Magazine | July 6, 2015, Issue

Reagan’s Supply-Side Genius

It still matters today

Among his many talents, Ronald Reagan had a special gift for proving his critics wrong. Almost none of the leading economists of the late 1970s thought that his supply-side tax-cutting agenda, along with stable monetary policy and deregulation, could revive the economy from the malaise of that decade. But the prosperity of the 1980s — with growth rates higher than 6 percent — proved the Gipper correct. An economics major from Eureka College understood our free-market system better than the so-called experts at Harvard, Yale, and MIT.

As the 2016 presidential campaigns gear up, Reagan’s policies are under assault again, this time even from some of our friends on the right. Several econo­mists at conservative organizations such as the American Enterprise Insti­tute and Na­tional Review are questioning the wisdom of cutting tax rates. This new group of economic conservatives, called “reformicons,” says that supply-siders are obsessed with cutting tax rates for the richest Ameri­cans at a time when middle-class tax cuts and tax credits should take precedence.

Reagan’s legacy has gotten tangled in this debate. Henry Olsen of the Ethics and Public Policy Center writes in the June 1 issue of NR:

Many claim [Reagan] today as the political father of supply-side tax policy, but his words and deeds show that it was not quite so. . . . By indexing standard deductions and tax brackets for inflation, he steered hundreds of millions of dollars to middle- and working-class families, money that theoretically could have been used to cut top rates even more. And his 1981 tax cut allowed all workers to contribute to tax-deductible IRAs, exactly the sort of middle-class tax cut that today’s supply-siders deride.

This is partly true. Reagan’s 1981 Eco­nomic Recovery Tax Act was an across-the-board 25 percent reduction in tax rates. Everyone got tax relief. Almost all supply-siders — from Jack Kemp to Art Laffer to Senator Bill Armstrong, the sponsor of the bill — supported indexing tax rates for inflation in order to end “bracket creep” and to prevent the government from profiting from inflation. And de­ductions for tax-free IRAs are supported by most supply-siders as a way to encourage saving by ending its double taxation.

The Tax Reform Act of 1986 was a quintessential Reagan idea. He saw efficiency gains to be had from closing loopholes and lowering rates. No one thought it could be done. All of the K Street lobbyists who benefited from the tax code’s special-interest favors were against Reagan’s ideas. But the legislation passed, reducing the number of tax brackets to two, 15 percent for the middle class and 28 percent for the wealthy. It cleared the Senate 97–3, with even liberals such as Ted Kennedy and Howard Metzen­baum voting yes. As a result, during Reagan’s two terms in office, the highest income-tax rate fell from 70 percent to 28 percent — one of the biggest reductions in tax rates in American history. Reagan was a supply-sider — period.

He understood from personal experience that high tax rates discourage work, investment, and growth. He used to tell the story of making only a certain number of movies a year, because once he got pushed into the highest tax rates of 70 percent or more, there was no rational justification for continuing to work.

The Reagan tax-rate reductions in­creased tax revenues from $500 billion to $1 trillion by the end of the 1980s. A study by economist Larry Lindsey found that the rate cuts for the highest income brackets paid for themselves by encouraging work and investment. Supply-side economics was a fiscal success. As the Gipper used to put it with his customary wit, “I knew my ideas were working when the media stopped calling it Reaganomics.”

Would Reagan have supported a flat tax that got rates down to 17 or 18 percent for all, with a generous deduction for families with children? All we can say for sure is that the idea is entirely consistent with his work to simplify the tax system and promote growth.

Mr. Olsen believes that successful Republican governors such as Scott Walker of Wisconsin have shunned cutting tax rates “for the rich.” Actually, at least ten highly successful GOP governors have adopted the Reagan supply-side model to improve growth. These tax-cutters include Mike Pence of Indiana, Bobby Jindal of Louisiana, John Kasich of Ohio, and Pat McCrory of North Carolina. At least three Republican governors are devising strategies to eliminate their state income tax entirely, including Mr. Kasich, Doug Ducey of Arizona, and Paul LePage in Maine.

