The Agenda

Bruce Bartlett on the Reagan Tax Cuts

In Bruce Bartlett’s view, the 1981 Reagan tax cut’s main virtue was that it eased the impact of the inflation-fighting efforts of the Federal Reserve:

 

Mainstream economists also argued that the cost of bringing down inflation, even a little bit, would be extraordinarily high. In a May 1978 paper, Brookings Institution economist Arthur Okun calculated that bringing the inflation rate down by just one percentage point would cost 10 percent of a year’s gross national product.

If Keynesian theory was correct, the 1981 Reagan tax cut, which reduced revenue by close to 3 percent of GDP per year, should have been massively inflationary. But in fact, inflation dropped like a rock, from 12.5 percent in 1980 to 8.9 percent in 1981 and 3.8 percent in 1982, where it basically stayed for the rest of the 1980s.

Of course, the Federal Reserve’s tight money policy did the heavy lifting on reducing inflation. But if Okun’s estimate had been even remotely correct, we should have gone through another Great Depression. Although the 1981-82 recession was painful, it was brief and not very deep. Real GDP fell 1.9 percent in 1982 but bounced back nicely, rising 4.5 percent in 1983 and 7.2 percent in 1984.

Republicans like to say that massive growth followed the Reagan tax cut. But average real GDP growth during Reagan’s eight years in the White House was only slightly above the rate of the previous eight years: 3.4 percent per year vs. 2.9 percent. The average unemployment rate was actually higher under Reagan than it was during the previous eight years: 7.5 percent vs. 6.6 percent.

Liberals argue that the real economic effects of Reagan’s policies show that they failed. However, I believe that these critics overlook the enormous importance of breaking the back of inflation at a relatively small economic cost — certainly far less than any economist would have thought possible in 1981. Reagan’s results should be measured against the (incorrect) expectation that a far more severe economic downturn would be needed to reduce inflation. On that basis, his policies were overwhelmingly successful.

In Bartlett’s view, however, conservatives overinterpret the impact of the Reagan tax cuts, as they neglect the impact of inflation on the economic climate of the Carter and early Reagan years. I think that there is much to this line of thinking, though I don’t necessarily embrace Bartlett’s conclusions.

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