A Taxing Lesson Forgotten, On Both Sides of the Pond

PM Margaret Thatcher & US Pres. Ronald Reagan

In the U.S., there is a constant battle going on between the right and the left over the optimal level of taxes. Those on the left want to raise taxes, claiming that raising taxes will increase government revenue, thus allowing them to spend more on services. Those on the right want to lower taxes, while also cutting spending, to get the U.S. fiscal house in order.

And with the UK finding itself in dire financial straits, or as reported in the press, skint broke, this debate is raging in both of my countries.

And I believe both sides of the political spectrum are missing the boat.

My suggestion, as it is in many issues we face today as a people, is look to history for examples of what has worked. And then try today what they tried back then, and see if we get the same results. We see too often today’s governments repeating practices of the past that failed, and then everyone is shocked when they fail again. And it seems more and more rare to find a government today that is willing to adopt the past policies and practices that succeeded in building economic vitality, extended freedom and opportunity, reduced bureaucracy, and drove growth that benefited all levels of society.

And the most recent example began 31 years ago, in the U.S., in 1981.

Set against the backdrop of record inflation in the 1970s and real economic growth from 1973 to 1982 averaging only 1.6 percent, newly-elected U.S. President Ronald Reagan instituted policies that were derided at the time by the opposition and the press, but that were completely in line with basic economic theory.

Reagan reduced taxes, reduced spending, reduced regulation, and reduced inflation, beginning in 1981. And for two years, this policy caused considerable pain and a steep recession. And then, as expected, things took off.

The economic boom lasted from November 1982 to July 1990, the longest period of sustained growth in peacetime in U.S. history, and the second-longest period of sustained growth in U.S. history ever. The U.S. economy grew by one-third. Average annual growth was 3.5 percent. And it was a boom that impacted all levels.

Across the board, income tax rates were cut, benefiting every person in the U.S., regardless of their level of income.

Groups Based on % of Total Income

Tax Rate Reduction

Top 20% of earners

35%

60-80%

44%

40-60%

46%

20-40%

64%

Lowest 20% of earners

263%

And what was the result. You might think that reducing taxes and enabling people to keep more of their hard earned income would cause less revenue for the government and cause those who were relying on government services to take the hit. That’s at least what you hear today. However, economics and the hard evidence from the 80s, indicates the complete opposite.

Total government revenues were at $517 billion in 1980. By 1990, revenues had reached $1 trillion. And those revenues from income taxes, at much lower rates, climbed from $244 billion in 1980, to $467 billion in 1990. If you figure in inflation, which reduces the value of a dollar each year, revenue increased 28 percent.

Yes, taxes went down, inflation went down, spending went down, and revenue increased!

Why? To put it simply, people don’t make money just to save it for retirement. They invest it. They spend it. And when they have more of it, they use it. And by using it, demand for goods and services goes up, companies have to hire more people, and companies and people make money. And when companies and people make more money, they pay taxes. And if they make enough additional money, even at a lower tax rate they end up paying more to the government.

Basically, the economic growth spurred on by reduced governmental burdens, caused incomes to rise so that the costs of the cuts were very quickly overwhelmed by the increases in revenue due to increased spending and investment by citizens and businesses.

Yes, it was painful for two years. Then it was good for many more.

Both the US and UK governments should take note. And then decide whether what they are more interested in. Either the long-term focus on the health of the economy and the improvement of citizen’s lives, or the short-term focus on their next election and their hold on power.

I would suggest the former, as when it is done right, the latter is their reward.

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