Fast-Forwarding Tax Cuts
By Amity Shlaes
This essay is adapted from Amity Shlaes’s regular column “The Forgotten Book,” which she pens for “Capital Matters” as a fellow of National Review Institute.
Republicans tell us they are close to finding the votes to pass a tax measure that extends the expiring 2017 tax cuts. The deal also includes breaks for products made in the United States, and a tax hike on carried interest. To which one can only say: let the bill be mostly cuts.
And let them get it done soon.
That’s the thing about tax cuts. They work better when they come sooner.
An example of that is the very cuts the administration hopes to extend today. President Trump’s 2017 measures lowered the corporate rate significantly and cut the top marginal rate on individuals as well. The 2017 tax law helped to place the economy in good condition to recover from a blow.
The blow came in the form of the Covid shutdown, which forced a drop of nearly 30 percent in GDP in the second quarter and joblessness of close to 15 percent. The pandemic crisis endured, for months and then years.
Meanwhile, however, came a miracle in the dark. The economy found its footing fast and has grown strongly in intervening years. When Americans stepped out into the sunlight after their Covid hibernation, jobs were there to greet them. Part of that vigorous activity came from the extraordinary federal spending on relief during the Covid period. But a good share of the new energy stemmed from the favorable tax situation. This bounce back provided a sharp and welcome contrast to the long period of slow growth following the 2008 financial crisis. It also contrasted with much slower growth in Europe after Covid. That 2017 law deserves much of the credit for giving the period of 2020–2024 in the U.S. its name: “The Great Recession That Wasn’t.”
The Supply-Side Test
What happens when tax cuts don’t arrive in time comes clear in one of the valuable old books that are the subject of this column: The Growth Experiment, a meticulous biography of Ronald Reagan’s historic tax drive published first in 1990. The author was someone who enjoyed a ringside seat: Lawrence Lindsey, a Harvard professor who served three years on Reagan’s Council of Economic Advisers. Unlike many texts by Washington insiders, however, Lindsey’s is more judicious than jingoistic. That makes him a pleasure to read.
Lindsey commences by sketching out the awful context. Under President Jimmy Carter, the top federal income tax rate was 70 percent. What’s more, the wind of inflation was blowing citizens into higher tax brackets. As 1980, an election year, commenced, the economy moved into recession.
The turnaround maestro who emerged as the Republican candidate, Ronald Reagan of California, promised tighter money, less spending—and tax cuts. The experiment part was the emphasis on the supply side: Reagan planned tax changes to free firms and individuals to produce more, rather than the traditional policy of cash givebacks to induce mass consumer spending. The campaigning Reagan put his supply-side promises front and center. So, it turned out, did the voter; as Lindsey reminds, “it was largely for those promises that he was elected.”
By the time of Reagan’s inauguration in 1981, the recession had passed. But the broader economic crisis abided. Interest rates stood, as Ronald Reagan would later put it, into “outer space”: over 20 percent for the prime rate, and at 15 percent for home mortgages. Enterprise wasn’t leading the country, it was hiding under the table.
These troubles appeared to advantage the new president. Yet Reagan’s battle to see through dramatic tax cuts for producers proved a tough one. Traditional Keynesian economists charged that Reagan’s tax cuts would strengthen inflation: as Lindsey points out, Carter’s treasury secretary, G. William Miller, warned that plans like Reagan’s were a “great hoax on the American people.”
On the Hill, the new president’s negotiating position was worse than, say, President Trump’s today. In 1980, Republicans had wrested control of the Senate from Democrats for the first time in a generation. But Democrats still held the House. And tax bills originate in the House. There, instead of Mike Johnson or Jodey Arrington, two Democratic veterans, House Speaker Tip O’Neill of the Commonwealth of Taxachusetts, and Ways and Means Chairman Dan Rostenkowski of Illinois, sat at the other side of the president’s negotiating table.
Unlike today’s politicians, Reagan put energy into building coalitions. He lured, encouraged, and cajoled Congress into passing legislation that took a “meat axe to the tax code,” as Lindsey puts it. The Economic Recovery Tax Act, or ERTA, as it was known, reduced the top marginal rate from 70 percent to 50 percent and indexed tax brackets to inflation.
Lindsey details other supply-side aspects: increased depreciation allowances and reduced taxes on interest and dividends. Finally, the bill cut the capital gains rate to 20 percent. People followed the implementation of the “meat axe” with the same combo of horror and fascination with which they follow the Trump administration’s “meat axes,” such as the plan to dismantle the Department of Education.
There was anger, but, Lindsey notes, for scholars, there was a lovely sense of inquiry in the undertaking: “The 1981 tax cuts represented as clear a test of the Keynesian and supply-side paradigms as any of us could have designed.”
Delays
Wall Street, too, was intrigued. After hesitating, the market commenced the perma-rally many of us grew up with. Main Street was not so sure. The principal problem was that the final bill staged many of its rate cuts and shifts over several years. Bracket indexing would have to wait until tax year 1985, which meant that filers would not see the benefits until they submitted their return in 1986. Meanwhile, the Federal Reserve was not dropping interest rates. Pain came before gain.
