Reaganomics

Reagan gives a televised address from the Oval Office, outlining his plan for tax reductions in July 1981

Reaganomics (a portmanteau of Reagan and economics attributed to Paul Harvey^[1]) refers to the economic policies promoted by the U.S. President Ronald Reagan during the 1980s, also known as supply-side economics and called trickle-down economics by critics. The four pillars of Reagan's economic policy were to:^[2]

1. Reduce Growth of Government spending.
2. Reduce Income Tax and Capital Gains Tax.
3. Reduce Government regulation.
4. Control the money supply to reduce inflation.

In his stated intention to increase defense spending while lowering taxes, Reagan's approach was a departure from his immediate predecessors. Reagan enacted lower marginal tax rates in conjunction with simplified income tax codes and continued deregulation. The federal deficit fell from 6% of GDP in 1983 to 3.2% of GDP in 1987.^[3] The federal deficit in Reagan's final budget fell to 2.9% of GDP.^[2] The rate of growth in federal spending fell from 4% under Jimmy Carter to 2.5% under Ronald Reagan.^[2]

William A. Niskanen, one of the architects of Reaganomics, summarizes the policy as "Reagan delivered on each of his four major policy objectives, although not to the extent that he and his supporters had hoped," and notes that the most substantial change was in the tax code, where the top marginal individual income tax rate fell from 70% to 28%, and there was a "major reversal in the tax treatment of business income," with effect of "reducing the tax bias among types of investment but increasing the average effective tax rate on new investment." Roger Porter, another architect of the program, acknowledges that the program was weakened by the many hands that changed the President's calculus, such as Congress.^[2][4] The effect was primarily a change in the composition of tax revenue, towards payroll and new investment, and away from higher earners and capital gains on existing investments, with comparatively small effect on overall tax revenue: the changes "reduced the federal revenue share of GDP from 20.2 percent in fiscal 1981 to 19.2 percent in fiscal 1989," a 1% reduction.

[edit] Historical context

Oil prices 1968–2006; peak is 1980, with steep decline over 1980s.

US demographic window, initial peak c. 1980 (US is light green).

Prior to the Reagan administration, the United States economy experienced a decade of rising unemployment and inflation, known as stagflation. Political pressure favored stimulus resulting in an expansion of the money supply. President Richard Nixon's wage and price controls were abandoned.^[5] The federal oil reserves were created to ease any future short term shocks. President Jimmy Carter started phasing out price controls on petroleum, while he created the Department of Energy. Much of the credit for the resolution of the stagflation is given to two causes: a three year contraction of the money supply by the Federal Reserve Board under Paul Volcker, initiated in the last year of Carter's presidency,^[5] and long term easing of supply and pricing in oil during the 1980s oil glut.

[edit] Taxes

President Reagan lifted remaining domestic petroleum price and allocation controls on January 28, 1981^[6] and lowered the oil windfall profits tax in August 1981, helping to end the 1979 energy crisis. He ended the oil windfall profits tax in 1988 during the 1980s oil glut.^{[citation needed]}

With the Tax Reform Act of 1986, Reagan and Congress sought to broaden the tax base, eliminate many deductions, and reduce rates. In 1983, Democrats Bill Bradley and Dick Gephardt had offered a proposal to clean up/broaden the tax base; in 1984 Reagan had the Treasury Department produce its own plan. The eventual bipartisan 1986 act aimed to be revenue-neutral: while it reduced the top marginal rate, it also partially "cleaned up" the tax base by curbing tax loopholes, preferences, and exceptions, thus raising the effective tax on activities previously specially favored by the code.

[edit] Deregulation

The question of how much of the overall trend of deregulation can be credited to Reagan remains contentious.

The economists Raghuram Rajan and Luigi Zingales point out that many of the major deregulation efforts had either taken place or begun before Reagan (note the deregulation of airlines and trucking under Carter, and the beginning of deregulatory reform in railroads, telephones, natural gas, and banking). They argue for this and other reasons that "the move toward markets preceded the leader [Reagan] who is seen as one of their saviors."^[7] Economist William A. Niskanen, a member of Reagan's Council of Economic Advisers and later chairman of the libertarian Cato Institute, writes that deregulation had the "lowest priority" of the items on the Reagan agenda^[2] given that Reagan "failed to sustain the momentum for deregulation initiated in the 1970s" and that he "added more trade barriers than any administration since Hoover."

