The Surprising Truth About Reagan’s Tax Cut

It widened the deficit—not by cutting the top rate, but purely by relieving families from automatic increases through bracket creep

By Phil Gramm and Michael Solon. Excerpts:

"Since the top 40% of income earners in America pay some 90% of income taxes, reductions in tax rates would be expected to give a larger dollar-value tax cut to people who pay the most taxes. But data from both the Internal Revenue Service and the Joint Committee on Taxation show that when Reagan took office in 1981, the top fifth of income earners paid 64% of all federal income tax, the next-highest fifth paid 21%, and the bottom three-fifths paid 15%."

"By 1985, the 1981 tax cuts, including inflation indexing of the tax brackets, had been fully implemented. The share of the individual income-tax burden had increased to 67% for the top fifth and dropped to 19% for the next fifth and 14% for the bottom 60%. By 1988, Reagan’s last year in office (and after the 1986 tax reforms), the figures were 71%, 17% and 12%.

Incredibly, by 2022, the top fifth paid 88% of income taxes, the next fifth 13% and the middle fifth 4%. That adds up to 105%, but the arithmetic works because the bottom 40% received checks from the Treasury thanks to refundable credits like the earned-income tax credit, on net paying them a total of 5% of all income-tax collections."

"Federal revenue as a share of gross domestic product grew twice as fast from 1973 through 1980 as it had grown to that point in the postwar period—reaching 19.1% in 1980, a peacetime record. Bracket creep had become bracket gallop."

"In the 1970s inflation-adjusted social welfare spending—entitlements and means-tested welfare programs—nearly tripled, but much of the cost never showed up in the federal deficit."

"both political parties supported major tax cuts in 1981"

"When inflation plunged to 3.2% in 1983, a year for which CBO had projected a 9% inflation rate, bracket-creep revenues collapsed and the deficit soared to 5.9% of GDP. By 1985 income-tax rates had been cut by a quarter, and the tax brackets had been indexed to eliminate bracket creep. The economy was in its third year of rapid growth."

"The day Reagan left office, the American economy was one-third bigger than when he arrived. Tax rates had been cut and tax brackets indexed to eliminate bracket creep. Nondefense spending was 2.5% of GDP less than it had been the day Reagan took office, and defense spending was 0.9% bigger."

"the entire increase in the deficit during the Reagan presidency resulted from the abolition of bracket creep which by definition doesn’t help anyone rich enough to be already paying the top rate"

"Even though the level of general prosperity has improved dramatically since 1988, sending real per capita income up by 80%, real means-tested welfare spending has more than quadrupled" 

Tariffs as Fiscal Policy

From Jeffrey Miron.

"President Trump has claimed his tariffs will raise enough revenue to allow for income tax cuts.

Recent research, however, finds that even at optimal tariff rates, these tariffs

would raise an amount less than one-fifth of federal income tax revenue … generat[ing] efficiency losses nearly equal to the revenue raised.

Tariffs are also

regressive … [and] today’s tariffs are particularly high, variable, and uncertain. This raises compliance costs, reduces investment, creates serious tax administration problems, and encourages corruption and wasteful lobbying efforts.

Lastly, while tariffs do reduce imports, they also reduce exports and invite retaliatory tariffs, which in turn harm US manufacturers.

Tariffs are a blunt instrument that—even without the current volatility, but even more with it—cause efficiency losses, increase compliance costs, and harm the industries they allegedly help."

The ObamaCare Blue-City Bailout

Federal taxpayers pay as municipalities save billions by dumping their retirees onto the government exchanges

By Allysia Finley. Excerpts:

"Mr. Emanuel dumped his city’s retirees onto the nascent ObamaCare exchanges, where federal subsidies can reduce premium payments. Voilà, Chicago’s $2.1 billion unfunded retiree healthcare liability vanished. Now U.S. taxpayers pick up the tab for Chicago’s retirees in their 50s and early 60s."

