On this day in 1981, at his California home Rancho del Cielo, Ronald Reagan signs the Economic Recovery Tax Act (ERTA), a historic package of tax and budget reductions that set the tone for his administration’s overall economic policy.
During his campaign for the White House in 1980, Reagan argued on behalf of “supply-side economics,” the theory of using tax cuts as incentives for individuals and businesses to work and produce goods (supply) rather than as an incentive for consumers to buy goods (demand). In Congress, Representative Jack Kemp, Republican of New York, and Senator Bill Roth, Republican of Delaware, had long supported the supply-side principles behind the ERTA, which would also be known as the Kemp-Roth act. The bill, which received broad bipartisan support in Congress, represented a significant change in the course of federal income tax policy, which until then was believed by most people to work best when used to affect demand during times of recession.
The ERTA included a 25 percent reduction in marginal tax rates for individuals, phased in over three years, and indexed for inflation from that point on. The marginal tax rate, or the tax rate on the last dollar earned, was considered more important to economic activity than the average tax rate (total tax paid as a percentage of income earned), as it affected income earned through “extra” activities such as education, entrepreneurship or investment. Reducing marginal tax rates, the theory went, would help the economy grow faster through such extra efforts by individuals and businesses. The 1981 act, combined with another major tax reform act in 1986, cut marginal tax rates on high-income taxpayers from 70 percent to around 30 percent, and would be the defining economic legacy of Reagan’s presidency.
Reagan’s tax cuts were designed to put maximum emphasis on encouraging innovation and entrepreneurship and creating incentives for the development of venture capital and greater investment in human capital through training and education. The cuts particularly benefited “idea” industries such as software or financial services; fittingly, Reagan’s first term saw the advent of the information revolution, including IBM’s introduction of its first personal computer (PC) and the rise or launch of such tech companies as Intel, Microsoft, Dell, Sun Microsystems, Compaq and Cisco Systems.
Economists have argued to what degree Reagan’s economic policy drove the boom of the 1990s, but his tax program undoubtedly set in motion powerful forces of change that would result in both short- and long-term economic gains. On the other hand, critics of so-called “Reaganomics” argued that his tax cuts and the effects of steady economic growth disproportionately benefitted the wealthy, and increased the gap between the nation’s rich and poor.