The Kennedy-Johnson tax cut was undoubtedly the crowning achievement of the Keynesian Revolution. It was something unique in American history: it wasn’t stimulus in response to a recession – it was a tax cut to prevent an expansion from slowing. It was Growth Keynesianism: the recognition that demand played a role in keeping long-run growth going, in addition to regulating the ups and downs of the business cycle.
As a result of the tax cut, the Keynesian Golden Age as an idea was born.
Investment boomed – and stayed positive for the entire decade. The following fiscal year, the federal budget deficit actually shrunk. The stock market loved it – between 1962 and 1966, the Dow Jones nearly doubled. Capital and labor were rewarded at the same time, rather than being locked in a zero-sum competition with each other, as wages and profits went up together. Unemployment, which had paused for a moment on its way down, resumed its decline. Nor was there really much inflationary pressure that came out of it – prices were still more or less stable. Even in purely budgetary terms, tax revenues rose from $94 billion in 1961 to $153 billion in 1968, an increase of 62 percent.
Macroeconomically, the academic formulas held up. In the words of Walter Heller, chairman of the CEA and the brain behind the tax cut, “the rationale […] came straight out of the country’s postwar economics textbooks.”
Not every liberal liked the tax cut. Leon Keyserling, an economist who had served Harry Truman, worried that the richest 12 percent of Americans would get perhaps as much as 45% of the benefits. Michael Harrington, the scholar of poverty, called the plan “reactionary Keynesianism.”*
But these were minority voices. In fact, its rather stunning just how popular and universally applauded growth Keynesianism was back then. By mid-1963, a large tax reduction was supported by, among others, Senators Humphrey, Javits, Keating and Case, many congressmen, the AFL-CIO, the US Chamber of Commerce, the (then non-failing) New York Times and The Washington Post. One of the leading champions of the cut was the President’s Advisory Committee on Labor-Management Policy, whose members included a leaders from business, labor, and the academy:
- Henry Ford II – grandson and CEO of the Ford
- Thomas Watson, Jr – president of IBM
- Joseph L Block – CEO of Inland Steel Company
- George Meany – president of the AFL-CIO
- Walter Reuther – president of UAW
- Arthur F. Burns – economic advisor to Eisenhower
Despite its popularity and efficacy, however, the tax cut was soon overtaken by events. The Vietnam war quickly moved to dominate the budget. Urban unrest rocked the nation, as long-simmering racial tensions exploded. The 1970s saw oil shocks, a productivity slowdown, and a generalized malaise that came to be known as “stagflation.” Ultimately, our neoliberal world came out of that crisis. The 1964 tax cut was the first – and, it turns out, the only – time in postwar history that growth Keynesian remedies were ever really tried. And they worked.
JFK’s Economic Platform
One of the things that made JFK unique was his openness to academic advice. Part of this was his Boston Brahmin upbringing – where he was from, men of a certain class and stature were expected to be on good terms with more than a few egg-heads. But another part was his honest lack of commitment to any strong political vision – he hadn’t made up his mind on a lot of issues, and so was open to being convinced by those around him. Hence, JFK wasn’t the first Keynesian president, so much as he was the first president who wasn’t pre-Keynesian in his prejudices.
Part of his bid for the presidency was bulking up on academic firepower early on. In 1958 he convened an informal group of economic advisors from the top schools in Connecticut – James K. Galbraith and Seymour Harris from Harvard, Paul Samuelson from MIT, and James Tobin from Yale. Together they set the economic tone of Kennedy’s presidential bid. They were neither too young to have taken the Keynesian worldview for granted, nor too old to have gone through the painful intellectual conversion process to Keynes (or, worse, failed to go through it). They were the cohort which had been drafted as soldiers on the front lines of the Keynesian Revolution at the very beginning. Now these soldiers had been promoted to generals, and they were responsible for putting their academic ideas into practice.
The Keynesian program was to stimulate the economy to reach full employment, and not just for its own sake, but to make overall economic potential grow faster too – 5% growth in potential output was their promise. On the campaign trail, JFK constantly bemoaned the higher growth rates that Europeans were achieving. Everyone else in the advanced capitalist world seemed to have ample investment opportunities, but in America investment had been wimpy.
The idea was that this could be achieved through a burst of social programs – minimum wage, expanded unemployment and old age insurance, socialized medicine, and urban renewal – which would pour demand into the economy. Hence the dual justification: not only was there not enough total spending in the economy, but much of the spending which was there was of unworthy quality. Better to replace conspicuous consumption with public goods which would also stimulate the economy.
There was also a populist component to his campaign. In addition to extra spending, JFK promised easy money – faster money printing and wider access to credit for the common man. This was a demand that rural democrats had been making for nearly a hundred years by that point. But there was just one problem: the US was officially a part of the Bretton Woods system of fixed exchange rates. Low interest rates would cause capital to flee, and imperil the international position of the dollar. So while JFK promised easy money, he promised to raise taxes to pay for the spending – hence keeping equilibrium interest rates even lower, and capital at home in the US.