"Detroit, Stockton, Calif., and San Bernardino, Calif., also saved billions by shifting pre-Medicare retirees to ObamaCare when they filed for Chapter 9 bankruptcy in the 2010s."

"Democrats in Congress, who are refusing to reopen the government unless Republicans agree to extend the pandemic-era ObamaCare subsidies that are set to expire at the end of the year. The news is filled with stories of people who will have to pay modestly more for their insurance, never mind that the feds would still pick up roughly 80% of the cost for a typical plan."

"few governments have set aside money to pay for their retirees’ future healthcare costs. The Reason Foundation reports that state and local governments faced $958 billion in retiree medical obligations in 2023, about $2,900 per American. The liabilities are largest in blue states"

"The sweetened ObamaCare subsidies, however, can slash premium payments for retirees with bigger pensions." 

Newsom Falls for the ‘Red Moocher State’ Myth

A simplistic look at federal finances gives the false impression that blue states subsidize everyone else

By Steven Malanga. He is senior editor at City Journal and senior fellow at the Manhattan Institute. Excerpts:

"Some of the biggest categories of “spending” aren’t discretionary programs that help finance state budgets, but cash sent by Washington to people and businesses that earned it. That California and other states come up short in receiving this money can be a function of their own failings rather than any funding bias."

"The biggest category these studies measure is direct payments from the federal government to individuals, principally via Social Security and government employee pensions. A big chunk is money that people have worked for and that the feds send them where they retire."

"Only 16% of California’s population is over 65."

"California is one of the most expensive places to retire."

"Federal contracting dollars constitute another huge spending category. This is money that businesses and other private entities earn for work performed for the government—especially for national defense—not money Washington disperses based on a state’s population or tax “contributions.”"

"California does quite well is in receipt of federal grants, some of which clearly represent spending that bolsters state budgets."

"In the 2024 balance-of-payments study, California received 18% more per capita than the average among states."

"California and New York, home to high-flying industries like technology and finance, send more on average because residents earn more"

"The difference is exacerbated by the progressive nature of federal taxes"

"Moynihan . . . realized there was little to be done to change the payment imbalances because of the complexity of federal funding." 

"he proposed in his 1999 report a “grand compromise” between the parties to pare spending and taxes by Washington and leave more money in the states."  

Here's What Would Happen If We Seized All the Wealth From America's 800 Billionaires

Don't comfort yourself with wishful thinking that millionaires and billionaires could take the entire burden of the deficit off our hands

By Jessica Riedl of the Manhattan Institute. Excerpts:

"Let's begin with an extreme example. America has about 800 billionaires. Imagine we seized every single dollar of their wealth—every home, property, business, investment, car, and yacht, right down to their kids' teddy bears—and sold it all for full market value.

That would raise enough revenue to finance the federal government for 9 months. Not 9 months out of every year: 9 months one time. Then, with no billionaires left to pillage, it's gone—as is your 401(k), because most of that wealth would've been liquidated out of the stock market.

Even taxing million-dollar earners at 100 percent marginal tax rates wouldn't balance the long-term budget. Not even if each of those taxpayers would keep working for zero net pay (and they would not).

Only slightly more realistically, imagine that President Bernie Sanders gets to implement his dream tax proposal: federal income tax rates as high as 52 percent, an uncapped 15.3 percent payroll tax on all wages, and capital gains tax rates of 62 percent—plus the state tax rates on top of those. Sanders also proposed hitting corporations with a world-leading 35 percent corporate tax rate that includes all multinational income, a wealth tax rate as high as 8 percent, an estate tax rate as high as 77 percent, new financial transaction taxes, and several other surtaxes.

Sanders' tax proposal would set marginal income, capital gains, business, wealth, and estate tax rates at their highest levels in the developed world. Total new revenues: approximately 1.5 percent of GDP, after accounting for losses to dampened economic growth. That is a lot of money. But it's not enough to close more than a fraction of a current-policy budget deficit heading toward 8 percent of GDP in the next decade. And even those revenue figures implausibly assume that people and corporations would continue working, saving, and investing despite combined federal and state marginal tax rates on labor and investment that would approach 80 to 100 percent.

