Conservatives who prescribe deep cuts in income taxes have a problem. Their medicine for what ails the economy was tried in 1981, but did not deliver the results that they promised. Cuts in marginal rates failed to boost saving, investment, middle class incomes, or revenues from the income tax.
The saving rate of American businesses and households plunged in the 1980s. Net investment decreased as a percentage of national income, and income growth for typical American households failed to improve, remaining sluggish. For many working families, incomes actually shrank. Income tax revenues fell, both absolutely and as a fraction of national income, swelling the federal deficit.
While the 1981 tax cuts helped high-income taxpayers prosper, analysts can find few signs that the prosperity was shared by ordinary workers or their families. Most statistics show that the hourly wage received by a typical worker declined during both the Reagan and the Bush administrations.
Supply-side zealots are unfazed by this record and urge another round of tax cuts. They prefer partisan fantasy to clear-eyed analysis when judging the historical record.
One of their cherished fantasies is that middle class families enjoyed unparalleled income growth as a result of the 1981 tax cuts. The record tells a different and sadder story.
From 1981 through 1988, Congress and the president reformed the tax code, reducing top rates significantly. What happened to middle-class incomes after the 1981 tax cuts? Almost before the ink was dry on the 1981 legislation, the nation entered its worst post-war recession. Median family income tumbled in both 1981 and 1982, then started to climb in the longest peacetime expansion. Median income grew 1.7% a year during the recovery, one of the slowest rates of improvement of any postwar expansion. Incomes fell in the 1990-91 recession, and continued to shrink during the recovery that followed. Real median income was just 2% higher in 1992 than in 1980, President Carter’s last year in office.
Why do supply-siders see this record as a vindication of tax cuts? Mainly because they take credit for income gains in an expansion and blame others for income losses in two recessions. Applying this standard, the Carter Administration was a triumph of good policymaking. Median real income grew 1.7% a year in 1977-79 before falling in the 1980 recession. Few supply-siders would give Carter a passing grade for economic performance. But they award Reagan an A+ for performance that, from the point of view of middle class income, was only slightly less dismal.
Tax statistics show that Americans with very high incomes have benefited from the change in the top marginal rates, which remain well below where they were when Reagan took office. Taxes for the wealthy were a smaller percentage of their incomes in 1992 than they were in 1980. Even though they faced lower rates, high income taxpayers accounted for a larger percentage of total income tax payments than they did in 1980. The reason is simple: Their incomes rose much faster than those of middle class families, who as we have seen, enjoyed very small gains after 1980.
All credible income statistics show that the incomes of poor and lower middle-class families have shrunk since 1980. Families with sinking incomes will pay a gradually smaller percentage of total taxes under a progressive income tax system if other families continue to enjoy income growth.
Another fantasy of supply-siders is that tax revenues are a constant percentage of national income, no matter how much we trim the top rate. From an incorrect assumption, they draw a false conclusion: The top rate could be cut in half without any loss in revenues.
In fact, personal and corporate income tax revenues plunged after top rates were cut in 1981. Measured in constant prices, revenues from the personal and corporate income tax did not return to their 1981 level until 1987. Measured as a percentage of national income, revenues from the personal and corporate income tax fell 2 percentage points between 1980 and 1984, and even today remain well below the comparable percentage in 1980. In relation to national income, the revenue of the federal government has fallen less than personal and corporate income taxes. But this is because payroll taxes, which fall most heavily on working families, increased after 1981.
The beginning of economic wisdom is to learn from experience. The plain message of the 1980s is that large cuts in top marginal rates are not a panacea for what ails the economy. Some symptoms, such as low investment and savings, were made worse by the ineffective medicine. When the tax cut doctors ignore or distort the lessons of the past, it is the ailing patient who suffers. Voters should bear that in mind when deciding who will prescribe their medicine.