A History of Modern Tax Cuts
When the federal income tax was first imposed in 1913, it included personal exemptions of $3,000, and marginal rates that took only 1 percent of the first $20,000 of taxable income and reached a maximum of 7 percent of each dollar of income over $500,000.
During World War I rates were increased to a range of 6 to 77 percent (with the poor paying only 6 percent while the rich paid up to 77 percent on the last dollars earned).
At the end of the war a major effort was launched by the Republican administrations of Harding and Coolidge to reduce the high wartime rates.
The primary force behind the cuts was Treasury Secretary Andrew Mellon.
Between 1922 and 1925 the marginal rate structure was decreased from a range of 4 to 73 percent to a range of 1.5 to 25 percent, and a number of changes were made in the tax base. (1)
The first cut in 1922 decreased the highest bracket rate from 73 to 58 percent, repealed the wartime excess profits tax, and instituted a preferential tax on capital gains. The arguments Secretary Mellon made for these decreases were clearly based on trickledown priorities. In 1924 Congress responded with an additional cut to a 2 to 46 percent range and also retroactively refunded 25 percent of taxes paid in 1923 and instituted a 25 percent earned income credit. Finally, in 1925 Congress further reduced rates to the 1.5 to 25 percent range.
As a result of these rate decreases, revenues decreased by 23 percent between 1922 and 1923 (from $861 million to $644 million) but then increased to $735 million in 1925 and to $1.16 billion in 1928. But perhaps more importantly, revenues increased between 1921 and 1925 in all income classes over $50,000, with increases ranging from 28 to 113 percent. At the same time, 44 percent of the taxpayers at the low end of the scale saw their tax burden fall to zero.
Do the 1920s tax cuts prove or disprove the supply–side arguments? Certainly revenue increased after the cuts, but only after an initial decrease and a three to four year recovery period. By 1929 revenues had risen to the 1921 level. Since no one can project accurately what revenues would have been without the rate changes, it is really impossible to say whether the Laffer arguments are supported or rejected by this experience. But at least one critic has observed, "At a time when only a few million Americans paid income taxes and federal spending was less than 5 percent of GNP (it was 3 percent in 1929), we are asked to believe that federal income tax cuts alone powered the growth of GNP from $70 billion in 1921 to $103 billion in 1929." (2)
More important than the total revenue impacts of the cuts, however, is the impact by income class. These results do seem to support the argument that substantial cuts in the highest marginal rates will have positive effects on incentives and will result in a net increase in tax revenues produced in these tax brackets. Those taxpayers who receive only labor incomes (wages and salaries) are unlikely to be able to alter significantly their total incomes in response to any tax changes and hence a cut in marginal rates for low and middle income taxpayers will likely result in net revenue losses for the Treasury. However, those in upper-income brackets who earn a substantial property income from investments seem likely to renew their efforts to increase that income when tax rates are decreased.
After the 1929 crash and the resulting fall in tax revenues, the Hoover administration again increased tax rates. Marginal rates were further increased during World War II, reaching 94 percent by 1944. Rates were reduced slightly during the 1950s, but when John Kennedy was elected president in 1960 the range of tax rates still stood at 20 to 91 percent and the economy had experienced an average real rate of growth of only 1 to 2 percent a year during the previous decade.
The tax cut passed in February 1964 is commonly called the Kennedy tax cut because it was introduced by President Kennedy before his assassination in November 1963, and is considered to be the major example of both a demand–side and a supply–side tax cut. While the Kennedy administration envisioned the tax cut as primarily a demand stimulus, it also had a significant impact on saving, investment, and production incentives. Originally proposed as an $11.5 billion tax cut designed to stimulate demand and get the country moving again, it contained cuts at all income levels and some major investment incentives.
The Kennedy tax bill reduced marginal tax rates from a 20 to 91 percent range down to a 14 to 70 percent range, with two–thirds of the cut effective in 1964 and one–third effective in 1965. In addition, Congress decreased the corporate income tax rate from 52 to 48 percent, increased the capital gains exclusion, and made a number of structural changes in the personal income tax base. This reduction provided a large tax break for those who earned high incomes and who did a majority of the personal saving in the United States. Supply–siders argue that the extra savings and the resulting investment provided an excellent example of how to use the tax system successfully to stimulate supply.
