Obama and the Age of Reaganomics

Certain ideas get so firmly fixed in some folks' brains that no amount of evidence can dislodge them. Such ideas become articles of faith. And one article of faith that is particularly deeply stuck in the minds of "the faithful" is that Reaganomics doesn't work.

The big idea behind Reaganomics is that cutting tax rates boosts the economy, which results in more tax revenue. The history of the last three decades bears this out.

The faithful have tried to disprove Reaganomics by contending that the 1993 tax rate hike is what gave us the good economy and the balanced budgets of the 1990s. This is pure speculation, because the faithful don't know what GDP and federal revenue would have been had rates remained lower.

But the bigger problem for the faithful is this: Reagan's 28-percent top rate on the Feds' largest source of revenue, the Individual Income Tax, didn't kick in until the 1986 tax bill. And what's more, Reagan's 1981 rate cuts were phased in over three years. So for most of Reagan's tenure, the top rate was 50 percent or more. Now, I don't have a degree in economics, but 50 percent is higher than Clinton's 39.6 percent. Also, the Republican Congress pushed through the tax rate cuts of 1997, which Clinton signed.

So the inconvenient truth the faithful fail to grasp is that the case for Reaganomics continued to be made during the 1990s, and it might have been demonstrated even more conclusively under Clinton than under Reagan.

But that doesn't stop the faithful -- guys like Marxist Andy Stern, former president of the Service Employees International Union (SEIU), who said on "60 Minutes," "I think I'm going to win the Nobel Prize because I think I can finally prove that Ronald Reagan is wrong, George Bush is wrong. Wealth does not trickle down, it trickles up."

And the late left-wing columnist Molly Ivins wrote, "[The] tax cut is part of a continuing right-wing fantasy going back to the Laffer Curve."

But this "continuing right-wing fantasy" has been the de facto policy of the U.S. since 1981, during which America has enjoyed her longest expansions, record job creation, low inflation, exploding GDP, etc, etc. Look at the numbers: Total federal revenue for fiscal 1980 was $517 billion, and for fiscal 2000 was more than $2 trillion. You do the math: During those twenty years, revenue shot up by a factor of 3.86, with radically lower tax rates throughout.

So the Age of Reaganomics never ended, not even under Clinton, and it continues apace to this day. The question becomes: for how much longer? Because now we hear that we can cure what ails us by raising tax rates. That's the plan of the Anointed One. And the faithful are falling in line behind Him. He who doubts Himself Not has designs on your money, which occasions another question:

How exactly does one help a faltering economy by taking money out of it?

On January 20, 1981, Ronald Reagan inherited the worst economy since the Great Depression. A new disease called "stagflation" infected America -- simultaneous high unemployment and high inflation, which theoretically weren't supposed to co-exist. The economy was so bad economists threw out economic theory, like the Phillip's Curve. The stock market hadn't inched up for fifteen years; parts of the country were in depression.

So if not with Reaganomics, how do the faithful explain the turnaround? (Historical inevitability?)

One of the cardinal sins the faithful regularly commit is their conflating the economy with the government. Whenever you hear the faithful talk about the economy, notice how quickly they segue into government finances, especially the federal deficit. It's as though their only criterion for judging an economy is whether or not it's adequately funding the government; if there's a federal deficit, it's the economy's fault.

We've had gangbusters economies while running deficits, and we've had lousy economies with balanced budgets. Example: The feds ran an on-budget surplus of $86.5 billion in fiscal 2000, the largest ever, even though the stock market suffered a historic meltdown and the fourth quarter saw negative GDP.

Deficits are a function of two things: revenue and spending. We understand how to increase revenue (Reaganomics), but Congress just can't help itself when it comes to spending. Increase revenue, and Congress will find something to spend it on, be it universal health care, universal pre-K, the Cowgirl Hall of Fame, a bridge to nowhere, or some public works project in West Virginia named for Robert Byrd.

The real reasons the feds ran budget surpluses at the end of the 1990s are:

  • The Republicans kept a lid on new spending. Even before they captured Congress in 1994, they killed HillaryCare, which would have been a budget-buster.
  • It was smack-dab in the middle of the dot-com bubble. As soon as the bubble burst, the extra revenue vanished.
  • We weren't spending nearly enough on defense, homeland security, intelligence, and anti-terrorism. When we started spending again on these essentials, the deficit returned.
  • We were practicing Reaganomics.

