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What Would Reagan Do (WWRD)?

September 9th, 2010 . by economistmom

Ironically, not cut taxes as much as President Obama is proposing!

Here’s an awesome story by Jeanne Sahadi on CNN-Money, citing several tax policy experts who explain that quite contrary to Reagan’s reputation, he actually signed into law what amounted to the “largest tax increase in (peacetime) American history”–upon realizing that our country couldn’t really afford the largest tax cuts that had he put in place earlier in his Administration.  But the Reagan Administration’s tax increases were large in terms of revenue gains, not in terms of marginal tax rates, because they did it the smart way: by reforming the tax system to make the tax base broader and more efficient.  (Pssst:  they accomplished this with a good deal of bipartisanship.)

From Jeanne’s story (emphasis added):

“Reagan was certainly a tax cutter legislatively, emotionally and ideologically. But for a variety of political reasons, it was hard for him to ignore the cost of his tax cuts,” said tax historian Joseph Thorndike.

Two bills passed in 1982 and 1984 together “constituted the biggest tax increase ever enacted during peacetime,” Thorndike said.

The bills didn’t raise more revenue by hiking individual income tax rates though. Instead they did it largely through making it tougher to evade taxes, and through “base broadening” — that is, reducing various federal tax breaks and closing tax loopholes…

“What people forget about Ronald Reagan was that he very much converted to base broadening as a means of reducing deficits and as a means of tax reform,” said Eugene Steuerle, an Institute Fellow at the Urban Institute who had helped lay the groundwork for tax reform in 1986 and served as a deputy assistant Treasury secretary during Reagan’s second term.

There were other notable tax increases under Reagan.

In 1983, for example, he signed off on Social Security reform legislation that, among other things, accelerated an increase in the payroll tax rate, required that higher-income beneficiaries pay income tax on part of their benefits, and required the self-employed to pay the full payroll tax rate, rather than just the portion normally paid by employees.

The tax reform of 1986, meanwhile, wasn’t designed to increase federal tax revenue. But that didn’t mean that no one’s taxes went up. Because the reform bill eliminated or reduced many tax breaks and shelters, high-income tax filers who previously paid little ended up with bigger tax bills…

All told, the tax increases Reagan approved ended up canceling out much of the reduction in tax revenue that resulted from his 1981 legislation.

Was this a politically-easy thing to do?  Probably not, but it was at least easier for a strong leader like Reagan back then, than it would be for an equally strong leader today.  Jeanne quotes Marty Sullivan:

“By today’s standards, the Gipper would easily qualify for status as a back-stabbing, treacherous RINO [Republican in Name Only],” wrote Tax Analysts contributing editor Martin Sullivan, in an article for Tax Notes in May.

Kind of ironic how President Obama’s current position on tax policy seems more in keeping with the ideals of at least today’s Republican party than would Reagan tax policies brought forward to today.

7 Responses to “What Would Reagan Do (WWRD)?”

  1. comment number 1 by: Gipper

    Reagan and the Republicans made the dismantling of the Soviet Union their biggest priority. The wanted to spend more on Defense. The Democrats had a big majority in the House. Reagan had to deal in order to get what he wanted most.

    Now the Democrats are going to have to learn to deal in order to get deficits under control. That is if they really do care about deficits. Obama will have to pull a Reagan (and a Bush 41) and anger his base by proposing permanent cuts in entitlement spending.

    But Obama is no Reagan or Bush 41. All we’re going to hear is partisan carping how important it is to raise taxes to close the deficit without any comparable clamor for spending cuts.

  2. comment number 2 by: Jim Glass

    Reagan’s first 1981 tax cut dwarfs all other post-WW II tax cuts, scored by the Office of Tax Analysis at 2.89% of GDP annually (average for four years after enactment).

    For perspective, Bush’s two biggest tax cuts, in 2001 and 2003, were 0.71% and 0.48%.

    Two bills passed in 1982 and 1984 together “constituted the biggest tax increase ever enacted during peacetime,” Thorndike said.

    At 0.98% and 0.39%. Yes, Reagan accepted that his first tax cut was too big, and eight other tax bills during 1981-88 on net increased taxes by 1.94% of GDP.

    That left all the 1981-8 tax laws cutting taxes by 0.95% of GDP — still a significant cut overall, but not the heroic amount he often is credited with.

    In contrast, while Bush II’s biggest tax cuts were nowhere near as big as Reagan’s big one, during in 2001-8 there where six tax acts, all cuts, totalling 1.73% of GDP, near twice Reagan’s net.

    OTOH, Reagan’s tax cut was enacted in a time of much bigger deficits than Bush’s. Deficits averaged 4.13% of GDP from 1981-8, 1.97% from 2001-8.

    “What people forget about Ronald Reagan was that he very much converted to base broadening as a means of reducing deficits and as a means of tax reform,” said Eugene Steuerle

    Yes, indeed! TRA’ 86 was a major bipartisan achievement, as the right gave up all kinds of special breaks and tax shelters and the left gave up high tax bracket rates. Combined the US emerged with a much lower-rate, almost no tax shelter, more efficient, less deadweight cost tax system.

    The whole developed world — from Sweden on — followed this example, moving in the same direction afterward. Except the US, which has been regressing back to the old ways ever since.

    In 1983, for example, he signed off on Social Security reform legislation that, among other things … required that higher-income beneficiaries pay income tax on part of their benefits

    Note that this was a means-tested benefit cut disguised to look like an income tax increase. The key is that this “income tax” isn’t remitted to the Treasury as general revenue as income tax is, but goes back to the SSA to pay other retirees’ benefits. It is a net benefit reduction that increases with income.