Personal savings increased by more than 50 percent in the two years following the tax cut and capital spending rose by one–third, matching the growth of the previous decade. In part, this growth was also a result of depreciation changes and the 7 percent investment tax credit introduced in 1962, but supply–siders argued that it also reflected a climate of business confidence in the ultimate success of the Kennedy economic program.
While there is insufficient evidence to prove whether or not the creation of a $12 billion deficit due to the tax cuts ever resulted in a Laffer response and a net revenue gain, business conditions, employment, and output certainly did grow, and eventually so did tax revenues. Between 1963 and 1965 revenues increased in all classes over $10,000, with increases ranging from 11 to 85 percent. Total revenue declined from $48.2 billion in 1963 to $47.2 billion in 1964, but rose again to $49.5 billion in 1965 and to $62 billion in 1967 (a 31 percent increase over 1963).
Do these figures support supply–side projections? Again, it is difficult to say positively. While income tax revenues increased by 31 percent between 1963 and 1967, revenues had increased by a similar 31 percent between 1959 and 1963, an equal time period without a major cut in tax rates. Further, one might argue that tax changes in the form of changes in depreciation rules and the introduction of the investment tax credit were primarily responsible for the increase in saving and investment. The economic statistics for the period show only what changes occurred, not any cause and effect relationship. If one wants to believe in supply–side policy, statistics do show an increase in the relevant values. However, if one is skeptical, the increases can easily be traced to other causes or argued to be only as large as would have been expected anyway. Again, the theory for tax cuts to stimulate supply cannot be proved or disproved using available historical evidence. Nevertheless, the success of the Kennedy tax cut has provided the major historical evidence offered by supply–siders that their program will work in practice as well as theory.
One of the first modern supply–siders was a congressman from New York named Jack Kemp, a former professional football quarterback. In 1977 Kemp teamed up with Senator William Roth of Delaware to propose a Kennedy style tax cut. The Kemp–Roth bill was introduced in July of 1977 and quickly became established as official Republican Party policy, with virtually every Republican in the House as a cosponsor. The bill proposed a reduction in rates to an 8 to 50 percent range, a reduction of approximately 30 percent. Later versions modified the bill to spread the tax cut over three years at 10 percent each year and included tax indexing and spending limitations.
The Kemp–Roth bill was endorsed early by candidate Ronald Reagan during the 1980 campaign and became the center of an election controversy. During the primary campaign George H. W. Bush (later Reagan's vice–president) called the proposal "voodoo economics" and President Carter made it a major issue in an effort to prove that Reagan would follow an unconventional and irresponsible tax policy. When Reagan was elected, the Kemp–Roth proposal became an integral part of his Economic Recovery Program.
No administration in modern history had been as obviously committed to the principles of trickledown policy as was the Reagan administration of the 1980s. While supporters have hailed the Reagan programs as an economic revolution that restored faith in the market system and reduced the influence of government, detractors decry the 80s as a blatant sellout to the interests of the rich and powerful. But whether one views trickledown as a blessing or a curse, the president obviously believed that such a policy was necessary to reverse the economic decline of the 70s and restore and revitalize the market economy
During the 1970s it had became increasingly difficult for monetary and fiscal authorities to deal effectively with the problems of inflation and unemployment. Control of inflation seemed to become the primary responsibility of the Federal Reserve Board of Governors, while a reduction in unemployment became the goal of fiscal authorities. But both problems worsened consistently throughout the decade.
Whenever unemployment increased, Congress responded with even bigger deficits and more government programs. At the same time, monetary authorities were pressured to allow a corresponding monetary expansion so total spending could rise and the unemployment rate could be reduced. Hence, monetary policy in the 1970s was designed primarily to accommodate an expansionary fiscal policy, while at the same time, Federal Reserve authorities were expected to use interest rates to control inflation. This conflict became increasingly serious throughout the decade.
In October 1979 the Federal Reserve announced a major change in policy and began using money supply growth as the primary policy target. Between then and the summer of 1982, monetary policy was more consistently restrictive. The Federal Reserve’s unwillingness to continue to finance federal deficits with an expanding money supply put additional upward pressure on interest rates during 1980-81 and contributed significantly to creating a recession that began in the late summer of 1981.
