From the WSJ Opinion Archives
WONDER LAND
Optimism Pays Off
Twenty-five years later, Reagan’s tax cuts are a global tide.
It was entirely appropriate that as its keynote speaker to celebrate the 25th anniversary of the 1981 Reagan tax cut, the Heritage Foundation in Washington this week should assign the job to Art Laffer. Mr. Laffer is surely the most irrepressibly ebullient practitioner of the dismal science of economics alive today, maybe ever. It is no surprise that more than a quarter century ago, then California Gov. Ronald Reagan, another genuinely cheerful soul in a dismal profession, would have found common cause with the young economist's view that cutting taxes would produce a wealth of benefits for the American people.
Now, 25 years later and with the post-Reagan Republican Party in tatters over a confused political agenda, Mr. Laffer stood beaming at the Heritage podium to inform its audience that "illegal immigrants are the lifeblood of our society." This produced a boo-burst from a distant corner, which Mr. Laffer seemed not to notice. When so informed over a nightcap at the Willard Hotel, he said with the famous smile, "What do I care? I've been booed at all my life."
As, indeed, has Reaganomics over its 25-year life. On this night Mr. Laffer, famous in part for cutting down economists' pretenses to ideas anyone can understand, had an answer for the boo-birds of Reaganomics: Almost alone, the United States since those tax cuts has managed to remain both a growth country and a developed nation.
Economic growth was always the sine qua non of supply-side tax theory, the belief that lower marginal rates would incentivize people to work, save and invest. Bob Bartley, the late editor of The Wall Street Journal editorial page, wanted nothing more than to focus this debate back then on the particulars of achieving growth in the economy. But for many garden-variety politicians and professional economists, the economy is an abstraction. Yes, they know something is going on out there in the workaday world, but it's all a second-order effect of their policies and theories. So at its creation the supply-side idea instantly bogged down into an argument, alive to this day, over whether the tax cuts would "pay for themselves." You know, the deficit, the budget, the "nonpartisan" economic models at the Congressional Budget Office, blah, blah, blah.
It was back about the time these arguments over fiscal policy were erupting in the late 1970s that this page began to propagate the phrase, "inside the Beltway." This of course refers to Interstate 495, which rings Washington like the bright outline that surrounds protoplasm under a microscope. The unicellular protozoa inside the Beltway live life swimming from this side to that, bumping each other. They enjoy it. And so even today the debate over tax cuts "paying for themselves" lives on, reincarnated as a proposal called "paygo" which decrees that no tax cut may pass into law unless an "offset" is laid upon the altar of the budget gods.
But let's return to the real world, where the object is growing an economy, not fertilizing Uncle Sam's giant budget beanstalk. In the final months of Ronald Reagan's presidency, something else happened that forced even Beltway accountants to look up from their ledgers: The Berlin Wall fell in 1989. Five years later this brought forth the second great wave of supply-side tax policy.
Communism had been running what might be called a 40-year demonstration study in life at one end of the Laffer Curve--what happens to economies when you tax away pretty much everything. Freed of this utopia, the peoples of Eastern Europe now had to devise new tax regimes appropriate to nations eager--for want of a better phase--to work, save and invest.
The first former Iron Curtain country to cut its taxes was Estonia in 1994, led by Prime Minister Mart Laar, who claimed then the only economics book he'd ever read was Milton Friedman's "Free to Choose." Estonia established a flat rate on personal incomes of 26%; two years earlier it had abolished all import tariffs. Estonia grew.
After Estonia, flat-tax regimes coursed across Eastern Europe, as listed below (bear in mind that the top rate in the U.S. is 35%): Lithuania, 33%; Latvia, 25%; Slovakia, 19% (the former sad sack of the region, Slovakia's growing economy has become its envy); Romania, 16%; Ukraine, 13%; Russia, 13%; and Georgia, 12%.
Yes, payroll taxes are often high, but unlike here, the political impulse is to reduce the tax burden; Estonia hopes to get its flat rate down to 20% by decade's end. Even the World Bank has noticed. In a September report on business reforms, it noted that the second most popular global reform the past few years, after easing regulations on new businesses, was "reducing tax rates and the administrative hassle of paying taxes." Bosnia-Herzegovina, emerging from the Balkan wars, has cut property taxes.
The accounting firm KPMG's annual corporate-tax survey, released this month, took special note of the history of corporate tax rates. The downward trend here was begun in 1985 with a corporate-rate cut in the U.K. by Reagan admirer Margaret Thatcher. "In the past 14 years," the report says, "the average corporate tax rate of countries surveyed by KPMG declined nearly 29%, dropping from an average of 38% to 27.1%." When Austria cuts its corporate rate to 25% from 34% and German companies started rolling across the border, German Finance Minister Peer Steinbruck accused the Austrians--I love this phrase--of "fiscal dumping."
During Ronald Reagan's presidency, the top marginal rate on personal incomes dropped to 28% from 70%. In 1993 Bill Clinton raised the top tax rate to 39.6%. In 2001 George Bush pushed the top rate back down to 35% and cut the rate on capital gains and dividends to 15%. Last week former Clinton Treasury Secretary Robert Rubin exhorted the Democrats to raise taxes "to solve the nation's fiscal problems."
The Rubin Solution may not be easy. Even a Democratic Congress might realize that raising taxes today is swimming against the global tides. In reversing the Clinton tax increases, passed in another age 13 years ago, and spreading tax cuts to the financial sector, George Bush has driven the roots of the Reagan tax philosophy deeper. If he resists a grand compromise on entitlements that raises taxes, it may prove to be his most enduring legacy.
Mr. Henninger is deputy editor of The Wall Street Journal's editorial page. His column appears Fridays in the Journal and on OpinionJournal.com.
