Reagan’s Tax Cut Just Turned 40 — And It’s Still The Most Important Tax Reform Since World War II

Ronald Reagan made tax cuts the centerpiece of his 1980 marketing campaign for the presidency. And after profitable the election, he made good on his promise. 

The Financial Restoration Tax Act (ERTA), enacted on August 13, 1981, was the most important tax reduce in American historical past. It was additionally remarkably sturdy, reshaping the federal tax system — and American politics — for many years to come back. 

First some numbers: Reagan’s tax reduce slashed revenues by 2.9% of GDP, in line with the Committee for a Accountable Federal Price range. That makes it the most important tax reduce for the reason that introduction of the trendy earnings tax in 1913, surpassing even the mammoth cuts handed after World Struggle II (2.7% of GDP in 1945 and 1.9% in 1948).

For sure, ERTA additionally eclipses the 2017 tax reduce; regardless of former President Trump’s repeated declare that his reduce was the most important, the Tax Cuts and Jobs Act clocked in at simply 0.6% of GDP. 

Now it needs to be mentioned that the 1981 tax reduce didn’t stay fairly so large; virtually instantly after Reagan signed the invoice into regulation, his financial advisers began searching for methods to unravel it. Fearful by grim deficit forecasts, they unveiled a set of “income enhancements” designed to sluggish the river of purple ink flowing from the treasury. 

Reagan would finally comply with a sequence of tax hikes; taken collectively, they lowered the scale of the 1981 reduce by virtually half, in line with Bruce Bartlett, who had a hand in drafting ERTA whereas working for the Reagan administration.

So the 1981 tax reduce began large . . . after which obtained smaller. However all that preliminary bigness mattered, establishing Reagan’s bona fides as a tax reformer — and as somebody who would ship on his guarantees. Within the brief time period, that mattered for U.S. electoral politics.

However different facets of the 1981 tax regulation had been much more essential — and had much more profound penalties. When Reagan arrived on the White Home, the highest marginal earnings tax fee for people was 70%. ERTA slashed it to 50% whereas additionally reducing charges in decrease brackets.

5 years later, the Tax Reform Act of 1986 would decrease (and consolidate) charges much more. 

These fee reductions had been economically essential, particularly when coupled with the elimination of tax preferences within the 1986 tax reform. However not all of them proved sturdy; Congress started to fiddle with the charges (and the tax base) virtually instantly. Most of the reforms had been undone inside just a few years.

However one side of the speed cuts proved very sturdy: Lawmakers by no means significantly reconsidered Reagan’s drastic cuts on the prime finish of the earnings scale.

ERTA knocked 20 share factors off the highest bracket fee, and the politics of post-ERTA taxation made no room for restoring that fee to its pre-Reagan heights — or something even shut. After 1981, 50% was the brand new 70%. And after just a few extra years, 28% was the brand new 70%. 

Lopping 20 factors off the highest fee was simply one of many two transformative achievements embedded in ERTA. The opposite was tax system indexing.

Earlier than 1981, inflation would usually push taxpayers into greater brackets, boosting income by means of a course of referred to as “bracket creep.” It was a handy solution to increase extra income — painful for hapless taxpayers however painless for the gutless lawmakers. 

ERTA put an finish to the bracket creep by requiring that key parts of the tax system be listed for inflation. That ended simple finance, forcing lawmakers to confront disagreeable realities and make arduous selections. It completely remodeled fiscal politics. 

Lastly, ERTA modified American politics effectively past the fiscal realm. As sociologist Monica Prasad argued in her excellent 2018 e book, Ravenous the Beast: Ronald Reagan and the Tax Lower Revolution, the 1981 tax reduce taught Republicans that tax cuts could possibly be the ticket to victory. 

“This primary tax reduce taught Republicans that tax cuts could possibly be fashionable — one thing that was not clear on the time, as a result of for many years earlier than then opinion polls had proven robust and constant opposition to deficits,” Prasad writes.

“ERTA remodeled the Republican Occasion from a celebration of fiscal rectitude into a celebration whose foremost home coverage aim is to chop taxes.” That transformation, furthermore, proved extraordinarily sturdy — way more sturdy than ERTA itself. 

These days, it’s trendy to speak concerning the 1986 tax reform as a watershed second within the historical past of American taxation. And in some respects it was: It was actually the apotheosis of fine intentions in fiscal policymaking.

Finally, nonetheless, it’s ERTA that deserves the crown for Most Vital Tax Regulation in Dwelling Reminiscence. As a result of ERTA did greater than change the tax system: It modified America.