By the end of the 1970s, high interest rates were recognized as a major economic problem creating problems of credit allocation and increasing the real costs of business investment, while also putting new burdens on family budgets, especially on the ability to save. The combination of decreased saving, tight money, and rising interest rates also had an adverse effect on business investment. The industries hit hardest by such a market were housing and construction, which rely heavily on the existence of favorable long-run credit availability. When interest rates increased and funds decreased, families stopped buying new houses, construction activity decreased rapidly, and the industry slumped into a major depression by 1980.
By the election of 1980 the nation faced: (1) the most persistent and serious inflation rate in this century, (2) the highest level of real interest rates in the nation’s history, (3) a high and persistent level of unemployment, (4) the lowest rate of personal saving in the post—war period, (5) a stagnant economy with a low level of private investment and a high level of pessimism in the business community, (6) a falling level of labor productivity, (7) increasing concern over energy and other shortages, (8) a government sector increasing both its absolute and its relative size, (9) a rapidly expanding government bureaucracy and regulation of business, and (10) a rising taxpayer’s revolt against high taxes.
Ronald Reagan campaigned on a platform of tax and expenditure reductions, a promise to increase defense spending, and a pledge to decrease government regulation. His Economic Recovery Program was a plan to emphasize private sector incentives and to decrease public sector size and market interference. In order to achieve his goals of increased saving, investment, and business confidence, the president designed his program to bestow initial benefits on the wealthy, with the expectation of trickledown to the rest of the economy.
The Reaganomics Economic Recovery Program
President Reagan's Economic Recovery Program was a conservative response to what he believed were the failures of liberal programs of the 1960s and 1970s to achieve the goals of full employment and price stability. While liberal programs concentrated on the full employment goal, Reaganomics clearly concentrated on the goal of price stability––even at the expense of an increase in short–run unemployment. While the employment goal was not unimportant, it did occupy a secondary role in the president's hierarchy of objectives.
President Reagan's Economic Recovery Program was submitted to Congress in mid–February 1981 and included several basic, independent, but related parts. First, he proposed a 30 percent reduction in personal income tax rates by 1984, with the first reduction of 10 percent to take effect July 1, 1981. He also proposed substantially faster tax write-offs for depreciation of new business investments. Over the three-year phase-in of the rate cuts, the 70 percent top tax rate would be reduced to 50 percent. These tax cuts were estimated to reduce federal revenue in fiscal 1981 by $8.9 billion, but revenue would increase by $53.9 billion in 1982, $100 billion in 1983 and $221.7 billion by 1986. They would also reduce the federal government's share of the nation's total output of goods and services from 21.4 percent in 1981 to 19.6 percent in 1986.
Another part of the program was proposed cuts in federal spending of $4.4 billion for fiscal 1981, $41.4 billion in 1982, $79.7 billion in 1983, and $123.8 billion by 1986. Included were proposed cuts in 83 major programs, including reductions in nearly every program except national defense and Social Security. The president also proposed an increase of $4.4 billion over President Carter's proposed budget in spending for national defense in 1981, to a total of $188.8 billion. National defense spending would then rise to $285 billion by 1984, or 32 percent of the federal budget, compared to only 24 percent in 1981. These changes would constitute a massive shift in the direction and priorities of the federal government.
The combination of proposed tax and spending changes would produce projected deficits of $54.5 billion in 1981, $45 billion in 1982, and a balanced budget by 1984. The growth in spending would be slowed substantially, while revenues would be rising rapidly in response to the tax cut incentives. The president's estimates of growth in economic variables such as inflation, unemployment, and total output clearly reflected the optimism of his supply side advisors.
Reagan’s tax legislation was passed on July 29, 1981, and provided for a projected revenue loss to the federal government of over $700 billion over a five--year period. The Economic Recovery Tax Act of 1981 was signed by President Reagan on August 13 and was hailed as the biggest tax cut in U.S. history. Personal income taxes were cut over a five-year period by $550 billion, with business cuts accounting for an additional $150 billion and estate and gift taxes another $12 billion. The major cut was an across-the-board reduction in personal tax rates by 25 percent, with 5 percent effective on October 1, 1981, and an additional 10 percent on July 1 of both 1982 and 1983.