    And as the floor income level at which this “tax” applies isn’t indexed to inflation, this means-tested benefit reduction has increased year-after-year (just as the AMT would if not “patched” annually) since enacted in 1983, and applies to lower-income retirees year after year. Yet nobody notices! Even though it is huge today compared to the 1980s. A heck of an effective disguise! It shows that how things are framed really matters.

    “By today’s standards, the Gipper would easily qualify for status as a back-stabbing, treacherous RINO [Republican in Name Only],”

    In some ways yes, though Reagan had previously darn convincingly established his Repub credentials, enabling him to engage in some “Nixon goes to China” moments, including in areas far removed from taxes.

    But remember his tax bottom line:

    * Reagan on net cut income taxes by 1.16% of GDP (that’s not counting the SS payroll tax increase).

    * Reagan and Tip closed the entitlement funding crisis of their day, SS’s imminent insolvency, with a deal that was near exactly 50% tax increases and 50% benefit cuts.

    If we could do the same thing today — close our exploding entitlement funding gap with a deal that’s 50% tax increase, 50% benefit cut — while reducing the tax cost of the rest of the government, our fiscal future would look a lot more bright and shining than it does now.

  3. comment number 3 by: AMTbuff

    The problem with any benefit cut deal is durability. Social Security benefits could be cut by changing formulas. Health care benefit cuts require rationing, which cannot be durably governed by formula. Only eliminating third-party payment of health care expenses has a chance of closing the gap, and progressives will never accept that. They’ll instead continue a sham system of publicly funded medical care to match today’s sham education provided by public schools. Unfortunately public health care will face the same cost explosion as public education, despite its grossly inferior quality.

    Consider: would anyone trust a deal for escalating funding cuts for government-run schools? Of course not. The same lack of credibility applies to any deal to rein in health care costs as long as the government remains the payer.

    From any angle, the only way out appears to be default or hyperinflation, followed by the forced drastic shrinkage of the safety net. It’s going to be very bad for those who were counting on larger benefits from government.

  4. comment number 4 by: VAT Brat

    Jim,

    Well said. 50% tax increase and 50% entitlement cuts. I’ve not heard a single Democrat even propose a 10% entitlement cut. Not even the venerable Stenny Hoyer. However, Republicans are expected to show statemanship and come up with 100% tax increases to cover the deficit.

    Oh well, I forgot about Defense spending cuts. I guess Democrats are all for those. But aside from that, what have they got?

    Here’s a challenge, Economistmom! Over the next 15 years, look at the cumulative debt increase and propose your best suggestion for cutting spending by half that amount. Then ask Greg Mankiw and Keith Hennsessey to come up with increasing taxes to increase revenues by 50% of that projected increase in debt.

    Now that would be something wonderful that could attract some real media attention. I’m sorry, but that Concord Coalition Road/Petersen Foundation tour is pretty pathetic. Let’s get some concrete solutions with concrete numbers on the board!

  5. comment number 5 by: SteveinCH

    This is quite easy to do actually.

    The tax side is simply allowing the Bush and Obama tax cuts to expire and cutting industry specific provisions in the corporate tax code.

    On the spending side, means test all transfer payments, cut defense by $100 billion, and hold the rest of spending constant in nominal terms.

    Do that and you balance the budget within 5 or 6 years.

  6. comment number 6 by: VAT Brat

    SteveinCH,

    I think means testing transfer payments is the way to go. Treat Social Security and Medicare as safety nets, not as substitutes for personal responsibility for one’s retirement. Unfortunately, means testing will be rabidly opposed by Democrats…..

    And here is where we’ll need to see some leadership from 2 quarters.

    First, from Obama. Nixon went to China. Bush 41 repudiated his no-new taxes pledge. Clinton refused to veto the abolition of federal welfare programs. Now Obama is going to have to read the riot act to his base and explain that we cannot afford the New Deal and Great Society anymore. It’s a painful admission, but the Republicans will also have to absorb pain when they tell their base that tax increases are the responsible course of action. It’s the President’s job to lead, not follow, in this great challenge.

    Second, we’re going to have to see economists at think tanks (that includes Economistmom) actually make means testing a responsible and necessary policy prescription with the same vigor they’ve demanded the scheduled income tax increases to occur. It should be a litmus test for anymore seriously claiming to be a deficit hawk.

    I’d go even further and recommend abolition of Schedule A deductions for state income taxes, mortgage interest, and make employer provided health care a taxable benefit. Eliminating those provisions make it possible to let tax rates increase less.

    However, none of this gets done until Obama takes the lead. I’m appalled that more so-called deficit hawks like Bartlett and Rogers haven’t berated Obama for his cowardice, failure to lead, and outsourcing of the challenge to a National Commission.

  7. comment number 7 by: AMTbuff

    VATBrat, those are indeed the correct ingredients. To enact them would require either superhuman leadership (which Obama could have exerted if he had acted in January 2009) or plain old dictatorship. After the government loses its ability to borrow, these steps and more will happen out of necessity. Let’s hope they are not accompanied by loss of our democratic government.

    I’ll add more elements to your list: Explicit cutoff of government funding for health care procedures that will cost too much per year of life saved. Medicare and Medicaid should be explicitly second-rate health care, a last resort rather than the first choice.

    Unrealized capital gains should be taxed annually. Defer payment of the tax if you want, but you will owe interest on the deferred amount. You can choose not to compute the gain annually, in which case the interest portion of your liability will be computed in the year of sale, assuming uniform appreciation over the holding period.

    With these major program cuts and base broadening, tax rates might actually decrease, limiting the economic damage of higher tax revenues.