The Reaganomics Tax Argument

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In his Farewell Address to the Nation on January 12, 1989, entitled “Believe in Ourselves and the Future Will Be Ours,” [1] President Reagan said this with respect to his economic policies:

“[F]rom the recession of ’81 and ’82 to the expansion that began in late ’82 and continues to this day, we’ve made a difference. * * *  In [1981], we began the actions we felt would ignite an economic comeback: Cut taxes and regulation, started to cut spending.  Soon the recovery began.”

Cut taxes, cut spending, and cut regulation.  Reagan undertook briefly to explain the economic rationale for this approach:

“They called it the Reagan Revolution, and I’ll accept that, but for me it always seemed more like the Great Rediscovery: a rediscovery of our values and our common sense.  Common sense told us that when you put a big tax on something, the people will produce less of it. So we cut the people’s tax rates, and the people produced more than ever before.”

The Incentive to Work

Reagan’s notion that when government cuts taxes, people produce more really does not make intuitive sense. Unless there is a tendency for people to reduce the amount they work when their income taxes are increased, we cannot expect lowering income taxes to result in more productivity or work.  People with full-time jobs or more than one job, in the middle class or below, presumably work as hard as they can or need to make as much as they can, especially in a recession.  The argument that people will work harder if they can keep a higher percentage of their pay implies that they are not already working as hard as they can.  Does mean that if you increase people’s taxes, lowering their take-home pay, they will slack off even more?

Logic forces the conclusion that the tax rate on earned income really has no bearing on how hard people will work and the amount of work product they provide.  This is a red herring.  After-tax income does, however, have an effect on how much money people will spend, and that does have an effect on demand and economic activity. (See the separate discussion of Keynesian economics.)

The Supply-Side Argument

The more typical Reaganomics argument is that tax cuts for wealthy people and corporations will result in jobs and growth because: (a) they will invest more; and (b) their investments will contribute to economic growth.  This “supply-side” argument actually defies common sense.  People who save a portion of after-tax earnings typically invest in securities, and the substantial additional savings resulting from a big tax cut for wealthy people would likely bid up prices in securities markets.  But how might such increased saving lead, per the Reaganomics argument, to more investment in production and more jobs?

Reducing personal income taxes for the rich might improve the terms on which firms can raise capital.  Investment decisions, however, depend on much more than the cost of capital.  Firms are expected to invest in capital expansion only when they expect to make a profit.  What this supply-side argument ignores – and this is its fundamental flaw – is that decisions to invest in a market economy are driven by demand-side considerations. In a recession, when demand is down, the expectation that additional investment will be profitable is especially low.  Further investment therefore awaits the recovery of sufficient expected demand. In short, the level of taxes on wealthy people’s personal income essentially has no bearing on the amount or timing of economic investment.  Nothing much has ever tickled down.

Reaganomics, in fact, is the exact opposite of how the economy actually works:  The Keynesian prescription for stimulus is tax cuts or government deficit spending for people with low incomes who will spend the money, stimulating economic activity and growth, not for the wealthy people who save most of the additional wealth taking money out of circulation.

The short answer to the claim that lowering taxes for the rich increases prosperity rather than simply making them richer is that what they do to increase their wealth through market activities extracts wealth from the rest of the economy.  When they are able to gain market control through monopoly power, corporations use that power to suppress wages and jobs and control prices, all in the interest of maximizing profits.  That’s how the rich get richer.

Ironically, they could gain more wealth in the long run, by paying more taxes, stimulating economic growth, and taking their share of the additional growth.  That is what happened from 1946 to 1980.  In this way they get a smaller piece of a larger pie.

The Last 30 Years

The economic history of the last 30 years dramatically proves the point. What hasn’t trickled down has, in fact, stayed up.  The massive tax reductions for the wealthiest Americans have caused increased inequality of incomes and wealth.  The tax cuts allow the wealthy to retain their growing wealth, locking down wealth transfers from below gained through economic activity.

Reaganomics on steroids, over the last 30 years, has shifted the tax burden so drastically away from the rich and onto everyone else that the inequality has gotten totally out of control.  Other corporate advantages built into the Reagan Revolution, like the discontinuance of anti-trust regulation or the maintenance of huge government business subsidies, also contributed greatly to excessive inequality.

As a result, unimaginable amounts of wealth have been concentrated in the hands of a very small number of people.  For example, today the top 400 households hold as much wealth as the entire bottom half of the American population, 155,000,000 people. 

Meanwhile, the American consumer economy, within which the lower 99% lives and functions, has drastically shrunk to less than 70% of what it would have been, and is now on the verge of a depression.

The tragic thing is that the economy, never properly stimulated over these 30 years, has never grown like it should have.  And the public debt that served to finance the tax cuts for the wealthy elite and their accumulation of wealth, is so high (now over $14 trillion), that traditional Keynesian fiscal measures designed to stimulate jobs and growth, even if they weren’t blocked politically by the right, don’t have much wiggle-room.  The United States is essentially bankrupt.

In these tragic circumstances, unfortunately, the Reaganomics “trickle-down” idea is still constantly pressed today as an article of ideological faith, to rationalize GOP federal and state budget proposals which reward wealthy people and corporations with still more wealth, while adding still more reductions in the jobs, incomes, and benefits of working people.

These very working people were likely swayed by this deception when they voted for their own demise in the November 2010 elections.  But in this process of both cutting programs and jobs for ordinary people and lowering or preserving already lowered taxes for the wealthy and corporations, the Reaganomics argument actually becomes absurd.  The argument, in effect, becomes: “We must cut jobs in order to create jobs.”

Now that they are better able to see how Reaganomics plays out in practice, people can more easily recognize it as a gimmick to rationalize the transfer of wealth to the top, and they are starting to fight back.

Deja Vu

To be clear, we are not arguing against any wealth and income inequality.  But inequality that drives the economy into a depression, as it did in 1929, is obviously excessive.  John Maynard Keynes, writing in the middle of the Great Depression, had it exactly right:

“For my own part, I believe that there is social and psychological justification for significant inequalities of incomes and wealth, but not for such large disparities as exist today.  There are valuable human activities which require the motive of money-making and the environment of private wealth-ownership for their full fruition.  Moreover, dangerous human proclivities can be canalized into comparatively harmless channels by the existence of opportunities for money-making and private wealth, which, if they cannot be satisfied in this way, may find their outlet in cruelty, the reckless pursuit of personal power and authority, and other forms of self-aggrandisement. It is better that a man should tyrannise over his bank balance than over his fellow-citizens. * * * [I]t is not necessary for the stimulation of these activities and the satisfaction of these proclivities that the game should be played for such high stakes as at present.  Much lower stakes will serve the purpose equally well, as soon as the players are accustomed to them.” [2]

JMH – 4/8/11


[1] The New York Times, 1/12/89. 

[2] John Maynard Keynes, The General Theory of Employment, Interest, and Money, first printing 1935, Harvest/Harcourt, Inc., 1953, 1964 ed., 1991 printing, p. 374.

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This entry was posted in Econ 101, Economics, Reaganomics. Bookmark the permalink.

One Response to The Reaganomics Tax Argument

  1. Edward Hacker says:

    A very clear refutation of the trickle down theory: reduce taxes to the wealthy, increase their wealth, and hope that in some way it trickles down to the middle-class and to the poor. The economic history of this country proves just the opposite.

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