March 1, 2001 | Backgrounder on Taxes
See also: The Truth
About Tax Rates and The Politics of Class Warfare
by Daniel J. Mitchell, Ph.D.
After President George W. Bush sent Congress an outline of his tax reform plan on February 8, some critics immediately began to attack it as a return to what they portray as the fiscally irresponsible policies of the Reagan Administration. According to these commentators, Congress should scale back--if not outright reject--President Bush's tax reform proposals because they are based on a period when the wealthy received excessive tax cuts and revenue was wasted on defense even though most Americans struggled in poverty. This is a revisionist view of recent history that ignores reality and denies the fact that President Reagan's sound policies and determination deserve much of the credit for the current economic picture. Congress should embrace President Bush's tax reform plan as a responsible return to the most successful economic policy of the 20th century.
President Ronald Reagan's record includes sweeping economic reforms and deep across-the-board tax cuts, market deregulation, and sound monetary policies to contain inflation. His policies resulted in the largest peacetime economic boom in American history and nearly 35 million more jobs. As the Joint Economic Committee reported in April 2000:2
In 1981, newly elected President Ronald Reagan refocused fiscal policy on the long run. He proposed, and Congress passed, sharp cuts in marginal tax rates. The cuts increased incentives to work and stimulated growth. These were funda-mental policy changes that provided the foundation for the Great Expansion that began in December 1982.
As Exhibit 1 shows, the economic record of the last 17 years is remarkable, particularly when viewed against the backdrop of the 1970s. The United States has experienced two of the longest and strongest expansions in our history back to back. They have been interrupted only by a shallow eight-month downturn in 1990-91.
Even with the growing surplus, however, a small but vocal faction in Congress opposes any policies that would allow taxpayers to keep more of their own money through real tax cuts and that generally would shift power from the government to the people. This attempt to rewrite history should not be surprising. Proponents of additional government spending try to make the Reagan boom appear to be a bust because they fear that Reagan's success will help President Bush build popular support for lower taxes, further deregulation, and reduced government spending. But their rhetoric is easily countered by the evidence.
history confirms the soundness of the Reagan, and now Bush, approach to economic policy. Under President Reagan, federal revenues increased even with tax cuts, federal spending did not decrease, the country experienced the longest period of sustained growth during peacetime in its history, and the rich paid more taxes proportionately than they had before the tax cuts were implemented.
Total federal revenues doubled from just over $517 billion in 1980 to more than $1 trillion in 1990. In constant inflation-adjusted dollars, this was a 28 percent increase in revenue.3
As a percentage of the gross domestic product (GDP), federal revenues declined only slightly from 18.9 percent in 1980 to 18 percent in 1990.4
- Revenues from individual income taxes climbed from just over $244 billion in 1980 to nearly $467 billion in 1990.5 In inflation-adjusted dollars, this amounts to a 25 percent increase.
Federal spending more than doubled, growing from almost $591 billion in 1980 to $1.25 trillion in 1990. In constant inflation-adjusted dollars, this was an increase of 35.8 percent.6
As a percentage of GDP, federal expenditures grew slightly from 21.6 percent in 1980 to 21.8 percent in 1990.7
Contrary to popular myth, while inflation-adjusted defense spending increased by 50 percent between 1980 and 1989, it was curtailed when the Cold War ended and fell by 15 percent between 1989 and 1993. However, means-tested entitlements, which do not include Social Security or Medicare, rose by over 102 percent between 1980 and 1993, and they have continued climbing ever since.8
- Total spending on all national security programs never equaled domestic spending, even when Social Security, Medicare, and net interest are excluded from domestic totals. In addition, national security spending fell during the Administration of the senior President Bush, while domestic spending increased in both mandatory and discretionary accounts.9 (See Chart 1.)
HOW DID REAGAN'S POLICIES AFFECT ECONOMIC GROWTH?