The 1981-82 Recession
When President Reagan signed the Economic Recovery Tax Act (ERTA) in August of 1981, he predicted that it would bring with it prosperity, economic growth, and a reduction in the level and influence of government in the economy.
Less than a month later, published statistics indicated for the first time that the economy was moving into a new recession. By mid–fall the administration began revising its previous forecasts on interest rates, unemployment, and especially on the size of the federal deficit.
By winter many were predicting the worst recession in the post–World War II period, and by the summer of 1982 interest rates remained high, unemployment had reached its highest level since the depression, saving and investment were still at recession levels, and inflation, after a brief drop in the spring, threatened to return again to the double digit levels of past years.
What went wrong with the president's expectations?
First, the recession came at the worst possible time for the president. The recession was clearly a monetary recession, caused by the tight monetary policies of the Federal Reserve since October 1979. These policies had created high interest rates that simply could not induce investment and sustained economic growth. Businesses were finally beginning to feel the financial pinch of 20 percent interest, and many businesses failed while others began to retrench or to postpone new projects, hoping for lower interest and more favorable conditions in the near future.
A second problem involved the links between taxes, saving, and investment. The president assumed that a tax cut would bring forth a corresponding increase in saving, and that saving would in turn induce a growth in investment in new plant and equipment. Neither of these links materialized during the first years of the program. For example, the administration projected that past increases in saving of $40 to $50 billion a year would increase to $60 billion during 1982, and then to $250 billion by 1984. Saving as a percent of income would have had to increase to more than 17 percent a year to reach these projections, but saving rates had never been over 13 percent. The administration appears to have counted on an incredible combination of fortunate circumstances to realize its projections. The recession simply guaranteed that those circumstances could not become reality.
By August of 1982 both the president and members of Congress were pleading with the Federal Reserve to abandon their policy of tight money and begin to loosen the monetary controls to help in the recession fight. Chairman Paul Volcker initially refused but later relented under pressure and monetary policy began to ease. The Fed lowered its discount rate (the interest rate on funds loaned to banks) and the banks' own lending rates began to fall.
President Reagan claimed that his tax cut program was responsible for the reduction in inflation and interest rates, and that Fed policy and the Carter administration were responsible for the recession. He also argued that Reaganomics was responsible for the recovery, but not for the deficit. While tight monetary policy is generally given responsibility for creating the recession, it must also be given most of the credit for ending it. As interest rates fell, new spending was created and the recovery began in January 1983, after almost a year and a half of recession and an unemployment rate that reached 10.8 percent in December 1982.
To the extent that Reaganomics was a contributor to the recovery and the deficit, it was not as a new invention of the president, but rather as a massive dose of traditional demand–side stimulation. Reagan failed in his goal of stimulating saving and investment until after the Fed created an environment for improved capital spending through lower interest rates.
By the winter of 1981–82, when the president began preparing his fiscal 1983 budget proposals, it was obvious that projected deficits of $100 billion or more for 1983–85 may even be too low. The deficit had become a major issue that threatened the president's entire budget program. During the budget negotiations in the spring of 1982, the president held firm for making further spending cuts and Congress pressed for new taxes or a postponement of the scheduled July 1 tax cut. Both claimed to be interested in reducing the budget deficit and restoring order to the budget process. A compromise was finally reached where spending would be reduced in unspecified ways in return for the president's support of a tax increase of $98 billion. The new proposed taxes were primarily increases in excise taxes and changes in administration, which would improve efficiency in collection rather than increase taxes owed.
The president could thus hold true to the principle behind his trickledown tax cuts, while still agreeing to a tax on consumption that would raise revenues and reduce the projected deficit. In return for the president's support on the tax increase, congressional leaders agreed to reduce spending $3 for each $1 in proposed new taxes. Over the three–year period, spending would thus decline by $284 billion. The bill passed in August 1982, and Reagan became the President who presided over both the largest tax cut in history and the largest single tax increase in history.
