Monday, August 14, 2006

Twenty-five years ago this month, in the early stages of what would prove to be the nation’s longest and deepest recession in the post-World War II era, sizeable bipartisan majorities in the Senate (67-8) and the House (282-95) adopted and President Reagan signed the largest tax cut in U.S. history. Senate Majority Leader Howard Baker of Tennessee called it a “riverboat gamble.” Brushing aside the bipartisan nature of the imminent vote, Rep. Dan Rostenkowski, the Democratic chairman of the House Ways and Means Committee, told his House colleagues in early August 1981: “Make no mistake about it. This is the president’s bill. It outlines a bold — and risky — economic strategy. Only time will tell whether the risks involved…were worth taking.”

The four principal features of the tax-cut bill were (1) a 25 percent across-the-board cut in income tax rates; (2) the elimination of the distinction between “earned” income (wages and salaries) and “unearned” income (interest and dividend income), whose top tax rate was reduced from 70 percent to 50 percent (even Bill Clinton did not raise the top rate above 40 percent); (3) the effective reduction of the top capital gains rate from 28 percent to 20 percent; and (4) the indexing of tax brackets and personal exemptions for inflation, beginning in 1985.

The across-the-board cuts were phased in over 1981 (5 percent), 1982 (10 percent) and 1983 (10 percent). When the final cut occurred in 1983, the U.S. economy embarked on one of its strongest expansions in history, growing at an annual compounded rate of 4.4 percent throughout the 1983-1989 period. Unemployment collapsed from 10.7 percent during the fourth quarter of 1982 to 5.4 percent during the fourth quarter of 1989. Contrary to the predictions of liberal economists, who insisted the tax cuts would be inflationary, inflation diminished from an annual average of 12.9 percent (1979-1980) to 1.1 percent in 1986 and to an average of 3.7 percent (1983-1989).

Something else collapsed by the fourth quarter of 1989: the Berlin Wall — a development that preceded the collapse of the Soviet Union by two years. To borrow a phrase from Mr. Rostenkowski: Make no mistake about it — the Berlin Wall and the Soviet Union would not have collapsed as soon as they did were it not for the resurgent American economy, which easily financed President Reagan’s military build-up, forcing the Soviet economy into de facto bankruptcy after its futile efforts to compete once the United States joined it in the arms race.

Here’s another relevant point: On the day Congress passed Mr. Reagan’s tax cuts, the Dow Jones industrial average closed at 946 and the S&P 500 closed at 131. Exactly 25 years later, the Dow closed at 11,240 and the S&P 500 settled at 1,279, reflecting increases of nearly 1,100 percent and 875 percent, respectively.

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