Despite the steep recession in 1982--brought on by tight money policies that were instituted to squeeze out the historic inflation level of the late 1970s--by 1983, the Reagan policies of reducing taxes, spending, regulation, and inflation were in place. The result was unprecedented economic growth:
This economic boom lasted 92 months without a recession, from November 1982 to July 1990, the longest period of sustained growth during peacetime and the second-longest period of sustained growth in U.S. history. The growth in the economy lasted more than twice as long as the average period of expansions since World War II.10
The American economy grew by about one-third in real inflation-adjusted terms. This was the equivalent of adding the entire economy of East and West Germany or two-thirds of Japan's economy to the U.S. economy.11
- From 1950 to 1973, real economic growth in the U.S. economy averaged 3.6 percent per year. From 1973 to 1982, it averaged only 1.6 percent. The Reagan economic boom restored the more usual growth rate as the economy averaged 3.5 percent in real growth from the beginning of 1983 to the end of 1990.12
Perhaps the greatest myth concerning the 1980s is that Ronald Reagan slashed taxes so dramatically for the rich that they no longer have paid their fair share. The flaw in this myth is that it mixes tax rates with taxes actually paid and ignores the real trend of taxation:
In 1991, after the Reagan rate cuts were well in place, the top 1 percent of taxpayers in income paid 25 percent of all income taxes; the top 5 percent paid 43 percent; and the bottom 50 percent paid only 5 percent.13 To suggest that this distribution is unfair because it is too easy on upper-income groups is nothing less than absurd.
The proportion of total income taxes paid by the top 1 percent rose sharply under President Reagan, from 18 percent in 1981 to 28 percent in 1988.14
Average effective income tax rates were cut even more for lower-income groups than for higher-income groups. While the average effective tax rate for the top 1 percent fell by 30 percent between 1980 and 1992, and by 35 percent for the top 20 percent of income earners, it fell by 44 percent for the second-highest quintile, 46 percent for the middle quintile, 64 percent for the second-lowest quintile, and 263 percent for the bottom quintile.15
- These reductions for the lowest-income groups were so large because President Reagan doubled the personal exemption, increased the standard deduction, and tripled the earned income tax credit (EITC), which provides net cash for single-parent families with children at the lowest income levels. These changes eliminated income tax liability altogether for over 4 million lower-income families.16
Critics often add in the Social Security payroll tax and argue that the total federal tax burden shifted more to lower-income groups and away from upper-income groups; but President Reagan's changes were in the income tax, not in the Social Security payroll tax. The payroll tax was imposed by proponents of big government over the past 50 years, and it is they, not Ronald Reagan, who should be held accountable for its distributional effects.
- For the top 20 percent of taxpayers, from 56.1 percent in 1980 to 58.6 percent in 1989.
- For the lowest 20 percent of taxpayers, from 1.6 percent in 1980 to 1.5 percent in 1989.17
No matter how advocates of big government try to rewrite history, Ronald Reagan's record of fiscal responsibility continues to stand as the most successful economic policy of the 20th century. His tax reforms triggered an economic expansion that continues to this day. His investments in national security ended the Cold War and made possible the subsequent defense spending reductions that are largely responsible for the current federal surpluses. His efforts to restrain the expansion of federal government helped to limit the growth of domestic spending.
If Reagan's critics had been willing to work with him to limit domestic spending even further and to control the growth of entitlements, the budget would have been balanced five to ten years sooner and without the massive tax increase imposed in 1993. Today, Members of Congress from across the political spectrum should stand on the evidence and defend the Reagan record.
To the extent that President Bush's proposals mirror those of Ronald Reagan, his plan should be a welcome strategy to lower the tax burden on Americans and to make the system more responsible. If the advocates of big government in Congress cooperate with President Bush rather than merely continuing to fund obsolete, wasteful, and redundant programs, there is no limit to the prosperity that Americans can generate.
Peter Sperry is the Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.
1. This paper is an update of an earlier Heritage Foundation publication on the Reagan record by Peter J. Ferrara, "What Really Happened in the 1980s?" in Issues '94: The Candidate's Briefing Book (Washington, D.C.: The Heritage Foundation, 1994), pp. 3-23; copies available upon request.