Two years ago, I ran a model that set every upper-income and corporate tax policy at its revenue-maximizing level without regard to economic damage. It showed roughly 1.5 percent of GDP in new revenues and much slower economic growth. This is not a good tradeoff for an economy. The mathematical reality is that there just aren't enough millionaires, billionaires, and undertaxed corporations to close a 30-year budget deficit of between $115 trillion and $180 trillion, depending on the baseline we use. It is not possible to finance annual deficits heading to $4 trillion in a decade and 14 percent of GDP over the next 30 years on the backs of corporations and only 5 percent of American families. There just are not enough super-rich people to pay for the other 300 million of us. And most of the available tax base resides in that large middle class.

Few Americans understand that our tax code is already extraordinarily progressive—more so than any other nation in the Organisation for Economic Co-operation and Development (OECD). And it's grown radically more progressive over the past 40 years. The top-earning 20 percent now pays 69 percent of all federal taxes, and the top 1 percent currently pays 25 percent of all federal taxes.

By contrast, the bottom-earning 60 percent of Americans—that's 3 out of 5 taxpayers—pay just 13 percent of total federal taxes, including a combined negative income tax.

Last year the federal government funded 263 days of spending by taxes instead of borrowing. Of that, the top-earning 20 percent funded the government for 201 days, or nearly 7 months. The next 20 percent funded 41 days. And the bottom-earning 60 percent of Americans—which means most of the U.S. population including the median-earners—funded the federal government for just 21 days of the year.

That level of tax progressivity might not be a bad thing. But most of the nation's total income comes from families earning under $400,000. And their dramatically lower current tax rates mean that the large majority of the available remaining tax base resides within the tens of millions of these families. No one likes the idea of raising middle-class taxes, but there's only so much revenue to raise from the wealthy, even at exorbitant tax rates.

Advocates of dramatic tax-the-rich policies often claim enormous potential revenues by invoking: 1) the 1950s income-tax brackets exceeding 90 percent; 2) European tax systems; and 3) corporations that paid little to no taxes last year. The reality is different. 

Those 91 percent income tax rates from the 1950s averaged only 7.2 percent of GDP in federal income tax revenues. As the top tax bracket fell to 70 percent in the 1960s and 1970s, income tax revenues actually rose to around 7.8 percent of GDP. And in the time since all the dramatic reductions of the top income tax rates starting in 1981, federal income tax revenues have averaged 8.1 percent of GDP. So Washington collects more income tax revenues as a share of GDP today with a top tax bracket of 37 percent than it collected in the 1950s with a 91 percent tax bracket. In fact, since 1950 the correlation between the highest income tax bracket and revenues as a share of the economy is -0.25 percent, meaning that higher top tax rates are correlated with lower income tax revenues.

How can eras with higher top tax brackets bring in less overall tax revenue? Because the highest income tax brackets don't tell us much about the total income tax revenues. What matters more are the income thresholds for every tax bracket, the amount of tax preferences and tax deductions, whether the tax system encourages tax avoidance and tax evasion, and—most importantly—broader economic growth rates. Those dials can produce more tax revenues than merely raising upper-income tax rates on a small number of taxpayers.

In fact, almost no one actually paid those old 91 percent tax rates, which kicked in at today's equivalent of a $4.1 million annual income. In 1961, that was only 446 families, and it raised just 0.1 percent of all income tax revenues. Moreover, all of the tax brackets between 52 percent and 91 percent collectively produced just 1 percent more income tax revenue than if we had capped those tax brackets at 50 percent. Those tax brackets won't even pay for 2 days a year of federal spending. People are free to advocate 91 percent tax rates, but they should not point to 1950s America as proof that they raise significant tax revenues that way.

