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How Reagans Tax Policies Created Today’s Income Inequality.

by on June 3, 2014

Ronald Reagan is often portrayed as a great “free market” President, who ushered in an era of lower taxes and smaller government that would make Ayn Rand proud, and according to theory would lead to a very robust middle class. While it is true that lower taxes will improve an economy if those taxes are reduced for the classes that spend the most, it is also true that if you increase those taxes on the spending classes they will have reduced incomes. That is a simple accounting identity, that when someone is taxed more they will have less money, that idea shouldn’t be tested.

During Reagan’s tenure unemployment started off at 7.5%, briefly increased to 10.8%, and by the time he left office it had dropped down to a decent level of 5.4%. Thus if you measure an economy based solely on unemployment levels then you would have to give Reagan a passing grade here. But if you only judge based on unemployment then you have to also give the same credit to Obama as he has seen a very similar drop in unemployment in his 6 years. But please don’t take this as an endorsement from me on Obama’s economic policies here, as that is not the point I am trying to make. Both Obama’s and Reagans unemployment rates history is pretty typical of any economy after it recovers from a recession.

The point that I am going to make here will be similar to Picketty’s point on wealth inequality, but I am going to use income inequality, something that is more tangible and measurable to the average Joe.

Income Inequality

There are certain things to look at in this graph that illicit information:

  • In 1971, after the collapse of the Bretton Woods system, there was an actual gain in national income for the labor class.
  • A few years later in 1973, there was then a temporary reduction in national income that was likely due to the 1973 oil crisis that led to a period of stagflation
  • As national income started to correct itself after the oil crisis, another recession hit, which caused another temporary reduction, and flat lined for a year or two.
  • Then in 1982 we see where national income went on a trajectory where it would reduce on a relatively constant basis for years to come.

So why, in 1982, did we see this destruction in the balance of national income?

In 1981 Reagan passed the Economic Recovery Tax Act, which reduced income taxes of the top bracket from 70% to 50%, so naturally when you reduce the amount of taxes by 20%, you are going to see the top bracket capture a higher percentage of income.  The lowest income tax bracket only saw a reduction in taxes from 14% to 11%.   So naturally math is going to win out here and the top tax bracket is going to start gaining more and more income as they tend to have the majority of income in this country, and they saw a much larger percentage decrease.

After ERTA had been enacted for a year, there was another tax act that passed called the  Tax Equity and Fiscal Responsibility Act.  This tax act caused even further damage to the ability for the labor class to capture more national income.  The major tax changes that did this was an increase in the gasoline tax and cigarette tax, and an increase in the portion of taxes paid into federal unemployment by businesses.  So while the lower classes saw a reduction in their income taxes they received larger taxes for driving and smoking, and a possible block of wage increases because their employers now had to pay more taxes for employing them.

There are of course the arguments that tax policies aren’t the only drivers to this income divergence, to which I agree with.  But things like trade liberalization policies, and technological advancements eliminating jobs had already been happening before these tax changes and the American economy still adapted.  There is also evidence in other countries that have the same technology, similar trade policies, that didn’t see the same changes in national income.

A former Reagan advisor, Bruce Bartlett, later claimed that this tax cost Americans $37.5 billion per year, which at the time, was 1% of U.S. GDP.  And Sheldon Richman called it the largest tax increase in american history.  So why is he still considered a great economic President from his followers?  The evidence is in, he was the greatest culprit to today’s income inequality.

Reagan image is from the talented Jason Seiler.

  1. ebrew79 permalink

    People like Arthur Laffer are the most terrible individuals on the planet. Knowingly devising a plan that would hurt the most vulnerable from an economic standpoint without any sort of concern is as callous as anything imaginable, and the sad thing is it’s continued for the last 30 plus years!

  2. Ian JobCreator Goodfriend permalink

    Good synthesis of events leading up to the big changes in the early 1980’s. often, those who exalt Reagan’s economic policies only mention one aspect (the top rate cut from 70 to 50 percent) and neglect to mention what happened to taxpayers in other brackets. Your inclusion of events in the 70’s also help to explain the “mystery” of that decade (many look back on the 70’s as the last period of growth for the working class, while others point to the 70’s as the start of the decline for the working class) – your research shows that the events of the 70’s led to the decade becoming a decade of extremes that some remember favorably and others remember less than favorably.

  3. Awesome content, thank You !!

  4. The reason for unemployment under Barack Obama was due to his policies.

    • He inherited high unemployment levels and left with almost record low unemployment levels. What are you referring to here exactly?

  5. The fact that the numbers are fudged to make Barack Obama look good. 93, 000,000 people out of the labor force under his administration-yeah, that’s a reduction of the unemployment rate. Pardon the sarcasm, however, that is a sizeable number.

    • The unemployment rate specifically discludes certain groups of people because they are not looking for work. So it only measures people looking for work.

      That 93 million number is used to scare people and to make them think things are bad when they aren’t.
      It includes every American of retirement age — 65 and older. It includes every high-school student at least 16 years of age. It includes every college and many graduate or professional-school students. It includes every person who has a disability that makes it impossible for them to work. It includes parents who are choosing to stay home to take care of their kids. It includes every adult who’s gone back to school full-time. It even includes trust-fund kids who are living off investments.

  6. Jp Hochbaum, you’re getting bad information.

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