“Common sense told us that when you put a big tax on something, the people will produce less of it. So we cut the people’s tax rates, and the people produced more than ever before.” –President Reagan’s Farewell Speech
Exactly twenty-five years ago, Ronald Reagan signed into law the first supply-side tax cuts since the JFK plan of the early 1960s. By reducing high marginal tax rates, Reagan transformed the American economy and opened the door to two-and-half decades of prosperity. Economic behavior responds significantly to the incentive power of low tax rates that raise the after-tax return on work, investment, and risk-taking.
Over this time span, the U.S. has experienced only six quarters of negative GDP — a remarkable performance. Roughly 45 million new jobs have been created, with the economy averaging about 3.5 percent real growth each year. In the 1980s, as the economy supplied more goods to absorb the Fed’s money supply, inflation plunged from the stagflationary 1970s. Meanwhile, entire new technology industries sprung up, forming an information economy that has transformed business and productivity.
Stock markets exploded in the Schumpeterian environment of entrepreneurship that Reagan helped launch. Wealth creation reached unheard of levels among the 100 million investors who were spurred by new incentives to keep more of what they earned, saved, and invested. Capitalism was rejuvenated in the U.S., and then it spread around the world.
Ankle-biting, demand-side Keynesians (most of whom reside in the Democratic party) are always looking for blotches, hanging toenails, and the occasional scrape on what is today’s muscular and statuesque American economic body. But the genial and optimistic Mr. Reagan undoubtedly chuckles from his perch on high, as he watches his critics scramble to come up with a coherent opposing idea. They can’t, and they won’t.
One of Reagan’s big ideas was that tax incentives matter. It has been a blockbuster, runaway success. But even today, twenty-five years later, it remains the greatest economic story never told.