By contrast, economist Milton Friedman has pointed to the number of pages added to the Federal Register each year as evidence of Reagan's anti-regulation presidency (the Register records the rules and regulations that federal agencies issue per year). The number of pages added to the Register each year declined sharply at the start of the Ronald Reagan presidency breaking a steady and sharp increase since 1960. The increase in the number of pages added per year resumed an upward, though less steep, trend after Reagan left office. In contrast, the number of pages being added each year increased under Ford, Carter, George H.W. Bush, Clinton, and others.^[8]

The apparent contradiction between Niskanen's statements and Friedman's data may be resolved by seeing Niskanen as referring to statutory deregulation (laws passed by Congress) and Friedman to administrative deregulation (rules and regulations implemented by federal agencies). In sum, a large study by economists Paul Joskow and Roger Noll concludes that the changes in economic regulation:

... simply do not reflect a sudden ideological change in federal executive branch views ... many of the significant changes in economic regulation began during the Carter administration and were initiated by liberal Democrats ... it is not particularly productive to refer to a generic deregulation movement or to think of it as a consequence of the election of Ronald Reagan.^[9]

[edit] Economic record

President Ronald Reagan signs the Economic Recovery Tax Act of 1981 at his California ranch.

Reagan's policies are widely recognized as bringing about the longest peacetime economic expansion in U.S. history, surpassed in duration only by the 1990s expansion that began under George H. W. Bush in 1991.^[10][11] During the Reagan administration, the American economy went from a GDP growth of -0.3% in 1980 to 4.1% in 1988 (in constant 2005 dollars),^[12] which reduced the unemployment rate by 1.6%, from 7.1% in 1980 to 5.5% in 1988, but with peaks of around 9.5% in 1982 and 1983.^[13] A net job increase of about 21 million also occurred through mid-1990. Reagan’s administration is the only one not to have raised the minimum wage.^[14] The inflation rate, 13.5% in 1980, fell to 4.1% in 1988, which was achieved by applying high interest rates by the Federal Reserve (peaked at 20% in June 1981).^[15] The latter caused a brief recession in 1982: unemployment rose to 9.7% and GDP fell by 1.9%.

Reagan significantly increased public expenditure, primarily the Department of Defense, which rose (in constant 2000 dollars) from $267.1 billion in 1980 (4.9% of GDP and 22.7% of public expenditure) to $393.1 billion in 1988 (5.8% of GDP and 27.3% of public expenditure); most of those years military spending was about 6% of GDP, exceeding this number in 4 different years. All these numbers had not been seen since the end of U.S. involvement in the Vietnam War in 1973.^[16] In 1981, Reagan significantly reduced the maximum tax rate, which affected the highest income earners, and lowered the top marginal tax rate from 70% to 50%; in 1986 he further reduced the rate to 28%.^[17] The federal deficit fell from 6% of GDP in 1983 to 3.2% of GDP in 1987.^[3] The Federal deficit in Reagan's final budget fell to 2.9% of GDP.^[2] The rate of growth in Federal spending fell from 4% under Jimmy Carter to 2.5% under Ronald Reagan.^[2] As a short-run strategy to reduce inflation and lower nominal interest rates, the U.S. borrowed both domestically and abroad to cover the Federal budget deficits, raising the national debt from $997 billion to $2.85 trillion.^[18] This led to the U.S. moving from the world's largest international creditor to the world's largest debtor nation.^[19] Reagan described the new debt as the "greatest disappointment" of his presidency.^[20]

The number of Americans below the poverty level increased from 29.272 million in 1980 to 31.745 million in 1988, which means that, as a percentage of the total population, it remained almost stationary, from 12.95% in 1980 to 13% in 1988.^[21] The poverty level for people under the age of 18 increased from 11.543 million in 1980 (18.3% of all child population) to 12.455 (19.5%) in 1988.^[22] The share of total income going to the 5% highest-income households grew from 16.5% in 1980 to 18.3% in 1988 and the share of the highest fifth increased from 44.1% to 46.3% in same years. In contrast, the share of total income of the lowest fifth fell from 4.2% in 1980 to 3.8% in 1988 and the second poorest fifth from 10.2% to 9.6%.^[23] And during Reagan's first term, homelessness became a visible problem in America's urban centers, leading many to blame Reaganomics.^[24] In the closing weeks of his presidency, Reagan told the New York Times that the homeless "make it their own choice for staying out there." ^[25] Political opponents chided his policies as "Trickle-down economics", due to the significant cuts in the upper tax brackets.^[26]

[edit] Tax receipts

During the Reagan administration, federal receipts grew at an average rate of 8.2% (2.5% attributed to higher Social Security receipts), and federal outlays grew at an annual rate of 7.1%.^[27][28] According to a 1996 report of the Joint Economic Committee of the United States Congress, during Reagan's two terms, and through 1993, the top 10% of taxpayers paid an increased share of tax revenue to the Federal government, while the lowest 50% of taxpayers paid a reduced share of the tax revenue.^[29]

