Reaganomics

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

Reaganomics ( /reɪɡəˈnɒmɪks/; 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. These policies are commonly associated with supply-side economics, or pejoratively as trickle-down economics or voodoo economics.

The four pillars of Reagan's economic policy were to reduce the growth of government spending, reduce income tax and capital gains tax, reduce government regulation of economy, and control money supply to reduce inflation.^[2]

Historical context

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

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.^[3] 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,^[3] and long term easing of supply and pricing in oil during the 1980s oil glut.

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. During Reagan's presidency the annual deficits averaged 4.2% of GDP^[4] after inheriting an annual deficit of 2.7% of GDP in 1980 under president Carter.^[4] The rate of growth in federal spending fell from 4% under Jimmy Carter to 2.5% under Ronald Reagan. GDP per working-age adult, which had increased at only a 0.8% annual rate during the Carter administration, increased at a 1.8% rate during the Reagan administration. The increase in productivity growth was even higher: output per hour in the business sector, which had been roughly constant in the Carter years, increased at a 1.4% rate in the Reagan years. ^[2]

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".^[5] 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 have since become widely accepted by many Republicans.

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. Cutting tax rates can increase revenue if the tax rate is beyond the revenue-maximizing tax rate (if the tax rate is to the right of the peak), and decrease revenue if the tax rate is to the left of the peak.

The contention of the proponents, that the tax rate cuts would more than pay for themselves, was influenced by a theoretical taxation model based on the elasticity of tax rates, known as the Laffer curve. 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.

Policies

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]} Reagan followed his 1981 tax cut with two large tax increases.^[7] In 1982 Reagan agreed to a rollback of corporate tax cuts and a smaller rollback of individual income tax cuts. The 1982 tax increase undid a third of the initial tax cut. In 1983 Reagan instituted a payroll tax on Social Security and Medicare hospital insurance.^[8]

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. Ultimately, the combination of base broadening and rate reduction raised revenue equal to about 4% of existing tax revenue^[9]

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

The primary effect of the tax changes over the course of Reagan's term in office was a change in the composition of tax revenue, towards payroll and new investment, and away from higher earners and capital gains on existing investments. Federal revenue share of GDP declined from 19.6% in fiscal 1981 to 17.3% in 1984, before climbing back to 18.4% by fiscal year 1989. Personal income tax revenues fell during this period relative to GDP, while payroll tax revenues rose relative to GDP.^[4] President Ronald Reagan's 1981 cut in the top regular tax rate on unearned income reduced the maximum capital gains rate to only 20%--its lowest level since the Hoover administration.^[10] This tax benefits the wealthy, however, in 1986 President Reagan set tax rates on capital gains at the same level as the rates on ordinary income like salaries and wages, with both topping out at 28 percent.^[11]

Reagan significantly increased public expenditures, 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.^[12] 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%.^[13] The federal deficit fell from 6% of GDP in 1983 to 3.2% of GDP in 1987.^[14] 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.^[15] This led to the U.S. moving from the world's largest international creditor to the world's largest debtor nation.^[16] Reagan described the new debt as the "greatest disappointment" of his presidency.^[17]

According to William A. Niskanen, one of the architects of Reaganomics, "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 70.1% to 28.4%, 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][18] President Reagan, has remained popular as an antitax hero despite raising taxes eleven times over the course of his presidency, all in the name of fiscal responsibility.^[19] Reagan ultimately raised taxes more times than he cut them.^[20] According to Paul Krugman, "Over all, the 1982 tax increase undid about a third of the 1981 cut; as a share of G.D.P., the increase was substantially larger than Mr. Clinton's 1993 tax increase."^[21] According to historian and domestic policy adviser Bruce Bartlett, Reagan's tax increases over the course of his presidency took back half of the 1981 tax cut.^[22]

Results

Spending during Reagan's two terms (FY 1981-88) averaged 22.4% GDP, well above the 20.6% GDP average from 1971 to 2009. In addition, the public debt rose from 26% GDP in 1980 to 41% GDP by 1988. In dollar terms, the public debt rose from $712 billion in 1980 to $2,052 billion in 1988, a roughly three-fold increase. ^[4] The unemployment rate rose from 7% in 1980 to 10.8% in 1982, then declined to 5.4% in 1988. The inflation rate declined from 10% in 1980 to 4% in 1988.^[2]

It has been claimed that Reagan's policies brought about the second longest peacetime economic expansion in U.S. history, surpassed in duration only by the 1990s expansion that began with George H.W. Bush in 1991 and ended with George W. Bush in 2001.^[23][24] This economic expansion continued through the Clinton administration with unemployment rates steadily decreasing throughout his presidency (7.3% at the start of his presidency and 4.2% at the culmination, with the lowest rate reaching 3.9% in 2000). ^[25] 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),^[26] which reduced the unemployment rate by 1.6%, from 7.1% in 1980 to 5.5% in 1988, but with peaks of around 10.8% in 1983. ^[25][27] 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.^[28] 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).^[29] The latter contributed to a relatively brief recession in 1982: unemployment rose to 9.7% and GDP fell by 1.9%.

