The Tax Cut That Won the Cold War
A few weeks ago marked the silver anniversary of one of the most pivotal events in American economic and foreign policy history. It was twenty-five years ago on August 13th that Ronald Reagan signed into law the Kemp/Roth tax cuts, also known as the Economic Recovery Act of 1981 legislation which helped set in motion the events which shaped the world in which we live today.
The bill reduced American income tax rates by approximately one-third across the board, and unleashed the pent up power of an economy besieged by double digit inflation, double digit interest rates and double digit unemployment.
The result was an economy that grew at phenomenal rates, created tens of millions of jobs, raised personal incomes and more than doubled overall revenues to the US Treasury, (something liberals and most economists said couldn't happen). In addition, investment and entrepreneurship blossomed, helping to foster the technology boom that has impacted just about every aspect of our lives.
It was a simple economics lesson that provided demonstrable proof that taxes have a dynamic impact on human behavior. As Larry Kudlow put it recently, "Economic behavior responds significantly to the incentive power of low tax rates that raise the after-tax return on work, investment and risk taking". In other words, people work harder and are more productive when they can keep more of the wealth that they create.
While the economic benefits alone make the Reagan tax cuts worthy of memorializing, the resulting economic growth and strength made it possible to overwhelm the Soviet Union in the Cold War. The fact that tax revenues dramatically increased made it possible for the US to finance a military buildup that forced the Soviets to spend themselves into oblivion in a vain attempt to keep pace.
The rapid growth in technological innovations made it possible to overwhelm the Soviets with the mere potential of what we could produce and bring to bear militarily. This, as well as the funding that such technology required, effectively ended the Soviet participation in the arms race, and ultimately the Soviet Union itself.
Gorbachev realized this at the Reykjavik summit in 1987. The productivity of a newly revitalized US economy gave the Soviets pause when Reagan refused to back off of pushing forward with a missile defense program (SDI) which could negate their strategic missile advantage.
In other words, they were convinced we might be able to pull it off, and they knew that they couldn't keep up. Shortly thereafter, their basket-case economy imploded under the weight of defense spending and subsidizing their impoverished satellite-state empire.
Arms cost money, not only to build, but to man and maintain. This explains why you don't see too many countries with backward economies sporting aircraft carriers. The more productive a nation's economy becomes, the more geopolitical power and influence it will have not just economically and diplomatically, but also in terms of military potential.
Reagan once said that "an economist is someone who sees something happen in practice and then wonders if it would work in theory". By now, it would seem that the "theory" of tax rates having a dynamic and dramatic influence on human behavior would be a little more accepted as having been proven in "practice".
To this day however, the mainstream media, liberal politicians and assorted economists refuse to acknowledge that lower tax rates are due any credit for the strength of the American economy over the course of the past quarter century.
Reagan understood that in order for the US to effectively compete and ultimately win the Cold War, we had to have a strong and growing economy that could produce superior weapons technology and field a superior military.
The principle is just as true today as it was then. Economic strength makes military strength possible. And a quick glance at world events underlines the importance of maintaining that strength.
Next time someone pooh-poohs the effectiveness of tax cuts, just ask them to point to the Soviet Union on any current world map.