Posted by: The Dauntless Conservative | September 1, 2010

The Reagan Tax Cuts: Lessons for Tax Reform


Much has been written and discussed about Ronald Reagan economic policies. I will show a positive correlation between tax cuts and the unemployment rates. That is what matters most to the rank and file American worker.  Also a revenue chart and a historical prime interest rates chart. I will preface with this report from Joint Economic Committee‘s report:

Excerpt:

The Reagan tax cuts, like similar measures enacted in the 1920s and 1960s, showed that reducing excessive tax rates stimulates growth, reduces tax avoidance, and can increase the amount and share of tax payments generated by the rich. High top tax rates can induce counterproductive behavior and suppress revenues, factors that are usually missed or understated in government static revenue analysis. Furthermore, the key assumption of static revenue analysis that economic growth is not affected by tax changes is disproved by the experience of previous tax reduction programs. There is little reason to expect static revenue analysis to evaluate the economic or distributional effects of current tax reform proposals much better than it evaluated the Reagan tax program 15 years ago.

Christopher Frenze

Chief Economist to the Vice-Chairman April 1996

http://jec.senate.gov/republicans/public/index.cfm?p=Search&q=reagan+tax+cut

The Economic Recovery Tax Act of 1981 was signed by Ronald Reagan on August 13, 1981 when the unemployment  rate stood at 7.4% for August 1981 and peaked at 10.8% in Novemeber-December 1982. The tax cuts went into effect at various times. In January 1983 the unemployment rate stood at 10.4% and started a downward trend until March 1989 at 5.0%. The leftist argument that Reagan tax cuts increased the deficit is a fallacy. The President of the United States cannot create either a budget deficit or a budget surplus. ALL spending bills originate in the House of Representatives and ALL taxes are voted into law by Congress. So, who controlled the House and Senate during Reagan’s Administration? There is much dispute about revenue increases. Well, naturally revenue did go up. Why would it not? It is quite a simple concept. When the unemployment rate goes down this results in increase of federal AND state AND FICA revenue from the paychecks of the hired populace.

Unemployment Rate Chart 1980-1990

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
1980 6.3 6.3 6.3 6.9 7.5 7.6 7.8 7.7 7.5 7.5 7.5 7.2
1981 7.5 7.4 7.4 7.2 7.5 7.5 7.2 7.4 7.6 7.9 8.3 8.5
1982 8.6 8.9 9.0 9.3 9.4 9.6 9.8 9.8 10.1 10.4 10.8 10.8
1983 10.4 10.4 10.3 10.2 10.1 10.1 9.4 9.5 9.2 8.8 8.5 8.3
1984 8.0 7.8 7.8 7.7 7.4 7.2 7.5 7.5 7.3 7.4 7.2 7.3
1985 7.3 7.2 7.2 7.3 7.2 7.4 7.4 7.1 7.1 7.1 7.0 7.0
1986 6.7 7.2 7.2 7.1 7.2 7.2 7.0 6.9 7.0 7.0 6.9 6.6
1987 6.6 6.6 6.6 6.3 6.3 6.2 6.1 6.0 5.9 6.0 5.8 5.7
1988 5.7 5.7 5.7 5.4 5.6 5.4 5.4 5.6 5.4 5.4 5.3 5.3
1989 5.4 5.2 5.0 5.2 5.2 5.3 5.2 5.2 5.3 5.3 5.4 5.4
1990 5.4 5.3 5.2 5.4 5.4 5.2 5.5 5.7 5.9 5.9 6.2 6.3

SOURCE: Bureau of Labor Statistics www.bls.gov

FEDERAL RECEIPTS

FY Ending Federal Receipts
1980-09-30 $517,112,000,000
1981-09-30 $599,272,000,000
1982-09-30 $617,766,000,000
1983-09-30 $600,562,000,000
1984-09-30 $666,438,000,000
1985-09-30 $734,037,000,000
1986-09-30 $769,155,000,000
1987-09-30 $854,288,000,000
1988-09-30 $909,238,000,000
1989-09-30 $991,105,000,000
1990-09-30 $1,031,972,000,000

SOURCE: Office of Management and Budget via St. Louis Federal Reserve http://stlouisfed.org/

HISTORICAL PRIME INTEREST RATES

Below is the average majority prime rate charged by banks on short-term loans to business, quoted on an investment basis. A little known fact about the Reagan administration is that government debt was financed with very high interest rates. Can the democrats and liberals blame Reagan for that? Here is a link to a sample monthly statement of the Public Debt for October 31 1981 to prove my point. Notice the “Average interest rate” column:

ftp://ftp.publicdebt.treas.gov/opd/opdm101981.pdf

So, the notion that Reagan “gave us high deficits” is not as truthful as it seems. Keep in mind that the Cold War was still going on and there was military build up because Carter destroyed the military.