What about the claim that Europe has shown how to finance large welfare states on the backs of the rich? In reality, those nations tax the wealthy at similar rates to the U.S. It is their heavy middle-class taxes that produce the typical OECD nations' 7.5 percent of GDP tax revenue advantage over the US across all levels of government. Specifically, every other OECD nation assesses a value-added tax (VAT)—essentially a sales tax—as high as 27 percent. Without the resulting 7.2 percent of GDP in average VAT revenues, U.S. and OECD tax revenues are nearly equal. Even the social democratic Scandinavian countries that collect 14 percent of GDP more than the US do it almost entirely from their VAT and higher payroll taxes—which come from everyone, not just the rich.

America's top tax brackets for income, capital gains, corporate, and estate taxes are actually all slightly higher than those of the typical OECD nations when merging all levels of government. We've got the most progressive tax system in the OECD because we tax the rich at similar rates as those other countries but we tax middle- and lower-earners dramatically less than they do. So if you want America to tax like Europe, then our middle class is going to get the nastiest surprise of its life. Europe is no longer the caricature Americans imagined decades ago.

Either way, eliminating those tax breaks and taxing these companies more could raise perhaps $100 billion a year. That's real money, but it's not a game-changer in the context of those $4 trillion annual deficits we're heading toward. And, of course, we'd lose the business investment and job creation that comes from those bipartisan incentives. 

Today, many wealthy individuals escape short-term income taxes by receiving most income in capital gains or borrowing against their wealth. The capital gains will eventually be taxed when the investments are sold, unless they carry it through to death. Ensuring that capital gains would be taxed at death or that rich people can no longer easily borrow tax-free against their wealth would be logical reforms—but they wouldn't raise revenue of any significance to our deficits. We will still have to make difficult choices on spending or middle-class taxes."

"Europe long ago learned the hard way that going overboard on wealth taxes and steep top income and corporate tax brackets can backfire on the economy. That's why their (non-VAT) tax codes have moved closer to ours"

Thinking About the Tariffs and the Laffer Curve

By James Pethokoukis of AEI.

"At a legendary 1974 Washington dinner, economist Arthur Laffer supposedly sketched his famous curve on a napkin, demonstrating how excessive taxation could reduce government revenue. Now researchers have applied this concept to tariffs, revealing a harsh truth: Even under optimal conditions, additional tariff revenues would peak far short of the amounts claimed by the Trump White House and just a fraction of the $2.4 trillion from federal income taxes. The more successfully tariffs cut imports, the fewer goods remain to tax, making a return to McKinley-era funding economically impossible.

Supply-side conservatives face a striking contradiction: While the famous supply-side theorist Jude Wanniski blamed the Great Depression on an investor freakout over the Smoot-Hawley Tariff Act, today’s supply-siders support President Trump’s tariffs despite negative market reactions. By Wanniski’s logic, these market selloffs should be viewed as rational verdicts on protectionist policies.

This inconsistency in supply-side thinking extends beyond market reactions to tariffs. The Laffer Curve demonstrates that between zero taxation (zero revenue) and 100 percent taxation (also zero revenue) lies a revenue-maximizing rate. When applied to tariffs, however, the analytical device suggests unavoidable and unpleasant trade-offs for Trumponomics supporters: The Trump administration wants tariffs to both reduce the trade deficit and increase revenue—goals that fundamentally conflict. 

A new analysis, “Tariffs cannot fund the government: Evidence from tariff Laffer curves,” undermines the idea that the Trump tariffs could replace federal income taxes.(A bit of basic trade economics: Tariffs don’t directly reduce trade deficits over the long run because these deficits are fundamentally determined by differences in savings and investment between the United States and foreign countries. Tariffs simply reduce overall trade. They cannot permanently alter net exports.)

