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Reagan’s Legacy

From Arthur Laffer: The Reagan Tax Cuts Did Too Pay For Themselves

reagan transformationDuring the Reagan years, “federal income taxes” as a percentage of GDP went from 9.1% in 1981 to 8% in 1989. And to James Pethokoukis of the American Enterprise Institute and others, this means the “Reagan tax cuts didn’t pay for themselves.”

But wait. Income tax revenues from the top 1% of income earners rose like mad as a share of GDP. In 1981, the top 1% of income tax filers paid total income taxes equal to 1.5% of GDP. In 1989, the top 1% paid a full 2% of GDP in income taxes. From 1981 to 1989, the highest marginal income tax rate, which is the rate paid by the highest income earners, fell from 70% to 28%.

Think about it: The highest income tax rate paid by the top 1% of income earners fell by 60% (from 70% to 28%), yet the top 1% of income earners paid 33% more in income taxes as a share of GDP.

From 1981 to 1989, total employment as a share of the adult population rose by 4 percentage points, which, in human terms, is an additional 7.4 million people employed above and beyond the number of people who would have been employed if employment as a share of population had remained at the 1981 level.

These people got their jobs because employers and job creators found hiring them more attractive in part because of the tax cuts.

Additional employment, of course, raises payroll and income taxes. For payroll taxes alone, the higher employment added $14 billion in taxes annually. For income taxes, there would be an equally as large increase in tax revenues.

These are huge increases in taxes because of the income tax cuts, but they don’t change taxes as a percentage of GDP because both tax revenues and GDP rise, yet they are real, real, real, even if there isn’t a change in the percentage.

And then, of course, we’d have to add in increased tax revenues from sales taxes, excise taxes and state and local taxes resulting from so many more people working, spending and earning higher incomes.

Let’s not forget that there was also a lot more spending from the highest income earners creating jobs and sales tax revenues. State and local tax revenue increases were huge during this period because tax rates changed little but GDP soared, as the chart below shows.

And then, of course, government budgets benefit directly from the reduction in welfare subsidies, social security outlays and unemployment benefits, yada, yada, yada — all due to the tax cuts. Reagan’s income tax cuts affected income taxes for some, but also revenues from a lot of other taxes as well as spending.