Recall what Richard Nixon did in 1971. The recovery from the mild 1969-70 recession was slow. Nixon worried that high unemployment and inflation threatened his re-election. In August he stunned the country by freezing wages and prices. Strict wage-price controls followed. In 1972 he won re-election with nearly 61 percent of the vote. The economy was pumped up by tax cuts and low interest rates, and prices were suppressed.
But the economic aftershock was enormous: pent-up price increases subverted wage-price controls and, combined with high oil prices, pushed inflation to 12.3 percent in 1974. The result was the steep 1973-75 recession, when unemployment hit 9 percent.
The latest version of election-year economics is Sen. Lloyd Bentsen’s plan to cut taxes $72.5 billion over five years. Congressional Republicans have already offered rival tax plans, and the White House may soon present a package. The pretext for tax cuts is to speed up the recovery. Be skeptical. For starters, the need is exaggerated. Yes, the recovery has been exceptionally slow, but then again, the preceding recession was mild. After the 1981-82 recession it took three years for the unemployment rate to drop to today’s level (6.7 percent in September).
Moreover, tax cuts like Bentsen’s or its GOP imitations won’t give the economy much of a shove. Bentsen’s plan would provide taxpayers a $300 credit for each child under 19. He would pay for the tax cut by cutting military spending by an equal amount. Hold it. Suppose a dollar in tax cuts increases consumer spending by a dollar; the stimulus would then be offset by a dollar’s cut in military spending, which reduces defense jobs.
Bentsen has a retort: my tax cut, he says, would take effect next January, while the defense cuts would begin only in October. The economy would get a nine-month stimulus. What are we to make of this? Not much. The 1990 budget agreement bars this maneuver; new tax cuts are supposed to be offset immediately by measures to prevent a rise in the deficit. Even without the budget agreement, Congress probably wouldn’t (as Bentsen concedes) pass a tax cut before year-end. But suppose Bentsen could manage his maneuver. There still wouldn’t be much effect. The net tax cut would be about $11 billion. This wouldn’t give much boost to a $5.6 trillion economy.
Virtually all today’s tax proposals involve similar deceptions. Their point is not to move the economy but to move voters. Benefits focus on the middle class, because the poor don’t vote in high proportion. Under Bentsen’s plan, 63 percent of the benefits go to taxpayers with incomes exceeding $40,000. What’s largely unmentioned is that all tax cut–even if offset by spending reductions-would give away money the government doesn’t have. Huge budget deficits remain despite the budget agreement. This involved $480 billion of deficit reductions between fiscal 1991 and 1995, mainly through tax increases and defense cuts. Even so, the Congressional Budget Office estimated in January that the basic deficit in fiscal 1996 would be 1.3 percent of gross national product down from 4.5 percent in 1991. Unfortunately, the CBO has revised its estimate for technical reasons; now, the 1996 deficit is estimated to be 2.6 percent of GNP, or $200 billion.
“The federal government is still vastly overcommitted,” says economist Rudolph G. Penner of The Urban Institute. Even if there’s an additional “peace dividend”–more defense cuts-the savings are needed to reduce future budget deficits. Naturally, election-year economics avoids such discomforting facts.
Ironically, the frantic quest for political advantage may not count for much. What matters is the economy’s condition, and the preelection jockeying typically affects this only slightly. Yale economist Fair has shown that if the economy grows in the nine months before an election and inflation is low, it’s hard for incumbents to lose. Nixon would have won without a price freeze.
In 1992, Bush will receive 57 percent of the vote if the economy achieves meager growth of only 2 percent and inflation remains in the 3 to 4 percent range, according to Fair’s formula. Since 1916, the formula has missed the actual vote by an average of three percentage points; since 1968, the average error is only one percentage point. To have a chance, Democrats need a deep recession and inflation exceeding 5 percent.
What this means is that election-year economics usually hurts the economy more than it helps politicians. In 1980, Jimmy Carter adopted credit controls in an effort to quell inflation without triggering a recession. The controls backfired: they triggered a recession without quelling inflation. In 1988, politicians of both parties evaded the savings and loan debacle. The delay added billions of dollars to the cost.
All the talk of tax cuts now may already be hurting the economy. Fears of higher budget deficits have pushed up longterm interest rates. If the recovery stumbles, only the Federal Reserve can prod it by easing credit. But Washington’s other efforts merit a silent prayer: please don’t do us any favors.
