970s. The budget deficit problem was not a result of a failure of tax

revenues to grow, but rather entirely the consequence of an extraordinary

growth in expenditures that went to fight what ultimately turned out to be two

highly unproductive wars, the War on Poverty and the Vietnam War.

Enough of my own speculation. The important point is that Prachowny has

provided a valuable addition to the literature, one well researched and

documented. Its faults are ones of omission rather than commission, and his

retelling of this era stimulates us to await a more comprehensive retelling of

the fiscal experiences of the Sixties.

Richard Vedder, Distinguished Professor of Economics at Ohio University, is

co-author with Lowell Gallaway of Out of Work: Unemployment and Government

in Twentieth-Century America (New York: New York University Press, 1997).

Subject(s):Government, Law and Regulation, Public Finance
Geographic Area(s):North America
Time Period(s):20th Century: WWII and post-WWII