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.
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
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).