So to execute this thought experiment, the researchers assume the US trade balance isn’t fixed. From this adjustment flows the finding that the more successful tariffs are at cutting imports, the fewer goods remain to tax. Shrinking imports automatically shrinks the taxable base. When tariff revenues help shrink the trade deficit by 50 cents on the dollar, the study finds, maximum additional revenue drops below $300 billion, enough to fund barely two weeks of federal spending.

From the paper:

In short, the Laffer rationale applied to US trade explains why a return to the McKinley era, when import tariffs used to finance half of US federal spending in the absence of income taxes, is unrealistic. Hiking import tariffs is not a viable solution to fund today’s public finances.

This reality exposes a central contradiction: A trade policy successful at reducing imports—which tariff opponents think is possible—necessarily limits its own revenue potential. For supply-siders who once championed tax reductions to stimulate economic activity, embracing tariffs (essentially tax increases on global commerce) represents a profound departure from their intellectual roots.

As markets continue to react negatively to protectionist policies, perhaps it’s time for a new napkin sketch, one that honestly depicts the limitations of tariffs as revenue instruments in a modern economy."

Don’t Cry for the Education Department

Good riddance as Trump moves to dismantle it. But what then?

WSJ editorial. Excerpts:

"The Education Department was created as a payoff to the National Education Association teachers union, which supported Carter’s candidacy in 1976, in the NEA’s first-ever presidential endorsement. “The idea of an Education Department is really a bad one,” an anonymous liberal House Democrat told the Journal’s Al Hunt in 1979. “But it’s NEA’s top priority. There are school teachers in every congressional district and most of us simply don’t need the aggravation of taking them on.”

When Carter signed the bill, he argued that elevating education to a cabinet post, separate from the old combined Department of Health, Education, and Welfare, would “eliminate unnecessary bureaucracy, cut red tape, and promote better service for local school systems.” It would even “save tax dollars.”"

"falling U.S. test scores show a tremendous need to broaden the argument on education. Last year 33% of eighth-graders scored below “basic” on reading, according to the National Assessment for Educational Progress."

Top 5 Reasons to End the US Department of Education

By Neal McCluskey of Cato.

"The US Department of Education is in the Trump administration’s crosshairs. Here are five major reasons it should be:

1. It’s unconstitutional: Education is nowhere among the specific, enumerated powers given to the federal government. That means the feds have no authority to govern in education. Even the big-government administration of Franklin Delano Roosevelt knew that. In 1943, the US Constitution Sesquicentennial Commission, which Roosevelt chaired, published a document that included the following: “Q. Where, in the Constitution, is there mention of education? A. There is none; education is a matter reserved for the states.”
2. It’s ineffective: As indicated by the chart below, in K–12 education there is no meaningful evidence that the department, or federal spending generally, has improved education outcomes. While federal spending has risen, National Assessment of Educational Progress outcomes have largely stagnated. Of course, standardized test scores might not be a great barometer of how well the education system is working, but it is the feds that elevated them under the No Child Left Behind Act, Race to the Top, and Common Core. So by Washington’s own measure, it has not been very effective.

 

3. It’s incompetent: US ED’s biggest job is to administer federal student aid programs, especially student loans. But as the Government Accountability Office recently reported, US ED has failed at basic functions like tracking repayments for years. Heck, it could not even simplify the form to apply for aid without creating havoc.

4. It’s unnecessary: We had been educating kids for centuries before the department launched in 1980 and leading the world economically, technologically, and more. And US ED’s own mission statement is full of words such as “promote” and “supplement,” not “control” or “run.” Because states, districts, families, and educators are responsible for education, not Washington.

5. It’s expensive: Until recently, the department employed nearly 4,200 people and cost about $2.8 billion for salaries and expenses. And that’s setting aside all of the money it distributes and programs it runs, which are not about the department itself but tally hundreds of billions of dollars a year, depending on how you account for the huge, murky, unconstitutional student loan programs.

An unconstitutional, ineffective, incompetent, unnecessary, and expensive federal department is not a benefit to the country. It’s a mistake that must go away."