High taxes, high spending, easy money – JFK was going to “get America moving again.” That was the program that his economists came up with, and the program that won him the presidency in 1960.
The Economic Situation
Well, the program and the recession of 1960-1961 won him the presidency. When JKF entered office in 1961, unemployment was 6.7%, compared with just 5.3% the previous January. The recovery was already underway by Inauguration Day, so the high unemployment numbers were easy for the incoming president to brush off – no one could blame Kennedy for what he had inherited. But this slump had followed quickly on the heels of the 1958 recession, when unemployment peaked at 7.5%. As Paul Samuelson said at the time, “more fraught with significance for public policy than the recession itself is the vital fact that it has been superimposed upon an economy which, in the last few years, has been sluggish and tired.”
Back-to-back downturns and slow recoveries from both contributed to the feeling that something ominous was ratcheting down the pressure in the American economy. Indeed, there had already been four recessions in the fifteen short years since the end of WWII.
Keynesians had a theory for what was happening (secular stagnation): there was a widening gap between economic potential and actual output because there just wasn’t enough to demand to keep the two together. There was debate regarding the causes of this “gap,” but the leading theory among Kennedy economists was Heller’s “fiscal drag” explanation: taxes ate up more and more of the economy, yet federal spending hadn’t kept pace, so the government was sucking demand out of the economy. Hence the relative lack of investment in the late 1950s.
Although the economy was recovering upon his entry into office, there was every reason to think that this was a ticking time bomb – the “Kennedy Recession” might be just around the next corner.
The challenge, then, would be to revive investment and coax it into staying around. But how? Monetary policy would have been one way – expand the money supply and lower interest rates to make it easier for businesses to borrow. Unfortunately, that option was ruled out – the U.S. was running a balance of payments deficit, and easy money would only make that worse. The dollar might lose some of its prestige if JFK had the Fed running the printing presses too hot, and its position was already on thin ice. Plus, only ten years prior the Fed had made a dramatic show of independence – the President didn’t control monetary policy, the FOMC did. The Democrats would have to change their strategy in response to circumstances.
The Political Situation
Although the long-range goals of the Kennedy administration were Galbraithian, the Congress’ were not. In particular, in the Chair of the House Ways and Means Committee, Wilbur Mills (D-AR), was a conservative on spending, as were most Southern Democrats and almost all Republicans.
Opposition in Congress came in at least four forms:
- Dislike of particular programs – for instance, many southern Democrats were against any form of welfare which might apply to blacks, or create solidary between white and black workers.
- Hope for later tax reduction – any increase in spending would have to be paid for by taxes eventually, so for those who perpetually wanted lower taxes, no spending would be worthwhile.
- Balanced budget ideology.
- Different forecasts and analysis regarding the current fragility of the economy:
- Some thought there was potential for inflation if aggregate demand went up too fast.
- Some thought the unemployment was structural – the wrong workers with the wrong skills in the wrong locations, a problem that couldn’t be fixed with aggregate demand, and called for liberal “education programs” instead.
- Some thought the current lack of investment was not due to demand, but to lack of profitable investment opportunities, which could only be remedied by investment tax credit, not deficit spending per se.
Given the political climate, Kennedy was afraid of being called a big spender, and worried that the ideology of balanced budgets was too strong.
[JFKs] political judgement told him that a period of gradual re-education would be required before the country and Congress, accustomed to nearly sixteen years of White House homilies on the wickedness of government deficits, would approve of an administration deliberately and severely unbalancing the Budget.
Had President Kennedy come out boldly for the sizeable deficit which objective economic analysis called for, he would have run into severe opposition in the divided Congress; and by becoming tarred with the asinine label of an “irresponsible spender,” the President might have put all his new program in jeopardy.
Keynesian analysis suggested that it was only a matter of time before the next recession due to chronic lack of aggregate demand; but most Congressmen did not agree. Without an urgent economic threat, there was no way they were going to pass a Keynesian spending bill. Further, JFK had been elected on a particularly small majority – so he had no mandate to push through social spending programs that Congress opposed. Without a crisis or the people backing him, JFK just had to wait. So in his 1961 Inaugural Address, he proposed a balanced budget.
Things would change over the next two years. By mid-1962 the economic warning signs were flashing red; by January 1963, the prospects for a “Kennedy Recession” were so bad that the president declared “the enactment this year of tax reduction and tax reform overshadows all other domestic issues in this Congress.” At that point, the famous journalist Walter Lippman wrote: “Tax reduction is something which we must have if we are to avoid very serious consequences not only to business and employment and to our standard of life but also to our position in the world.” But that’s getting ahead of our story.
