Reagan Tax Cuts

Reagan Tax Cuts

In discussing the Reagan Tax Cuts, after Ronald Reagan became President in 1980 there was a basic change in federal income tax policy when the Economic Recovery Tax Act of 1981 was signed in to law - with strong bi-partisan Congressional support. Conservatives thought that if anyone knew how to make a federal tax cut, certainly Ronald Reagan did.

Driven for years before then by Republican Senator Bill Roth and Democratic Congressman Jack Kemp, the Reagan Tax Cuts reduced the top tax bracket to just 50% by phasing in – over three years – a 25% cut to individual tax brackets, which were then indexed for inflation after that.

"The government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it." ~Ronald Reagan (

The new law also significantly changed the rules for tax depreciation and capital cost recovery on business expenses for equipment. Before then, capital cost recovery basically followed an idea called economic depreciation, which referred to the reduction in market value of a producing asset over a precise period.

Tax Cut City This Act replaced that concept with an Accelerated Cost Recovery System, which excited and incented many previously discouraged business investors and eventually led to an explosion of capital creation.

As well as accelerated cost recovery, to further spur even more capital creation, the Economic Recovery Tax Act also established a 10% Investment Tax Credit.

Before and even after 1981, many thought that tax policy is best used to change amassed demand whenever supply and demand become one sided; for example when the economy boiled up or went in to recession.

Although it was simply a return to a perspective of previous generations, the new tax cut signified a new approach to looking at tax policy. The basic idea was that taxes needed to have their most important effect on economic enticements in front of businesses and individuals.

Tax Rates Reduced

Therefore, the tax rate on the first dollar earned or the average tax rate is not as important as the tax rate on the last dollar earned or the marginal dollar.

Many thought that if marginal tax rates were lowered, the normal energies behind economic development would not be so restrained.

The thinking was that those who were most industrious would spend less time on leisure and transfer more of their forces to industrious activities so there would be a lot more money-making opportunities for businesses to cash in on.

A reasonable conclusion was that the tax base would be expanded when people moved out from tax-exempt to taxable activities because of a reduction in marginal tax rates.

The Reagan Tax Cuts really seemed to signify two moves away from earlier tax policy thinking; one deliberate and the other implied. The first was how incentives and marginal tax rates were now a central theme to how taxes affect economic activity. The other was a real move away from taxing income to taxing consumption.
While businesses could now benefit from accelerated cost recovery, the ratification of numerous new tax provisions resulted in a reduction of taxes on personal savings. For example, in 1981 the IRA (Individual Retirement Account) was born.

Federal Reserve

At the same time the Reagan Tax Cuts were being enacted, to try and reign in inflation, the Federal Reserve made changes to monetary policy with complete backing of the Reagan Administration.

However, the Fed miscalculated and their actions forced inflation to decline much quicker than they thought, and within just one year (by 1982), the economy spiraled into a significant recession. Now because federal spending was calculated based on higher inflation, spending levels were much higher than anticipated, adjusted for actual inflation.

Thus with the mishmash of a sudden increase in inflation-adjusted federal spending amid a recession - and the Reagan Tax Cuts, budget deficits leaped even higher than in the past, paving the way for a tax increase in 1984. As a result, several of the 1981 tax cuts were trimmed back, mostly affecting businesses.

Ronald Reagan Statue

As the Reagan Tax Cuts went into effect to a greater extent, the economy began to see strong and continued growth. While delayed and concealed by the agonizing process of forced deflation, the advantages of marginal tax rate cuts and incentives to invest did eventually materialize as was predicted.

Back To "Taxes After World War II"
After World War II and a number of income tax cuts, the Federal tax burden as a percentage of GDP went from a wartime high in 1944 of 20.9% back down to 14.4% in 1950. However, with the Korean War and the extension of Social Security, requiring even more revenues, by 1952, the tax burden returned back up to 19% of GDP...

NEXT -- "Social Security And Medicare Taxes"
As we discuss Social Security and Medicare Taxes, from the time it was enacted up until 1956, the Social Security System remained basically unchanged. From then on though, when Disability Insurance benefits were added in 1956, Social Security began to change steadily with benefits increasingly being added to the program...

Source: U.S. Department of Treasury

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