According to a United States Department of the Treasury economic study,^[30] the major tax bills enacted under Reagan, in the short term, increased total tax revenue and reduced the tax burden on the economy (~-1% of GDP). The Economic Recovery Tax Act of 1981 resulted in a reduced tax burden on the economy (~-3% of GDP) and an increase in total tax revenues (the largest tax cuts ever enacted).^[31] while other tax bills had neutral or, in the case of the Tax Equity and Fiscal Responsibility Act of 1982, a (~+1% of GDP) increase in revenue as a share of GDP. It should be however noted that the study did not examine the longer-term impact of Reagan tax policy, including sunset clauses and "the long-run, fully-phased-in effect of the tax bills".^[30] The fact that tax receipts as a percentage of GDP fell following the Economic Recovery Tax Act of 1981 shows a decrease in tax burden as share of GDP. Total tax revenue from income tax receipts increased during this time. The economic growth and increase in GDP outpaced the increase in tax receipt revenue, resulting in a slightly reduced tax burden as a percentage of GDP for the economy.

[edit] Theoretical justification

In his 1980 campaign speeches, Reagan presented his economic proposals as merely a return to the free-enterprise principles that had been in favor before the Great Depression. At the same time he attracted a following from the supply-side economics movement, formed in opposition to Keynesian demand-stimulus economics. This movement produced some of the strongest supporters for Reagan's policies during his term in office.

The Laffer curve illustrates the theory of tax rate elasticity. A revenue-maximizing tax rate beyond which revenue falls, while cutting tax rates can increase revenue.

Proponents contend that the tax rate cuts would more than pay for themselves was influenced by the Laffer curve, a theoretical taxation model based on the elasticity of tax rates. Arthur Laffer's model predicts that excessive tax rates actually reduce potential tax revenues, by lowering the incentive to produce; the model also predicts that insufficient tax rates (rates below the optimum level for a given economy) lead directly to a reduction in tax revenues.

Before Reagan's election, supply side policy was considered unconventional by the moderate wing of the Republican Party. While running against Reagan for the Presidential nomination in 1980, George H. W. Bush had derided Reaganomics as "voodoo economics".^[33] Similarly, in 1976, Gerald Ford had severely criticized Reagan's proposal to turn back a large part of the Federal budget to the states. Reagan's policies became widely accepted by Republicans.

[edit] Evaluation

[edit] Impact

According to a 1996 study^[34] from libertarian think tank Cato Institute:

• On 8 of the 10 key economic variables examined, the American economy performed better during the Reagan years than during the pre- and post-Reagan years.
• Real median family income grew by $4,000 during the Reagan period after experiencing no growth in the pre-Reagan years; it experienced a loss of almost $1,500 in the post-Reagan years.
• Interest rates, inflation, and unemployment fell faster under Reagan than they did immediately before or after his presidency.
• The only economic variable that was worse in the Reagan period than in both the pre- and post-Reagan years was the savings rate, which fell rapidly in the 1980s.
• The productivity rate was higher in the pre-Reagan years but much lower in the post-Reagan years.

Stephen Moore of the Cato Institute stated that "no act in the last quarter century had a more profound impact on the US economy of the eighties and nineties than the Reagan tax cut of 1981." He claims that Reagan's tax cuts, combined with an emphasis on federal monetary policy, deregulation, and expansion of free trade created a sustained economic expansion creating America's greatest sustained wave of prosperity ever. The American economy grew by more than a third in size, producing a $15 trillion increase in American wealth. Every income group, from the richest, middle class and poorest in this country, grew its income (1981–1989). Consumer and investor confidence soared. Cutting federal income taxes, cutting the US government spending budget, cutting useless programs, scaling down the government work force, maintaining low interest rates, and keeping a watchful inflation hedge on the monetary supply was Ronald Reagan's formula for a successful economic turnaround. Critics, however, pointed to the ballooning of the federal deficit as the prime cause for the economic recovery. In the 1988 vice-presidential debate, Senator Lloyd Bensen (D-Tex) quipped, "If you let me write $200 billion worth of hot checks every year, I could give you an illusion of prosperity, too."^[35]

[edit] Considerations

Tax revenues as a pecent of GDP.^[36]