To get to expansionary policy despite conservatives and the balance of payments, many members of the administration thought a temporary tax cut would be needed. The emphasis was on temporary, however – given the administration’s Galbraithian long-run goals and the balance of payments, it was necessary to keep the tax structure strong.
In the meantime, Kennedy did manage to increase spending by $3 billion over the Eisenhower estimates for 1962. The 1961 Area Redevelopment Act, for example, pushed out $507 million for loans and grants to “alleviate conditions of substantial and persistent unemployment in certain economically distressed areas.” Then in June, the Berlin Crisis broke out, and defense spending jumped another $3 billion in response. To get the funding to fight in Berlin, however, JFK was forced to promise to balanced next year’s budget as well – which meant another year of waiting to enact big spending programs.
To get things moving along, in mid-1961 the administration proposed a revenue-neutral tax cut to satisfy those in the opposition part 4c above. As proposed, Revenue Act of 1962 would:
- Give a tax credit equal to 8% of business investment over depreciation (since the administration only wanted to reward net investment).
- Tax corporate income made abroad but not yet repatriated.
- Shift withholding of income tax on interest and dividends to the source – to cut down on evasion, the theory being the corporations which issued dividends would be better at reporting their activity, and easier to police because they were larger and fewer, than individuals receiving them.
Congress promptly passed an amended version which only included part (1) and didn’t have the “over depreciation” handicap.
As 1961 became 1962, things were looking up. Unemployment fell from 6.9% to 6.1% in January. Inflation was also on the rise, and the balance of payment position worsened. Monetary policy continued to be on standby, and no one saw the need for further fiscal stimulus.
By the summer, however, things had changed. Kennedy got himself embroiled in a very public fight with U.S. Steel President Roger Blough. US Steel had planned to raise prices, but the Kennedy administration wanted them to wait on that in order to hold inflation down. The administration had issued “wage and price guidelines” in January in an effort to control price increases. They were not mandatory, but anyone violating them caught the President’s ire. As one of the central commodities of an industrial economy, changes in the price of steel would radiate through the whole network of prices. The White House won the battle but lost the war — although the price hike was put off, US Steel announced it would be building its future factories outside of the US. The relations with the business community darkened, with suspicion on both sides. At a Yale commencement speech, Kennedy called the relationship he had with business “a bog of sterile acrimony.” The stock market tanked, losing a quarter of its value in what many took to be a capital strike in protest of JFK’s “anti-business” aura. “Help Kennedy Stamp Out Free Enterprise” bumper stickers started appearing on American roadways. Unemployment’s decline stalled.
After five years of a weak, jobless recovery, the sudden standstill was enough urgency to push Democrats to act. In 1961 JFK wanted to increase spending. But no one in Congress did, and by summer 1962 the politics of avoiding a recession was more important than the morals of the New Frontier. Nor did they have time to argue for spending on the merits: to avoid recession it would not be possible “to wait until the economic intelligence gap had been closed,” Heller said. Hence, although it would hamper their spending plans in the future, the administration proposed a tax cut. “The use of tax reduction,” Heller recalled, “made it possible to induce a coalition of conservative and liberal forces to endorse and work for an expansionary fiscal policy even in the face of an existing deficit, an expanding economy, and rising government expenditures.”
But although JFK first promised a tax cut on June 7, 1962, it was only signed into law by LBJ on February 26, 1964. It took until January 1963 for the administration to come up with a finalized proposal, and the Congress took over a year to rehash the issues and rewrite a compromise bill.
Initially everyone was thinking the cut would be on the order of $3 billion. But to make it hit all classes at once, as well as corporate investment, it would take more than that if rates were going to come down meaningfully. For example: lowering the top marginal tax rate from 92% to 70% would cost less than $500 million. But reducing the bottom bracket by only 1% would lose $1.2 billion. Similarly, dropping the corporate tax rate from 52% to 48% would cost $2 billion. Adding it all up turned out to be $10 billion, minimum.
The Treasury Department had long been in the business of trying to simplify the tax code by closing loopholes and broadening the tax base – fewer exemptions meant the tax rate hit more income, which was less paperwork for everyone and more revenues for the Treasury. Treasury proposed $3.4 billion worth of loophole closings – so inevitably, the rate cuts also increased to $13.3 billion, and the total revenue decline was still $10 billion.
JFK wanted a bill that would pass three tests:
- Total spending for 1964 should be less than $100 billion.
- Expenditures for fiscal 1963 had been $92.6 billion and by September the spending in fiscal 1964 was looking like it would be $98 billion, rising to $102 billion in fiscal 1965. Republicans made the tax cut contingent on holding expenditure in 1964 to $97 billion and 1965 to $9 billion. LBJ proposed a budget that did them one better – held it to a proposed $97.9 billion in 1965, and it turned out $1.4 billion even lower than that.
