Policy Documents

Bast: American Prosperity: From Kennedy to Reagan

Joseph L. Bast –
November 1, 2010

In October I was asked to moderate a debate for the World President’s Organization on the topic, “Who has the best plan to restore American prosperity?” In preparation for that debate I read up on the history of economic growth and public policy in the United States, including an excellent book titled The End of Prosperity by Arthur Laffer, Stephen Moore, and Peter Tanous published in 2008. What follows is the first of a two-part essay that seeks to answer this important question.

The End of Prosperity

Experts at the National Bureau of Economic Research say the Great Recession ended last summer, but this would come as news to the 15 million Americans who are still unemployed and the 9.5 million people employed part-time but still searching for full-time work. At 9.5 percent, the unemployment rate today is actually more than three percentage points higher than it was during the recession. Gross Domestic Product might be inching upward, but unemployment is getting worse.

The Great Recession of 2008-2009 lasted 18 months (December 2007-June 2009), much longer than the recessions of 2000-2001 (11 months) and 1990-1991 (eight months), and slightly longer than the recession of 1981-1982 (16 months), the year after Ronald Reagan was first elected president. Worse, we are seeing the slowest economic recovery from an economic downturn since the Great Depression.

The American recovery is slower, in terms of employment growth, than 25 of 30 major industrialized countries. Many economists predict a “double dip” recession as economic growth rates fell from 5 percent in the fourth quarter of 2009 to 3.7 percent in the first quarter of 2010 and only 1.7 percent in the second quarter and 2.0 percent in the third quarter.

Not the First Time

This is not the first time the country lost the formula for sustainable economic growth. Way back in 1963, President John F. Kennedy discovered one important key to economic growth. He sponsored legislation to cut the top income tax rate from 91 percent to 70 percent. Back then, Democrats rallied behind the plan while Republicans, fearing deficits, opposed it.

More than 1 million net new jobs were created in the four years that followed, and the economic growth rate climbed from 4.3 to 6.6 percent. Instead of reducing tax receipts, the rate cuts caused revenues to grow from $48.7 billion in 1964 to $68.7 billion in 1966, more in two years than they had in the previous five years. On January 18, 1966, the Dow Jones Industrial Average hit 1,000 for the first time in history.

But it didn’t last. In 1966, a succession of presidents – who Laffer, Moore, and Tanous call the “four stooges of the American presidency,” Lyndon Baines Johnson, Richard Nixon, Gerald Ford, and Jimmy Carter – made one mistake after another. LBJ gave us welfare policies that have cost $5.4 trillion and trapped millions of people in a cycle of dependency. An income tax surcharge was adopted in 1968 raising the top tax rate back up to 77 percent. The alternative minimum tax (AMT) was born.

Richard Nixon gave us wage and price controls and the Environmental Protection Agency and closed the gold window, a step that would soon lead to inflation. Jimmy Carter hiked spending and taxes, watched as inflation reached 14 percent, and gave teacher unions and radical environmentalists seats at the table in his White House, seats they still occupy.

By 1979, the “misery index” – the rate of inflation plus the unemployment rate – had reached 17.1, and it would reach 20.8 in 1980 before finally beginning to fall. In the summer of 1979, Jimmy Carter gave a speech that came to be known as the “malaise speech” in which he described an “erosion of confidence in the future” that was “threatening to destroy the social and political fabric of America.” He didn’t realize that it was the public’s lack of confidence in his policies that was threatening his political career.

The Reagan Revolution

Ronald Reagan rediscovered the formula for economic growth. The Economic Recovery Tax Act of 1981 provided a 25 percent across-the-board cut in personal marginal tax rates, but the cuts were phased in, with most cuts not arriving until 1983. While the “misery index” began falling the moment Ronald Reagan was elected, the economy dipped into recession for seven months in 1980 and then into a deeper recession from July 1981 to November 1982. By 1982, unemployment had reached 10 percent and the stock market had fallen to 777, more than 20 percent below the mark set in 1966 in nominal terms and more than 70 percent lower in after-inflation terms.

But in 1983, when the tax cuts were finally in place, the economy responded by growing at a robust rate of 3.5 percent and then 6.8 percent in 1984. Inflation fell by two-thirds. Reagan cut taxes again in 1986 by consolidating the various tax brackets into only two, lowering the top tax rate from 50 percent to 28 percent, and raising the lowest rate from 11 percent to 15 percent but raising the income threshold for the lower level from $5,720 per year to $29,750 per year. The longest period of sustained economic growth in American history began.

America’s net worth climbed in real terms from $25 trillion in 1980 to $57 trillion in 2007. Laffer, Moore, and Tanous write, “More wealth was created in the U.S. over the past twenty-five years than in the previous 200 years. The economy in real terms is almost twice as large today as it was in the late 1970s.” They call it “the greatest period of wealth creation in the history of the planet.”

It wasn’t just the rich getting richer and the poor staying the same or getting poorer: Research on income mobility shows a poor family in 1979 was more likely to be rich by the early 1990s than to still be poor. The purchasing power of the median-income family rose to $54,061 in 2004, an $8,288 real increase since 1980.

"Sustained and now accelerated economic growth has rendered America's consumer cornucopia ever more lavish and various," wrote the Cato Institute's Brink Lindsey in his 2007 book, The Age of Abundance. He reports a litany of economic advances from 1970 to the mid 1990s, from the average size of new homes (up 43 percent) to the number of annual air travel miles per person (up 300 percent).

Taxes weren’t the only thing Reagan got right. He lifted price controls on oil and natural gas, continued deregulation initiatives that had started under the Carter administration, took on unions in a famous stand-off with striking air traffic controllers, and was an advocate of free trade. By giving Fed chairman Paul Volcker the go-ahead to restrain growth in the money supply, he brought inflation under control. And he reduced domestic spending in the first two years of his administration and thereafter slowed the rate of spending growth to less than it had been under any American president since World War II.

Alas, this episode of American prosperity came to an abrupt end in 2008, once again the consequence of changes to public policy.

Next Time: American Prosperity: From Reagan to Obama

Joseph Bast (jbast@heartland.org) is president of The Heartland Institute.