What’s more, less than a year after the prior recession had passed, a second recession hit. “Delaying the tax cuts certainly contributed to the resumption of economic recession in 1981–1982,” concludes Lindsey. By August 1982, the prime rate, important perhaps above all to small businesses and start-ups, had dropped but still stood at a daunting 14 percent. And only the first of the three staged tax cuts had taken effect.
Reagan spent the summer of 1982 wooing Democrats to go along—quite a contrast with the current administration’s modus operandi—with more tax reform. “We’re all Americans, we all want to get the economy moving,” he said when he announced an agreement on a second round of tax legislation.
This second bill proved a mix, with some, but only tame, tax relief for working Americans. The law also mandated tougher IRS enforcement, including the introduction of withholding for investment income, hardly a pleaser for the fixed-income crowd. Finally, the 1982 law included some tax hikes on business—the corollary concession to the carried-interest giveback in the current negotiations. Come August, Reagan blocked a spot on network TV to apologize for the “present state of our economy” and for the tameness of the tax bill. Opponents accused Reagan and Congress of leading “the greatest tax increase in history,” hardly accurate but effectively nasty.
A New Rhythm
As the 1982 midterms of Reagan’s first term neared, so did more bad news: joblessness crossed the crucial 10 percent line, moving higher than it had since the Great Depression. That November, Republicans lost seats in both Houses. The big growth experiment looked set to abort. To make matters worse, following the election, interest rates rose again.
By 1984, however, Main Street was beginning to find its footing. Unemployment was finally down in the 7 percent range, and the prime rate was heading further downward. Still, times were far enough from good that Reagan confronted plenty of challenges in his 1984 presidential campaign. “Morning in America,” Reagan’s theme in the reelection campaign, remained more aspirational than real.
But Reagan persevered. To defend his supply-side cuts, past and future, the incumbent campaigner this time did get down in the dirt with his opponent, Walter Mondale. In a PowerPoint-style ad trashing the Democrat, Reagan’s team contrasted “Reaganomics” and “Mondalenomics.” Reagonamics would “cut taxes” and “cut spending.” Mondalenomics would “raise taxes.” They both worked, the ad allowed: “The difference is Reaganomics works for you, Mondalenomics works against you.”
Though Reagan won his second election decisively, the GOP majority narrowed in the Senate. The class warriors of that era insisted that Reagan’s next tax law, a 1986 act, hike the capital gains tax rate back to 28 percent from the 20 percent set in 1981. The same law brought down the top marginal income tax rate to 28 percent. But again, there was a delay: the full rate reduction would apply only two years later, in 1988.
Some of the results of this third mixed bag were predictable. Capital gains revenues, which had exploded following the 1981 rate cut, now disappointed the government forecasters. On spending, Reagan broke his campaign promise and signed off on laws that increased outlays.
Still, by the later 1980s, Americans were beginning to sense that the morning was indeed genuine. The benefits for Wall Street spread to Main Street. Joblessness dropped well back below the 10 percent line and would hit 5 percent in the last days of the 1988 presidential campaign. Inflation was likewise decreasing, thanks to the rigorous work of Fed Chairman Paul Volcker. Contrary to the Keynesians’ claims, tax-rate cuts did not cause federal revenues to collapse. The deficit widened, but as Lindsey demonstrates, “three quarters of increases in deficits was due to spending; one quarter, or less, due to tax cuts.”
And no third recession materialized. Reagan had established a new rhythm: recessions every half a decade or less often—not back-to-back.
Frontloading tax Cuts
That Reagan stayed his course against such headwinds testified to his greatness, to use an overused word. It’s also a testimony to Reagan’s bipartisan work on the Hill: many Democrats joined him in cutting rates; indeed, it was Democrats who, sometimes, successfully pled for lower rates and Reaganomics. One of those Democrats was Phil Gramm, a Democratic congressman from Texas who switched to the Republican Party in 1983.
Of course, Reagan’s victory was also the victory of that supply-side principle: that lower rates could pay for themselves, if not on paper in the early years, in growth that would provide more revenues than the old adding machines in government offices predicted—and that a business-friendly environment could produce what we came to call the “Great Moderation.”
What would have made it all easier? Frontloading the tax cuts.
In 2013, Lindsey updated his book with a new title, The Growth Experiment Revisited. Both editions, however, reveal how very close Reagan, and supply-side economics, came to wiping out in that precarious first term. Republicans today are unwilling or unable to put the work into building the kind of loyal opposition that Reagan built. That fact tightens the time pressure on the lawmakers: it’s hard to imagine a Democratic House and Senate backing a Trump tax reform in 2027. This is the price of Trump tribalism.
“Trump Plays Reagan’s Game,” read a headline back in the president’s first term, describing the 2017 tax cuts. Now, the president is attempting to play Reagan’s game again. If the bill passed is strong enough, the results can indeed be “wonderful.” But only if Trump and Speaker Johnson get a strong law through. And only if they do so in time.
Amity Shlaes chairs the Coolidge Foundation, is the author of Great Society, and is a fellow of National Review Institute. A version of this article first appeared in National Review’s “Capital Matters.”