The ERTA included a 25 percent reduction in marginal tax rates for individuals, phased in over three years, and indexed for inflation from that point on. The marginal tax rate, or the tax rate on the last dollar earned, was considered more important to economic activity than the average tax rate (total tax paid as a percentage of income earned), as it affected income earned through “extra” activities such as education, entrepreneurship or investment. Reducing marginal tax rates, the theory went, would help the economy grow faster through such extra efforts by individuals and businesses. The 1981 act, combined with another major tax reform act in 1986, cut marginal tax rates on high-income taxpayers from 70 percent to around 30 percent, and would be the defining economic legacy of Reagan’s presidency.Reagan’s tax cuts were designed to put maximum emphasis on encouraging innovation and entrepreneurship and creating incentives for the development of venture capital and greater investment in human capital through training and education. The cuts particularly benefited “idea” industries such as software or financial services; fittingly, Reagan’s first term saw the advent of the information revolution, including IBM’s introduction of its first personal computer (PC) and the rise or launch of such tech companies as Intel, Microsoft, Dell, Sun Microsystems, Compaq and Cisco Systems.
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