The compromise where immediate tax increases were traded for the promise of future spending cuts also needs a brief explanation. In Congressional budget terms, a “cut” in spending really means a reduction in some previous estimate or projection of future spending. Thus, the $284 billion cut in spending was estimated by first projecting future spending to be very large, and then reducing that estimate. No actual reduction in spending was ever expected to occur. Both the president and members of Congress knew the rules and agreed so a budget bill could be passed.
A further illusion in spending cuts was to revise previous estimates of important economic variables that affect the budget amounts. For example, interest rates were assumed to be lower than previous estimates, thus decreasing the need for interest payments, and thereby reducing total spending. The same can be true for estimates of unemployment rates, growth rates, and inflation rates. More favorable or optimistic projections lead to reductions in spending estimates, so a "cut" is announced. In reality, government spending would have continued to rise in actual dollar amounts with or without the spending agreements. This practice simply perpetuated the growing illusion of budget management and no spending programs suffered actual dollar reductions.
By the fall of 1982 inflation and interest rates were both falling, but unemployment and estimates of the deficit were still rising. By the time of the elections in the fall of 1982, over 11 million Americans were unemployed, with the unemployment rate of 10.4 percent, a full 3 percentage points higher than when Reagan took office less than two years earlier. While the president tried to sidestep the unemployment problem, he very clearly wanted credit for the falling inflation rate.
By spring 1983 the president was calling for a massive employment plan and more expansionary monetary and fiscal policy. He stopped talking about stimulating supply and began to discuss expansion of aggregate demand. His new program was being called Reaganomics II because of the shift in emphasis toward more traditional policies.
The budget deficit continued to be a major political thorn for the administration. The actual deficit for fiscal 1982 turned out to be $128 billion, and the fiscal 1983 deficit was now being projected to be as much as $200 billion, with a budget request for 1984 estimating the deficit at $188 billion. But the president did not want to support new tax increases or reduce defense spending, and Congress refused to grant the requested reductions in social welfare programs. As a consequence, deficits were destined to remain over $150 billion a year throughout Reagan's entire tenure as president.
But there were also optimistic signs by early 1983. Inflation was under 4 percent for the first time in a decade, interest rates had been cut in half, and unemployment had begun to show signs of improvement. The recession had bottomed out and recovery was underway. Investment by business in new plant and equipment was beginning to rise after a two-year fall, and corporate profits were rising after a steady four–year decline. The recovery that began in January 1983 would last throughout all the Reagan years, and into the 1990s. It was not a rapid, spectacular recovery, but a slower, steady rise across most of the economy.
The Campaign and Election of 1984
By early 1984 the budget had become the number one political issue for the upcoming election. Reagan had begun to argue that the deficits could be expected to continue for a number of years at the $150 to $200 billion annual level. He was opposed to further tax increases and also argued that economic growth resulting from his original 1981 tax cut would still provide sufficient long–run revenue increases to eventually solve the deficit problem. If spending was held to small annual increases, increasing revenues would eventually balance the budget. It was clear that the campaign during 1984 would be centered on proposals to solve the deficit crisis.
The president's optimism led him to believe that he did not need to request further spending cuts or tax increases. It also led him to argue that deficits really didn't matter as much as he and other conservatives had argued in the past. He began to argue that there was a difference between a "good" deficit created by tax decreases and a "bad" deficit created by spending increases. Since the current deficits were clearly the direct result of the 1981 tax reductions, they were good and the long–run benefits would make any short–run disadvantages acceptable.
The Democratic candidate for the presidency was Walter Mondale, who focused his campaign on a call for a $60 to $70 billion tax increase. The campaign debate on the deficit turned out to be very one sided––the president wouldn't get involved. He continued to argue that the deficit really didn't matter in the short–run and would go away in the long–run. He was able to cast Mondale in the role of the traditional Democratic tax and spend candidate, and never tried to explain how he would deal with the budget problems. In the end, he didn't need to. The more Mondale tried to explain the details of his tax proposals, the more he lost in the polls. While the budget was the primary campaign issue for Mondale, it turned out to be a non–issue for the president and he walked away with the election.
