(Bloomberg Opinion) -- Since 1980, tax cuts have been the chief economic policy offering of the national Republican Party. Why is that?
Republican politicians and some economists will tell you that it’s just smart economics: Cutting taxes brings faster growth. This is surely true in some cases, but on the whole, economic growth has been slower since the first great Republican-led tax cut in 1981 than it was in preceding decades. There are non-tax-related reasons for that growth slowdown, and there have been lots of tax hikes as well as cuts since 1981. But it’s fair to say that the economic evidence on whether tax cuts spur sustained increases in growth is pretty mixed.
Another theory is that reducing taxes “starves the beast,” resulting in a smaller government more in line with conservative beliefs. But federal spending is about as high now as a share of gross domestic product as it was in 1980. One could just as well reason, as economists Christina D. Romer and David H. Romer did a decade ago, that “a tax cut without an associated spending cut weakens the link in voters’ minds between spending and taxes, and so leads them to demand greater spending.”
In recent years, scholars outside of economics have come up with a new set of explanations that focus on the growing political power of corporations and the wealthy (and on the Supreme Court decisions that have helped unleash this power). But while this may explain a lot about U.S. political and economic life since the 1970s, it doesn’t really explain the Economic Recovery Tax Act of 1981.
At least, that’s what Northwestern University sociologist Monica Prasad concluded while working on her doctoral dissertation at the University of Chicago in the late 1990s. She had set out to show that the outsize role of money in U.S. politics, and the power that this gave to business groups, had led to the 1981 tax cuts. “There was only one problem,” she writes. “There was no such evidence.” Further research, enabled by the release of new archival materials from the Ronald Reagan Presidential Library, only strengthened this negative conclusion, which she lays out in her illuminating, important and in places charmingly droll new book “Starving the Beast: Ronald Reagan and the Tax Cut Revolution.”
What did drive the Reagan tax cuts, then? Mainly the hope that voters would like them, Prasad argues. There was widespread public dissatisfaction with taxes in the U.S. in the late 1970s — understandable as the U.S. depended more heavily on income taxes than other wealthy nations, and double-digit inflation pushed Americans into higher income tax brackets even as real earnings stagnated. There was even greater dissatisfaction with inflation itself. Presidential candidate Ronald Reagan (1) proposed cutting individual income tax rates across the board and (2) argued that this would reduce inflation, an unorthodox theory but one that, given that other efforts to slow the upward price spiral had so far failed, seemed to many like it might be worth trying. After Reagan won handily in 1980, the Democrats who retained control of the House of Representatives opted not to oppose the tax cuts. Business interests were able to get some tax changes they wanted added to the legislation, but many of those were rolled back in 1982 to combat rising deficits.
“The optimistic version of these findings is that the tax cut was a triumph of democracy,” Prasad writes. “Taxes had gone up to levels where people were dissatisfied with them, and politicians responded appropriately by lowering them.” Prasad is too much of an academic to fully embrace such optimism, but she use archival evidence and polling data to knock holes in other explanations ranging from business power to racism to ideological fervor. And really, the aspect of the 1981 tax legislation with the biggest long-term fiscal impact — the indexing of income tax brackets to inflation (proposed by Republican Senator Robert Dole and subsequently embraced by Reagan) — is kind of hard to depict as anything but a reasonable political response to a state of affairs that was causing hardship for many Americans.
The Reagan tax cuts did bring big revenue shortfalls, although this was ironically in large part because inflation was tamed before they fully took effect, thanks to Federal Reserve Chairman Paul Volcker’s recession-inducing campaign of interest rate hikes. The tax cuts were phased in over three years with the expectation that inflation-induced bracket creep would offset most of the revenue losses. But when the inflation rate fell from 13.5 percent in 1980 to 3.2 percent in 1984, that didn’t work out. It took a decade of tax increases under Reagan, George H.W. Bush and Bill Clinton, then big declines in defense spending after the fall of the Soviet Union, to bring the federal budget into balance.
After Bush signed off on one of those tax increases in 1990 and subsequently lost the presidency, Prasad writes, the GOP “began to consciously brand itself as the party of tax cuts.” This occurred mostly at the state level in the 1990s, but after the election of George W. Bush in 2000, a couple of big national tax cuts followed, while the most significant legislative accomplishment of the Donald Trump presidency has been the Tax Cuts and Jobs Act of 2017.
That last tax cut was different from the others in that it chiefly targeted business and did not come at a time of high tax dissatisfaction. It also doesn’t seem to be have been popular with voters, which leaves a conundrum for Republicans. Wall Street Journal editorial writer Jude Wanniski had proposed in 1976 that Republicans counter the “Spending Santa Claus” that was the Democratic Party by becoming the “Santa Claus of Tax Reduction.” Or, as Prasad puts it, “Tax cuts solve for Republicans the problem that Americans say they prefer small government but support almost everything the government actually does.”
One major discovery since the Reagan tax cuts is that, thanks to global demand for U.S. Treasury securities, it’s much easier to reconcile these seemingly opposing desires by running large, long-run deficits than anybody (except perhaps economist Robert Mundell) thought in the 1970s. But if Americans don’t even want tax cuts anymore, at least not for everybody, then the GOP may have a big problem.
To contact the editor responsible for this story: Brooke Sample at bsample1@bloomberg.net
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Justin Fox is a Bloomberg Opinion columnist covering business. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”
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