Life at the end of the Reaganomics rainbow

SINCE RONALD REAGAN'S death, man inspiring speeches have been delivered and adulatory" articles written about his presidency. Few of the tributes, however, have recognized Reagan's greatest achievement, which was indispensable to the U.S. triumph in the Cold War and is crucial for the current war on terrorism. Reagan tapped the creativity of America's entrepreneurs to bring about a global, not just a national, economic revolution.

Poets describe creativity as "Promethean," referring to the mythical hero who brought fire to the Earth. A Promethean era in world history, the Reagan presidency lit the fires of American creativity--and they have been roaring ever since. His ideas transformed U.S. finance, global economics, and world politics. They reverberated through Eastern Europe, the Soviet Union, and China with the power of Joshua's trumpets. They made South Korea a more economically important and promising country than France or Germany.

To the defenders of the old order Third World despots, legal monopolies, land trusts, gold funds, oil cartels, bureaucracies, and tyrannies of all kinds--the Promethean roar was an insufferable racket. They mustered all their powers to prevent the transformation from occurring. The facts reveal their failure--and Reagan's success. Since 1980, U.S. marginal tax rates fell some 40% on income and 75% on capital gains and dividends, and the economy added close to 36,000,000 jobs. During the same period, Europe and Japan created scarcely any net new employment outside of government. American companies now constitute 57% of global market capitalization, and the U.S. commands close to half of the world's economic assets.

America, responsible for one-fifth of global gross domestic product in 1980, produced one-third of global GDP in 2003. That is Ronald Reagan's legacy. The key to this awesome and unprecedented triumph was Reagan's dismantling of the confiscatory tax codes imposed on the capitalist world during World War II. Supporting Reagan's tax rate reductions was a movement of economists add journalists called supply-siders. We were so unpopular that Sen. Bob Dole (R.-Kan.) used to crack a "good news/bad news" joke about a Greyhound bus going over a cliff. The good news was that it was "full of supply-side economists."

A central component of supply-side economics is the Laffer Curve--named for its inventor, economist Arthur Laffer--which shows that low tax rates produce more revenue than high ones. Reagan understood and embraced this concept. He would regale White House visitors with a story about actors and producers in Hollywood who simply stopped working when their marginal tax rates rose over 50%. A rate high on the Laffer Curve means that more work for more income is less profitable than maneuvering to avoid taxes on existing income. According to nay research, the correct curve shows that tax rates should be kept very low--well below 20%--and that higher rates tend to reduce long-run government income and massively reduce private sector wealth.

In the media and the academy, however, the Laffer Curve widely is discredited. Even many Republicans speak of "paying" for tax cuts with spending cuts and claim that the real burden of government on the economy is what it spends rather than how it taxes. Not so--to say that tax cuts cost money is to ply that current tax rates do not obstruct economic activity, and, therefore, that reductions are unnecessary. If you concede that tax cuts reduce government revenue, it becomes quite difficult to defend tax cuts effectively in a democracy where at least one-third of the voters directly are dependent on government spending for their livelihoods, and where most of the rest cherish some type of government program.

Reagan's genius was to show us a way out of this dilemma. The real undeniable test of tax policy is not short-term transfers in revenue but long-term shifts in spending that are most clearly manifested by increases in the Federal budget, Between 1981-2004, current government spending in terms of dollars increased fivefold while the total hovered a little above 20% of GDP.

In the mid 1980s, World Bank economist Keith Marsden showed how this is possible: Low-tax countries increase their spending three times faster than comparable high-tax nations. This is because the low-tax economies grow six times faster. For most of the period since World War II, the fastest growing economy in the world, with the fastest growth in government spending, was Hong Kong, with a top rate of 16%. A study by ,lade Wanniski at Polyconomics extended the analysis through the Reagan era, with file stone results. In recent years, Ireland, New Zealand, and Russia massively increased spending after drastically reducing tax rates. Russia has increased outlays by some 60% after enacting a 13% flat tax.

Why do I stress government spending, after a long career of attacking it? The reason is simple: What is crucial is not the absolute level of government but the size of government compared to the size of the private sector. In every country that has enacted tax-rate reductions, the absolute growth of the private sector outpaced the growth of government enormously.