The president did respond to the Mondale tax increase proposals in one way––he promised that if reelected he would not raise taxes during his second term. He had signed into law during the spring the Deficit Reduction Act of 1984, a $50 billion "down-payment" on the deficit that was a combination of tax reform and tax increase. He clearly disliked the bill and disliked the idea of having presided over two tax increases and only one tax cut in his first four years in office.
The 1984 tax bill was the first of a series of tax reform bills, and tax reform became an increasingly important issue throughout the year. A debate over fundamental tax reform had begun, which included proposals for a flat tax with a comprehensive tax base and a single tax rate. A modified flat tax proposal was finally made by Treasury Secretary Donald Regan soon after the November elections. The proposal called for the use of only three tax rates (15%, 25%, and 35%) and the elimination of such tax preferences as tax–free fringe benefits, tax shelters, accelerated depreciation allowances, and the investment tax credit. Also included were the elimination of popular deductions for state and local taxes and non–mortgage interest payments, and reductions in the ability to deduct medical payments.
President Reagan's first term ended on a far brighter economic note than it had begun. Inflation was reduced to the 4 percent annual range, unemployment was almost back to its pre–recession level, interest rates had been cut in half, and the recovery was two years old. On the negative side, the budget deficit had created more red ink for the president than for any president in history, and a trade deficit had appeared for the first time in almost a century.
The 1986 Tax Reform Act
Two major issues dominated Reagan's second term; tax reform and the budget deficit. Tax reform began in November 1984 with the Treasury proposal for a modified flat tax and elimination of many deductions and special tax treatment. It became official administration policy on May 28, 1985 when President Reagan proposed "America's tax plan" that would "reduce tax burdens on the working people of this country, close loopholes that benefit a privileged few and simplify the tax code.
The Reagan tax plan called for two major kinds of shifts in the income tax burden. First, tax rates would be lowered while the tax base was expanded through elimination of many deductions, shifting the burden from both the rich and poor toward the middle class. The Treasury estimated that over half of all taxpayers would pay lower taxes, while only a fifth would see their tax bills rise. Second, the tax burden would be shifted from the individual income tax to the corporate tax. Corporate tax rates would also be reduced, but depreciation rules would be tightened and the investment tax credit reduced, so tax bills of most manufacturers would rise, while those in retailing, services, and high–tech industries would receive cuts.
The president said he wanted a tax system that would be simpler, fairer, and would increase incentives to save and invest. The goal was to reduce the number of tax brackets from 15 to 3, increase personal exemptions and the standard deduction, but broaden the tax base by reducing the ability to deduct items such as consumer interest payments and state and local taxes. Savings would be increased by the lower rates and by an expanded ability to deduct Individual Retirement Account (IRA) contributions. Such changes would mean the very poor would pay no tax, and all those who relied on itemized deductions and special treatment to reduce their taxes would see their bills go up. The tax would be easier to compute and would subject more income to tax under lower rates. In fact, the proposals moved the system in the direction advocated by tax economists for two decades.
A final tax reform bill was passed and sent to the president in September of 1986. Individual tax rates were reduced to 15% and 28% (with a 5% surcharge for some high–income taxpayers), personal exemptions were increased to $2,000 and the standard deduction was increased to $5,000 for couples. Deductions for state sales taxes and for consumer interest were eliminated, and contributions to IRA accounts were limited to those who did not have a company retirement account or earned less than $50,000 a year. The corporate tax rate was cut to 34%, depreciation allowances were reduced and the investment tax credit eliminated.
The most controversial changes were the elimination of special tax treatment for capital gains and the loss of ability to deduct passive tax shelter losses against ordinary income. Capital gains are those gains realized from the sale of capital assets such as stocks, bonds, and land. Tax shelters were primarily investments in real estate limited partnerships that provided paper losses, often in excess of the actual investment, that could be used to reduce taxes on income such as wages and salaries. These changes were serious setbacks for trickledown because they resulted in increasing the tax base for the very wealthiest taxpayers. But tax rates had been cut so drastically that revenue requirements demanded some expansion of the tax base.
The new law was expected to shift over $100 billion in taxes from individuals to corporations, to remove millions of taxpayers at the lowest levels from the tax rolls entirely, and to make the tax fairer by decreasing the extent to which taxpayers could reduce their taxes through tax shelters and capital gains. The president's goal of increasing fairness was the only goal really achieved. While the rate system had been simplified, the base had been made a great deal more complicated, and incentives to save and invest (aside from the general rate reduction) had actually been reduced rather than increased.