It should be obvious that a tax rate can't be too high lest it kill off whatever it's taxing. The "killing effect" of high tax rates is implicit in sin taxes, which seek to mold folks' behavior. For example, the government uses high tax rates on tobacco to deter kids from smoking. If government wanted to totally kill off the tobacco industry, it could, say, raise cigarette taxes to a hundred bucks a pack.

Let's define "optimal tax rate" as that rate which brings in the most revenue over the long haul. Government could jack up tax rates above the "optimal tax rate" and perhaps get more revenue -- but only for a while. Eventually the disincentive of the higher rates would come into play, and revenues would plunge.

As to what the "optimal tax rate" might be, I haven't the foggiest. But fiscal 2007 saw total federal revenue of $2.568 trillion (see Table 1.1). This is the record, the most federal revenue ever. It is five times the revenue right before Reagan, and 26 percent more than Clinton's best year. And it happened under the Bush tax rates.

Those would be the same Bush rates that are set to expire in 2011. So Obama and the Democrats could be setting themselves up for a fall if their higher rates fail to quickly bring in more revenue than the lower rates did in 2007. That kind of revenue is unlikely without considerably higher economic growth. But Obama has also instituted a slew of new taxes with ObamaCare that are set to go into effect in 2011. If these new taxes and the return of higher rates on the old taxes coincide with a double-dip in the recession, then Reaganomics will have additional vindication.

In the April 16, 2008 Democratic debate on ABC, Charles Gibson asked Senator Obama about tax rates:

GIBSON: All right. You have, however, said you would favor an increase in the capital gains tax. As a matter of fact, you said on CNBC, and I quote, "I certainly would not go above what existed under Bill Clinton," which was 28 percent. It's now 15 percent. That's almost a doubling, if you went to 28 percent. But actually, Bill Clinton, in 1997, signed legislation that dropped the capital gains tax to 20 percent.

OBAMA: Right.

GIBSON: And George Bush has taken it down to 15 percent.

OBAMA: Right.

GIBSON: And in each instance, when the rate dropped, revenues from the tax increased; the government took in more money. And in the 1980s, when the tax was increased to 28 percent, the revenues went down. So why raise it at all, especially given the fact that 100 million people in this country own stock and would be affected?

OBAMA: Well, Charlie, what I've said is that I would look at raising the capital gains tax for purposes of fairness. ... [Emphasis added.]

GIBSON: But history shows that when you drop the capital gains tax, the revenues go up.

OBAMA: Well, that might happen, or it might not.

Obama seems more committed to "fairness" than to higher revenue. But since we've had record federal revenue with the current rates, why change them?

If Congress taxed at the "optimal tax rate" but ran a deficit, the reason for that deficit would clearly be spending. Congress is forever tinkering with tax rates, but it has never controlled its spending. Mechanisms like Gramm-Rudman, which trigger automatic cuts, don't work because Congress will just override them. And pay-go? Pay-go is a fraud.

The only way a rate hike could be justified is if Congress preceded it with radical spending cuts. Otherwise, it'll just be more billions down the rat hole -- your money, squandered by professional politicians. So let's see Congress pass some rescission bills and reform entitlements before we allow them to even think about raising tax rates.

The faithful have given President Bush so much grief for his tax rates. For eight years, he had to endure an unending chorus of "tax cuts for rich, tax cuts for the rich." But Bush's phased-in rate cuts for the top bracket totaled only 4.6 percent. Did Reagan ever receive such flak for his massive 42-percent cut?

Do the faithful really wish to go back to the 70-percent top rate under Carter? Or would they prefer the 91-percent rate Kennedy inherited? Or do they just have a fetish for the number 39.6? In any event, it would be a stunning victory if the faithful would just agree that a man should be allowed to keep 50 percent of what he makes.

When it comes to cutting tax rates, Reagan's still the all-time champ. Since Reagan, none of the rate adjustments in the Individual Income Tax, neither up nor down, have been very sizable. Surely, we're pretty close to the "optimal tax rate."

Ave Ronaldus Magnus.

Jon N. Hall is a programmer/analyst from Kansas City.
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