The state experiment proves that tax cutting is still very good politics. Re­publican governors who cut tax rates were reelected last year, many with towering majorities. Voter hostility to higher taxes was clearly evident earlier this year, when 80 percent of Michigan voters rejected a ballot initiative to hike the sales tax and the gas tax to pay for new roads.

Even Sam Brownback, the governor of Kansas, won reelection despite a multi-million-dollar campaign by union and other left-wing, out-of-state donors, assisted by the New York Times and local media, to oust him — and to make his political scalp an example of what happens when you cut taxes. Mr. Brown­back cut income-tax rates and eliminated income taxes altogether for pass-through small businesses, the profits of which are claimed by the owners and had heretofore been taxed at individual rather than corporate rates. The economic effects have been positive. Kansas’s rate of job creation has been one of the highest in the farm-state region. Job growth has especially surged on the Kansas side of Kan­sas City, where businesses have relocated from Missouri to take advantage of the new tax policy. It’s true that the state has a big revenue hole to fill this year, but that is because the legislature never cut spending to offset the tax cuts.

If you want to see an amazing supply-side success story, look at North Carolina. Since Governor McCrory slashed the top income-tax rate in 2013, the state has had nearly the fastest decline in unemployment in the nation, and it just announced a $400 million budget surplus. Supply-side ideas work.

What about Scott Walker’s record on taxes? Mr. Walker’s heroic economic and political success has consisted in winning collective-bargaining reforms and enacting right-to-work legislation — huge economic bonuses for his state. Walker’s tax cut reduced rates a little at the top and more for the middle class. But clearly the employment rebound in Wisconsin is due to the union and labor reforms.

The importance of Mr. Olsen’s argument is that it brings to the fore the debate among conservatives about whether supply-siders focus too much on cutting tax rates on the rich. That claim un­doubtedly will be the refrain from the left for the next 18 months, so we’d better have good answers.

The economic case is simple. High corporate- and individual-income-tax rates make the U.S. tax system uncompetitive with the rest of the world and reduce investment and savings here. This hurts the middle class more than any other, and is one reason its wages aren’t growing. The federal income tax today is highly progressive, with two-thirds of taxes paid by the top 10 percent of earners. The main problem for the middle class today isn’t that it pays too much income tax — though it does — but that its take-home pay hasn’t risen, and has in fact fallen, for eight years.

Tinkering with the tax code may not be a political or economic winner. The system needs to be rebuilt from scratch and made simple and pro-growth. Our polling at the Heritage Foundation finds that what Americans want most from the tax system is “fairness,” so shaping the popular definition of that term will be key to winning the policy debate. A fair tax system shouldn’t be understood as one that takes from the rich and gives to the poor. Rather, it should be one that requires everyone to play by the same set of rules. The 10,000-page tax code violates the American idea of fairness because it is crammed with special favors for the politically connected. It is not fair that some successful individuals and companies game the system to pay nothing while others pay the highest taxes in the developed world. A broad tax base with low rates would be good policy and politics. This was the simple elegance of the 1986 tax reform.

It is doubtful that adding new tax credits for the middle class, as reformicons advocate, is going to help the economy or excite voters much. We should take a lesson from Herman Cain, who in 2012 captured the attention of the nation and especially conservatives with his 9-9-9 plan, which called for a 9 percent national sales tax, a 9 percent business tax, and a 9 percent flat-rate income tax. It was popular because it was bold and simple.

The debate among conservatives and GOP presidential candidates about how to fix the tax system in a pro-growth and politically achievable way is a healthy one, and it’s critical that we get the answers right. The good news is that, so far, all of the GOP presidential contenders have said that they want to cut tax rates. We will see which among many approaches — including the flat tax and the national sales tax — voters prefer.

Ronald Reagan was a politician, of course, and we at Heritage sometimes disagreed with his compromises. But the Gipper understood that good policy is usually good politics. He was principled but not doctrinaire. We don’t know what Reagan would have considered the best tax plan today, but, having known him, we are pretty sure he would have loved this debate about how to overhaul a corrupt system that is slowing growth and hurting American workers.

– Mr. Feulner is the founder of the Heritage Foundation, of which Mr. Moore is a senior fellow.

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