The industry with the biggest concern was commercial real estate. With capital gains treated as ordinary income for the first time since 1921 and the elimination of passive tax shelter losses against ordinary income, investment flows into the real estate industry were expected to decrease drastically. And since depreciation deductions for real estate had also been curtailed, the industry was dealt a double whammy. Real estate profits had long depended on the three-part combination of rental incomes, capital gains, and tax losses, and now the third part of the combination was gone and the second reduced, so real estate investment would depend on the ability to provide the same type of returns required of other investments. Moving from a favored to an un-favored position would certainly not increase investment flows into the industry.
Reaching Reagan’s Goals
With the possible exception of the 1986 tax law, every policy and program of the Reagan years was directly or indirectly designed to shift both income and power toward the wealthy. He did so by arguing he was transferring power from government to the private sector, reducing taxes and spending, and creating an economy where private initiative would be rewarded. What he failed to argue was that the rewards were to be distributed on a very unequal basis, with most going to a small percentage of the population.
But did Ronald Reagan succeed in reaching the goals he had set for his presidency? If one goal was to create a shift in the distribution of income, then he gets one point for success. There can now be no question that the richest few gained the most during the Reagan years. His stated campaign goals during the election in 1980 were to reduce inflation, interest rates, taxes, spending, and the budget deficit, while increasing national defense spending. While inflation, interest rates, and taxes for some did fall during the eighties, both national defense and overall spending increased substantially. And the Carter deficits of the seventies now seemed minuscule compared to the Reagan deficits of the eighties.
The major reasons given for implementing the Reaganomics programs were for stabilization purposes; to reduce inflation and interest rates, while stimulating economic growth and employment. Inflation and interest rates were reduced by more than half, unemployment rose sharply and then fell substantially, and growth remained positive but sluggish throughout the decade. The promised growth in savings and investment failed to materialize, and what the president called the longest period of prosperity in history distributed its benefits unevenly. And the successes on the inflation and employment fronts can easily be attributed to actions of the Federal Reserve rather than the president's program.
Budget deficits under Reagan exceeded those of all other presidents combined over the previous 200 years. A combined product of the Reagan tax cuts and the 1981–82 recession, the deficits helped inflate the value of the dollar, kept real interest rates high, restricted private investment, and reduced national savings. Reaganomics sharply reduced the progressivity of the tax system and redistributed real income upward, creating the most unequal distribution of income since the 1930s.
The budget deficits, combined with high real interest rates and a rising price of the dollar also created the largest trade deficit in history and a corresponding capital inflow that turned the U.S. into the world's largest debtor nation. But the short–term benefits of the capital inflow kept the economy growing and postponed the need to deal with the budget deficit. Meanwhile, the rush to deregulate and loosen antitrust regulations created an environment of excess that led to scandals in the Savings and Loan industry and the Housing Department, as well as insider–trading and stock scandals that led to numerous indictments and convictions of citizens and public officials, and more distrust of both business and elected leaders than any period in modern history.
The Reagan version of trickledown was a mixed blessing. Those at the top of the income scale and those who saw government turn away while they had free reign in the market saw the eighties as a period of great expansion and growth. Those at the low end of the income scale and those who could only watch as the administration turned the economy over to vested interests saw the Reagan years as a period when the wolves were assigned to watch the hen house. If the Reagan years did nothing else, they provided a lesson in what excesses can do when they go unchecked for eight years.
Notes:
1) Historical information on tax cuts was taken from John Mueller, “Lesson of the Tax Cuts of Yesteryear,” Wall Street Journal, 5 March 1981.
2) Walter Heller, “The Kemp-Roth-Laffer Free Lunch” Wall Street Journal, 12, July, 1978.
Budget figures here and in later chapters have been taken primarily from the annual Economic Report of the President (Washington D.C., U.S. Government Printing Office).
Other figures are taken from daily newspapers such as the Wall Street Journal and weekly newsmagazines such as Business Week and U.S. News and World Report.
