The US Budget Battles: Part I. Creating the System
Then came the Reagan Revolution. Cutting the budget was among the first tasks of the Congress. When President Reagan took office in 1981, the US economy was very sluggish. Interest rates averaged 21%; in some parts of the country, unemployment averaged 15%; national statistics placed it at 11.5%. The capital gains rate (the tax investors and business owners pay on dividends and the projected or imaginary earnings on those investments) was 31%; consumer prices in nearly all sectors of the economy were rising steadily. The Congress obviusly had a difficult task ahead of it. The one certainty was that some drastic action had to be taken. Opinions differed as to where and how such action should come. Democrats proposed deeper cuts to the defense budget and suggested a nuclear freeze. Republicans debated the pros and cons of supply-side economics (the belief that government spending is of little consequence to the end result of increasing productivity because the debt accumulated today will be paid off with later surplus revenue) and balanced budget economics (the belief that government must exercise fiscal responsibility by spending less or freezing funds today to pay off pending debts and avoid future debts). Eventually the supply-siders won. The end result of all the discussion was a complete overhaul of the tax codes in 1986. The revised Code set capital gains rates at 28% as a compromise to the 20% sought by the Kemp/Roth plan. The top tax bracket was 31%. The other aspects of the revised Code imposed spending cuts on social programs. These often drastic cuts did not affect Social Security funding.
The economic effects were exactly as expected. Investment increased; businesses grew because they were able to keep more of their profits to invest other ways. Interest rates were 8.5% in 1988. Prosperity returned and restored the American spirit of entrepreneurial capitalism.
Then came the 1990 budget battle which led President Bush Sr. to negate his "no new taxes" campaign pledge. The top tax rate rose from 31% to 33%. Capital gains rates did not change, but clearly the intent of the budget was to target the most profitable economic producers. This trend continued with the 1993 Clinton tax increase. According to the administration spokespeople, that budget offered five years of spending projections intended to reduce the deficit. To fund this half trillion dollar plan, spending rose by $265 billion, the top tax rate rose from 33% to 39%
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