jan 1, 1981 - ERTA cuts taxes

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supply-side economics (Reaganomics):Economic theory that tax cuts encourage business investment (supply) and stimulate individual consumption (demand). In reality, supply-side economics created a massive federal budget deficit.


ERTA:Legislation introduced by President Reagan and passed by Congress in 1981 that authorized the largest reduction in taxes in the nation’s history at that time. (


The new president kept his political message clear and uncomplicated. “What I want to see above all,” he remarked, “is that this country remains a country where someone can always get rich.” Standing in the way, Reagan believed, was government. In his first year in office, Reagan and his chief advisor, James A. Baker III, quickly set new governmental priorities. They launched a three-pronged assault on federal taxes, social-welfare spending, and the regulatory bureaucracy as part of a rollback of the wider liberal state. To fight the Cold War, they advocated a vast increase in defense spending and an end to détente with the Soviet Union. In response to the resurgent economies of Germany and Japan, they set out to restore American leadership of an increasingly global market for goods and services.


To achieve its economic objectives, the new administration advanced a set of policies to increase the production (and thus the supply) of goods. The theory underlying supply-side economics (Reaganomics), as this approach was known, emphasized investment in productive enterprises — the making of goods but also the provision of services, from financial services to fast food. According to supply-side theorists, the best way to boost that investment was to reduce the taxes paid by corporations and wealthy Americans, who could then use their windfall to expand production.

Supply-siders believed that the resulting economic expansion would increase government revenues and offset the loss of tax dollars stemming from the original tax cuts. Meanwhile, the increasing supply would generate its own demand, according to the theory, because more goods creates more wealth for the economy as a whole, which becomes new spending by individual consumers and companies alike. This approach presumed — in fact, gambled — that future tax revenues would make up for present tax cuts. The idea had a growing list of supporters in Congress, led by an ex-professional football player from Buffalo named Jack Kemp, who praised supply-side economics as “an alternative to the slow-growth, recession-oriented policies of the [Carter] administration.”


Reagan took advantage of Republican control of the Senate, as well as high-profile allies such as Kemp, to win congressional approval of the 1981 Economic Recovery Tax Act (ERTA), a massive tax cut that put supply-side principles into practice. The act reduced income tax rates for most Americans by 23 percent over three years. For the wealthiest Americans — those with millions to invest — the highest marginal tax rate dropped from 70 to 50 percent. The act also slashed estate taxes, levies dating from the Progressive Era aimed at curtailing the transmission of huge fortunes from one generation to the next. Finally, the new legislation trimmed the taxes paid by business corporations by $150 billion over a period of five years. As a result of ERTA, by 1986 the annual revenue of the federal government dropped by $200 billion (nearly half a trillion in 2020 dollars, or roughly the gross domestic product of Norway).

David Stockman, Reagan’s budget director, hoped to match this reduction in tax revenue with a comparable cutback in federal expenditures on Social Security and Medicare. But Congress, and even the president himself, rejected Stockman’s idea; they were not willing to antagonize middle-class and elderly voters who viewed those entitlements as sacred. As conservative columnist George Will noted ironically, “Americans are conservative. What they want to conserve is the New Deal.” After defense spending, Social Security and Medicare were by far the nation’s largest items on the federal budget; pruning other programs could not achieve the large spending reduction required to offset tax cuts. This contradiction between New Right Republican ideology and political reality would continue to frustrate the GOP into the twenty-first century.

There were more immediate, and embarrassing, issues related to supply-side economics. In a 1982 Atlantic article, Stockman admitted that the theory was based on faith, not economics. To produce optimistic projections of higher tax revenue in future years, Stockman had manipulated the figures. Worse, the White House bureaucrat told the Atlantic reporter candidly that supply-side theory was based on the long-discredited idea that helping the rich would eventually benefit the lower and middle classes — what was derided as “trickle-down” economics. Stockman had drawn back the curtain, much to Republicans’ consternation, on the flawed reasoning of supply-side theory. But it was too late. The tax cut had passed Congress, and since Stockman could not slash major programs such as Social Security and Medicare, he had few options to balance the budget.

With budget cuts not making up for the falling tax revenue, the federal budget deficit increased dramatically. Military spending contributed a large share of the growing national debt, but President Reagan would not budge. “Defense is not a budget item,” he declared. “You spend what you need.” Reagan and Defense Secretary Caspar Weinberger pushed a five-year, $1.2 trillion military spending program through Congress in 1981. During Reagan’s presidency, military spending accounted for one-fourth of all federal expenditures and contributed to both rising annual budget deficits (the amount overspent by the government in a single year) and a skyrocketing national debt (the cumulative total of all budget deficits). Despite pledging fiscal conservatism, Reagan oversaw a tripling of the federal debt in his two terms, rising from $930 billion in 1981 to $2.8 trillion in 1989 (Figure 29.1).

During World War II, the federal government incurred an enormous budget deficit. But between 1946 and 1965, it ran either an annual budget surplus or incurred a relatively small debt. The annual deficits rose significantly during the Vietnam War and the stagflation of the 1970s, but they really exploded between 1982 and 1994, in the budgets devised by the Ronald Reagan and George H. W. Bush administrations, and again between 2002 and 2005, in those prepared by George W. Bush. The Republican presidents increased military spending while cutting taxes, a budgetary policy that produced deficits.

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