International transactions current account and the federal budget deficit led to a significant increase in public debt, but with a decrease in the rate of growth of federal spending. Nominal national debt rose from $900 billion to $2.8 trillion during Reagan's tenure while the federal deficit fell from 6% of GDP in 1983 to 3.2% of GDP in 1987.^[3] The federal deficit in Reagan's final budget fell to 2.9% of GDP.^[2] Advocates of the Laffer curve contend that the tax cuts did lead to a near doubling of tax receipts ($517 billion in 1980 to $1.032 trillion in 1990),^[37] so that the deficits were actually caused by an increase in government spending. An analysis calculated that the average real income-tax receipts per working-age person grew 0.2% from 1981 to 1990 and 3.1% from 1990 to 2001.^[38] In 1982, during Reagan's second year in office, the U.S. recession had not yet ended. The effect of Reagan's tax cuts were at least partially offset by phased in Social Security payroll tax increases that had been enacted by President Jimmy Carter and the 95th Congress in 1977.^[39] An accurate accounting indicates that receipts increased from $599 billion in 1981 to $1.032 trillion in 1990, an increase of 72%. In 2005 dollars, the receipts decreased from $1.25 trillion in 1981 to $1.13 trillion in 1983 and did not return to $1.25 trillion until 1985. The receipts in 1990 were $1.5 trillion in 2005 dollars, an increase of 20%.^[40] In contrast, from 1991 to 2000, receipts increased by 90% in current dollars, or 60% in 2005 dollars.

Real wages in the U.S.^[41]

Another recent critique of Reagan's policies stem from Tax Reform Act of 1986 and its impact on the Alternative Minimum Tax (AMT). The tax reform would ostensibly reduce or eliminate tax deductions. This legislation expanded the AMT from a law for untaxed rich investors to one refocused on middle class Americans who had children, owned a home, or lived in high tax states.^[42] This parallel tax system hit middle class Americans the hardest by reducing their deductions and effectively raising their taxes. Meanwhile, the highest income earners (with incomes exceeding $1,000,000) were proportionately less affected, thereby shifting the tax burden away from the richest 0.5% to poorer Americans.^[43] In 2006, the IRS's National Taxpayer Advocate's report highlighted the AMT as the single most serious problem with the tax code.^[44] As of 2007, the AMT brought in more tax revenue than the regular tax which has made it difficult for Congress to reform.^[43]

[edit] Keynesian interpretation

The following Keynesian interpretation of Reaganomics is given by Paul Krugman:^[45]

The secret of the long climb after 1982 was the economic plunge that preceded it. By the end of 1982 the U.S. economy was deeply depressed, with the worst unemployment rate since the Great Depression. So there was plenty of room to grow before the economy returned to anything like full employment.

In this view, Reaganomics was not a refutation but rather a confirmation of Keynesian economics: the expansion was primarily a recovery from the 1982 recession, which was created by the textbook Keynesian monetary policy of Volcker,^{[citation needed]} not the tax policy of Reagan. At the start of the Reagan administration, inflation was high. The textbook Keynesian prescription for high inflation is high interest rates (contractionary monetary policy),^{[citation needed]} designed to create a sustained period of high unemployment to break the price/wage spiral. Volcker did precisely this, creating the 1982 recession, then lowered interest rates once inflation was under control, resulting in economic growth and the unemployment rate coming down gradually.

Krugman argues that there is nothing unusual about the economy under Reagan – because unemployment was reducing from a high peak, it is entirely consistent with Keynesian economics for the economy to grow as employment increases while inflation remains low – the expansion was a cyclical recovery, but did not feature an increase in the structural rate of growth as its supply-side proponents argued.

[edit] Personal life

Ronald Reagan who had earned his Bachelor's degree in Economics claimed to be influenced by "classical economists" such as Frédéric Bastiat, Ludwig von Mises, Friedrich Hayek, and Henry Hazlitt.^[46] Upon Reagan's death, a memo released by Jude Wanniski, economics advisor to Reagan during his 1980 campaign, highlights Reagan's firm grasp of economic concepts and his knack for conveying them so a layperson could understand.^[47]

Not all of Reagan's advisors were privy to his beliefs on economics. Donald Regan, the President's former Secretary of the Treasury, and later Chief of Staff, noted: "In the four years that I served as Secretary of the Treasury, I never saw President Reagan alone and never discussed economic philosophy or fiscal and monetary policy with him one-on-one....The President never told me what he believed or what he wanted to accomplish in the field of economics.”^[48] Reagan's chief economic adviser, Martin Feldstein, stated: "I briefed him on Third World debt; he didn't take notes, he asked very few questions....The subject came up in a cabinet meeting and he summarized what he had heard perfectly. He had a remarkably good memory for oral presentation and could fit information into his own philosophy and make decisions on it."^[49]

[edit] See also

[edit] Footnotes

[edit] References

[edit] External links

• Laffer, Arthur. "The four pillars of Reaganomics". Heritage Foundation. http://www.heritage.org/research/economy/wm1311.cfm. 
• "Reaganomics". University of Houston. http://www.digitalhistory.uh.edu/database/article_display.cfm?HHID=406. 

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