- Total spending excluding defense, space, and interest payments should decline.
- The deficit should not exceed $12.4 billion, the deficit Eisenhower had run to fight the 1958 recession – the shield of Eisenhower’s memory should be enough, Democrats thought, to defend them from accusations of being loose with the coin-purse.
To hit all three targets and lose $10 billion in revenue, the only way to do it was to lay the tax cut out in stages – hence much of the rate cuts were spread out into 1965 and 1966.
Yet this was all in vain – by 1962 the balanced budget ideology was a “paper tiger,” in the words of Herbert Stein:
“The Congressional conservatives with business support had put through a tax reduction in 1938 although there was a deficit. They had fought for tax reduction in 1947 even though, on the official estimates, that would have caused a deficit in the next fiscal year. They had tried to reduce taxes in 1953 despite the deficit in hand and in prospect.”Stein, The Fiscal Revolution
Conservative opposition was not to deficits, but to social spending. Hence the main issues were the loophole closures and the total expenditures – not a debate about balancing the budget, the new economics or the old, or the size of the deficit. The committee bill was more than 300 pages long, and only 7 dealt with the rate cuts – the rest were loophole closures. In the end, almost none survived the special interest onslaught.
To sell the bill, Kennedy famously gave a speech to the Economic Club of New York. He said he was committed to “an across-the-board, top-to-bottom cut in personal and corporate income taxes.” The tax system, mostly designed during World War II, “exerts too heavy a drag on growth in peace time; that it siphons out of the private economy too large a share of personal and business purchasing power; that it reduces the financial incentives for personal effort, investment, and risk-taking.”
According to President Kennedy:
Our true choice is not between tax reduction, on the one hand, and the avoidance of large Federal deficits on the other. It is increasingly clear that no matter what party is in power, so long as our national security needs keep rising, an economy hampered by restrictive tax rates will never produce enough revenues to balance our budget just as it will never produce enough jobs or enough profits… In short, it is a paradoxical truth that tax rates are too high today and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now.
“I gave them straight Keynes and Heller,” he boasted to Walter Heller afterward, “and they loved it.” Indeed, the focus on purchasing power could have come from any growth Keynesian: “When consumers purchase more goods, plants use more of their capacity, men are hired instead of laid off, investment increases and profits are high.” Even behind closed doors JFK sounded like a growth Keynesian: “The unused capacity is so great, that there really isn’t an incentive for more investment than modernization or technological changes require.”
The bill didn’t pass until February 1964. Between proposal and passage, not only did the culminating moments of the high cold war and civil rights movement happen – the Cuban Missile Crisis and the March on Washington for Jobs and Freedom (more on this in a later post) – but also JFK was assassinated.
Lyndon B. Johnson, in his first speech to Congress, let the nation know how urgent the issue was: “No act of ours could more fittingly continue the work of President Kennedy than the early passage of the tax bill.” After Johnson agreed to decrease the total federal budget to under $100 billion for 1965, the conservative Harry F. Byrd dropped his opposition in the Senate, and the bill sailed through.
The Treasury Department has nicely summarized the tax changes for us. The act:
- reduced top marginal rate from 91% to 70%
- The top rate applied to household incomes over $180,000, (roughly $1,380,000 in 2015 dollars).
- reduced the corporate tax rate from 52% to 48%
- phased-in acceleration of corporate estimated tax payments (through 1970)
- created minimum standard deduction of $300 + $100/exemption (total $1,000 max)
But these are just the headline figures. In reality, the act cut taxes across the board – taxes were reduced from 20 percent to 10 percent in the bottom bracket. In total, the cut was projected to decrease income taxes by about $10 billion and corporate taxes by about $3.5 billion.
Walter Heller worried that in the effort to construct an economic policy he characterized as both liberal and progressive, the homage paid to the conventional wisdom and “to balanced budgets, and the hostages thus given to the old deficit, debt, and spending phobias, will rise to haunt us in later efforts.” Just before he died, Kennedy told Heller, “First we’ll get your tax cut, and then we’ll get my expenditure programs.” Unfortunately, things didn’t exactly work out that way.
General large bibliography here.
Herbert Stein, The Fiscal Revolution.
Andrew Shonfield, Modern Capitalism.
Seiichiro Mozumi, “The Kennedy Johnson Tax Cut of 1964, the Defeat of Keynes, and Comprehsnive Tax Reform in the United States,” Journal of Policy History 30/1.
Prachowny, The Kennedy Johnson Tax Cut: A Revisionist History, review and review.
Time, “JFK and Ronald Reagan on Tax cuts“
A Textbook treatment here
The Hill, “Celebrating a time when tax-cutting was the cause of Democrats“
Cato, “Did the Kennedy Tax Cuts Cause Rising Inflation?“
Heritage Foundation, “The Historical Lessons of Lower Tax Rates“