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The lesson of the 1981 ‘‘supply-side’’ tax cuts

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Snapshot for June 16, 2004.

The lesson of the 1981 “supply-side” tax cuts

When President Reagan took office in 1981, he quickly succeeded in passing substantial “supply-side” cuts in both individual and corporate income taxes.  He predicted that the 1981 tax cuts would “pay for themselves” through higher investment and faster growth in productivity and incomes.  Once enacted, the 1981 tax cuts opened up wide budget deficits (6% of gross domestic product, the largest peacetime deficit in history), leading Congress and the president to agree to substantially increase taxes on corporations in 1982 and on payrolls in 1983.  Although those measures helped to narrow the budget deficit, large deficits persisted and further major tax hikes were adopted in 1990 and 1993.  By the time that the tax increases of 1993 took effect, any supply-side effects of the 1981 tax cuts had been largely eliminated.

Contrary to the predictions of supply-side proponents, the 1981 tax cuts did not lead to better economic performance.  Economists generally measure performance from one business cycle peak to the next.  The last three peaks occurred in 1979, 1989, and 2000.  It is instructive to compare the performance of investment, productivity, and output in the 1979-89 cycle, which was influenced by the 1981 tax cuts, with the 1989-2000 cycle, which was little affected by those cuts.

Economic performance in the 1980s versus the 1990s

The boost to investment from the 1981 tax cuts that supply-siders had predicted never materialized.  In fact, investment grew much faster during the 1990s than the 1980s—5.9% versus 2.5%.  Productivity also grew much faster in the 1990s.  Although total output, or GDP, grew slightly faster in the 1990s (3.2% versus 3.1%), the promised increase in federal revenue was a bust.  Revenues rose at only a 2.5% rate in the 1980s compared to 4.1% in the 1990s.

Proponents of the tax cuts of 2001, 2002, and 2003 again used supply-side arguments about improved economic performance and claims that the tax cuts would “pay for themselves.” The economic experience of the 1980s and 1990s does not support those arguments.

This Snapshot was written by EPI Research Director Lee Price.

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