Reaganomics Research Paper

Incentive Effects of Taxes on Income From Capital: Alternative Policies in the 1980's

Don Fullerton, Yolanda K. Henderson

NBER Working Paper No. 1262 (Also Reprint No. r0581)
Issued in 1984
NBER Program(s):Public Economics

In this paper, we evaluate existing tax law as of 1980, President Reagan's tax reform initiatives as enacted in the Economic Recovery Tax Act of 1981 (ERTA) and the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), as well as other proposals that were not enacted. For each law, we measure marginal effective total tax rates for capital in the corporate sector, the noncorporate sector, and the owner-occupied housing sector. These rates include taxation under the corporate income tax, the personal income tax, and property taxes, in order to capture the full distortion of individuals' choices between present and future consumption as well as the distortions in the choice of investment. Effective tax rates in 1980 were perceived as high in the corporate sector, at least partly because of inflation, and especially when compared to the tax-free treatment of imputed rents from owner-occupied housing. In contrast, we find that (1) the total effective tax rate in the corporate sector was only 35 percent, about half of the rate in some previous estimates; (2) the total effective tax in the noncorporate sector was 36 percent, higher than in the corporate sector; (3) the total effective tax in owner-occupied housing was 19 percent, because of a higher relative property tax rate; and (4) under either 1980 or 1982 law, the marginal effective total tax rate does not rise with inflation in any sector or for the economy as a whole. By 1982 the rate in the corporate sector fell to 30 percent, by more than in other sectors.

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Document Object Identifier (DOI): 10.3386/w1262

Published: Sawhill, Charles R. and Isabel V. Hulten (eds.) The Legacy of Reaganomics: Prospects for Long-Term Growth. University Press of America, 1984.

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Executive Summary

Bob Dole’s proposal for a 15 percent income tax cut has reignited the long-standing debate about the economic impact of Reaganomics in the 1980s. This study assesses the Reagan supply-side policies by comparing the nation’s economic performance in the Reagan years (1981-89) with its performance in the immediately preceding Ford-Carter years (1974-81) and in the Bush-Clinton years that followed (1989-95).

On 8 of the 10 key economic variables examined, the American economy performed better during the Reagan years than during the pre- and post-Reagan years.

  • Real economic growth averaged 3.2 percent during the Reagan years versus 2.8 percent during the Ford-Carter years and 2.1 percent during the Bush-Clinton years.

  • Real median family income grew by $4,000 during the Reagan period after experiencing no growth in the pre-Reagan years; it experienced a loss of almost $1,500 in the post-Reagan years.

  • Interest rates, inflation, and unemployment fell faster under Reagan than they did immediately before or after his presidency.

  • The only economic variable that was worse in the Reagan period than in both the pre- and post-Reagan years was the savings rate, which fell rapidly in the 1980s. The productivity rate was higher in the pre-Reagan years but much lower in the post-Reagan years.

This study also exposes 12 fables of Reaganomics, such as that the rich got richer and the poor got poorer, the Reagan tax cuts caused the deficit to explode, and Bill Clinton’s economic record has been better than Reagan’s.

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