1976 6.84%
1977 6.83%
1978 9.06%
1979 12.67%
1980 15.26%
1981 18.87%
1982 14.85%
1983 10.79%
1984 12.04%
1985 9.93%
1986 8.33%
1987 8.21%
1988 9.32%
1989 10.87%
1990 10.01%

More reading:  http://www.treasury.gov/resource-center/tax-policy/tax-analysis/Documents/ota41.pdf

http://www.treasury.gov/resource-center/tax-policy/tax-analysis/Documents/ota58.pdf

SOURCE: Board of Governors of the Federal Reserve System http://www.federalreserve.gov/

Source www.irs.gov/taxstats

More reading: https://ustreas.gov/education/fact-sheets/taxes/ustax.shtml

The above url has been archived at:

http://www.policyalmanac.org/economic/archive/tax_history.shtml

The Reagan Tax Cut

The Economic Recovery Tax Act of 1981, which enjoyed strong bi-partisan support in the Congress, represented a fundamental shift in the course of federal income tax policy. Championed in principle for many years by then-Congressman Jack Kemp (R-NY) and then-Senator Bill Roth (R- DE), it featured a 25 percent reduction in individual tax brackets, phased in over 3 years, and indexed for inflation thereafter. This brought the top tax bracket down to 50 percent.

The 1981 Act also featured a dramatic departure in the treatment of business outlays for plant and equipment, i.e. capital cost recovery, or tax depreciation. Heretofore, capital cost recovery had attempted roughly to follow a concept known as economic depreciation, which refers to the decline in the market value of a producing asset over a specified period of time. The 1981 Act explicitly displaced the notion of economic depreciation, instituting instead the Accelerated Cost Recovery System which greatly reduced the disincentive facing business investment and ultimately prepared the way for the subsequent boom in capital formation. In addition to accelerated cost recovery, the 1981 Act also instituted a 10 percent Investment Tax Credit to spur additional capital formation.

Prior to, and in many circles even after the 1981 tax cut, the prevailing view was that tax policy is most effective in modulating aggregate demand whenever demand and supply become mismatched, i.e. whenever the economy went in to recession or became “over-heated”. The 1981 tax cut represented a new way of looking at tax policy, though it was in fact a return to a more traditional, or neoclassical, economic perspective. The essential idea was that taxes have their first and primary effect on the economic incentives facing individuals and businesses. Thus, the tax rate on the last dollar earned, i.e. the marginal dollar, is much more important to economic activity than the tax rate facing the first dollar earned or than the average tax rate. By reducing marginal tax rates it was believed the natural forces of economic growth would be less restrained. The most productive individuals would then shift more of their energies to productive activities rather than leisure and businesses would take advantage of many more now profitable opportunities. It was also thought that reducing marginal tax rates would significantly expand the tax base as individuals shifted more of their income and activities into taxable forms and out of tax-exempt forms.

The 1981 tax cut actually represented two departures from previous tax policy philosophies, one explicit and intended and the second by implication. The first change was the new focus on marginal tax rates and incentives as the key factors in how the tax system affects economic activity. The second policy departure was the de facto shift away from income taxation and toward taxing consumption. Accelerated cost recovery was one manifestation of this shift on the business side, but the individual side also saw a significant shift in the enactment of various provisions to reduce the multiple taxation of individual saving. The Individual Retirement Account, for example, was enacted in 1981.

Simultaneously with the enactment of the tax cuts in 1981 the Federal Reserve Board, with the full support of the Reagan Administration, altered monetary policy so as to bring inflation under control. The Federal Reserve’s actions brought inflation down faster and further than was anticipated at the time, and one consequence was that the economy fell into a deep recession in 1982. Another consequence of the collapse in inflation was that federal spending levels, which had been predicated on a higher level of expected inflation, were suddenly much higher in inflation-adjusted terms. The combination of the tax cuts, the recession, and the one-time increase in inflation-adjusted federal spending produced historically high budget deficits which, in turn, led to a tax increase in 1984 that pared back some of the tax cuts enacted in 1981, especially on the business side.

As inflation came down and as more and more of the tax cuts from the 1981 Act went into effect, the economic began a strong and sustained pattern of growth. Though the painful medicine of disinflation slowed and initially hid the process, the beneficial effects of marginal rate cuts and reductions in the disincentives to invest took hold as promised.

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