The prevailing narrative surrounding President Jimmy Carter’s economic legacy often centers on his appointment of Paul Volcker as Federal Reserve chair in 1979. This appointment is frequently credited with taming the rampant inflation that plagued the late 1970s and early 1980s. This narrative suggests that Volcker’s tight monetary policy, combined with Ronald Reagan’s tax cuts and increased defense spending, brought an end to the era of stagflation. However, this conventional wisdom significantly overstates Volcker’s role and minimizes the crucial impact of tax cuts, particularly those initiated during Carter’s own presidency, in revitalizing the American economy.
The argument for Volcker’s pivotal role overlooks the fundamental economic context of the 1970s. The high marginal tax rates, topping out at 70 percent, coupled with the instability caused by the dollar’s departure from the gold standard in 1971, created an environment hostile to monetary policy effectiveness. The global rush to hedge against the declining dollar rendered any actions taken by the Federal Reserve, regardless of who held the chair, largely inconsequential. Whether it was Arthur Burns, William Miller, or Paul Volcker, their influence was minimal because the underlying issue was not monetary policy but rather the lack of confidence in the dollar itself.
Volcker’s perceived “success” in combating inflation in the 1980s should be primarily attributed to the significant tax cuts enacted during the Reagan administration. These cuts dramatically lowered marginal tax rates across the board, including capital gains, top income, and corporate rates. These reductions, combined with inflation indexing of the income tax code and depreciation reform, created a powerful incentive for investment and economic activity. The increased demand for dollars driven by these pro-growth policies made monetary policy implementation significantly easier. Even a less competent Fed chair would likely have overseen a period of disinflation given the surge in economic activity fueled by the tax cuts.
The dramatic reduction in inflation during the 1980s can be directly linked to the increased value of the dollar resulting from the tax cuts. Lower marginal rates meant individuals and businesses retained a larger share of their earnings, incentivizing productive activity and diminishing the need to hedge against inflation. This effectively dried up the speculative pressures that had fueled inflation in the preceding decade. While Volcker’s policies, such as shifting from quantity to price targeting and maintaining higher interest rates, might have played a supporting role, they were ultimately secondary to the fundamental shift in economic incentives created by the tax cuts.
Ironically, the seeds of these transformative tax cuts were sown during Carter’s presidency. In 1978, a bipartisan bill proposing a 30 percent across-the-board income tax cut, along with a capital gains tax reduction, landed on Carter’s desk. However, Carter, opposed to the income tax cut, effectively killed the bill in conference, accepting only the capital gains tax reduction. This decision proved a missed opportunity. The dollar reached its lowest point against foreign exchange immediately after Carter signed the truncated bill, demonstrating the market’s disappointment with the lost potential of broader tax relief. The subsequent rise in the dollar’s value, beginning in 1978 and continuing until 1985, correlated strongly with the implementation of tax cuts.
Had Carter embraced the full tax cut package in 1978, the economic landscape of the late 1970s and early 1980s could have been dramatically different. The phased-in tax reductions, combined with spending triggers that provided a degree of fiscal responsibility, could have spurred economic growth and curbed inflation much earlier. The success of California’s Proposition 13 in 1978, which drastically cut property taxes, demonstrated the potent economic stimulus of significant tax relief. Had Carter followed a similar path nationally, it’s plausible that inflation would have begun to subside in 1979, negating the narrative of a “crisis” requiring Volcker’s drastic measures.
In addition to the capital gains tax cut, Carter’s significant deregulation efforts also contributed to the disinflationary boom of the 1980s. These policies, combined with the eventual tax cuts under Reagan, created an environment conducive to economic growth and price stability. The focus on Volcker’s role tends to overemphasize the individual while overlooking the broader economic forces at play. The real driver of the economic turnaround was the shift in incentives brought about by tax cuts and deregulation, creating a fundamentally different economic landscape where inflation was no longer a persistent threat.