The job growth under the Reagan administration was an average of 2.1% per year, with unemployment averaging 7.5%. Comparing the recovery from the 1981-82 recession (1983–1990) with the years between 1971 (end of a recession) and 1980 shows that the rate of growth of real GDP per capita averaged 2.77 under Reagan and 2.50% under Nixon, Ford and Carter. However, the unemployment rate averaged higher under Reagan (6.75% vs. 6.35%), while the average productivity growth was slower under Reagan (1.38% vs. 1.92%), and private investment as a percentage of GDP also averaged lower under Reagan (16.08% vs. 16.86%). Furthermore, real wages declined sharply during the Reagan Presidency.^[30]

The number of Americans below the poverty level increased 8.4% 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.^[31] 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.^[32] 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%.^[33] And during Reagan's first term, homelessness became a visible problem in America's urban centers, leading many to blame Reaganomics.^[34] 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."^[35] Political opponents chided his policies as "Trickle-down economics", due to the significant cuts in the upper tax brackets.^[36]

Tax revenues as a percent of GDP.^[37]

During the Reagan administration, federal receipts grew from $618 billion to $991 billion (an increase of 53%); while outlays grew from $ 746 billion to $1144 billion (an increase of 60%).^[38][39][40] 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 income taxes (not including payroll taxes) to the Federal government, while the lowest 50% of taxpayers paid a reduced share of income tax revenue.^[41] Personal income tax revenues declined from 9.4% GDP in 1981 to 8.3% GDP in 1989, while payroll tax revenues increased from 6.0% GDP to 6.7% GDP during the same period.^[4] This represented a more regressive tax regime, with more revenue derived from the flat payroll tax versus the progressive income tax.

According to a United States Department of the Treasury economic study,^[42] 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) but a decrease in total tax revenues (the largest tax cuts ever enacted).^[43] 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".^[42] 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.

Budget Deficit in Billions of Dollars.

Reagan's tax policies contributed to an increase in both the international transactions current account deficit and federal budget deficit, as well as a significant increase in public debt. National debt more than tripled from 900 billion dollars to 2.8 trillion dollars during Reagan's tenure. 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.^[14] 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),^[45] so that the deficits were actually caused by an increase in government spending.

However, an analysis from the Center on Budget and Policy Priorities argues that "history shows that the large reductions in income tax rates in 1981 were followed by abnormally slow growth in income tax receipts, while the increases in income-tax rates enacted in 1990 and 1993 were followed by sizeable growth in income-tax receipts." Specifically, the analysis calculated that the average annual growth rate of real income-tax receipts per working-age person was 0.2% from 1981 to 1990 and a much higher 3.1% from 1990 to 2001.^[46] 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 only 20%.^[47] In contrast, from 1991 to 2000, receipts increased by 90% in current dollars, or 60% in 2005 dollars.

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.^[48] 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%.^[49] In contrast, from 1991 to 2000, receipts increased by 90% in current dollars, or 60% in 2005 dollars.

Critics point to declining real wages as a result of Reaganomics.^[50]

Interpretations

Positive interpretations

According to a 1996 study from libertarian think tank Cato Institute:^[51]

• 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. He also claims that the American economy grew by more than a third in size, producing a $15 trillion increase in American wealth. 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.

In a speech by Milton Friedman to the Cato Institute:^[52], Friedman states that "Reaganomics had four simple principles: lower marginal tax rates, less regulation, restrained government spending, noninflationary monetary policy. Though Reagan did not achieve all of his goals, he made good progress." This is why entrepreneurs flourished under Reaganomics: lower tax rates and inflation coupled with less regulation favored improved environments for market-based funding, risk-taking, access to labor (leading to greater employment), and a more level playing field between these entrepreneurs and large corporations. Illustrating this, the Heritage Foundation:^[53] states that this is why "the U.S. government must allow the entrepreneur to enjoy the rewards of success. If taxes take away most profit, then the entrepreneur will have less incentive to take a risk. If there are great restrictions on how the entrepreneur can use his profit, then there is little reason for the entrepreneur to take a risk. The entrepreneur's courage to take a risk is what leads to new American discoveries and what drives the U.S. economy forward. Reaganomics knows this. It is one of the reasons why Ronald Reagan has reduced American taxes dramatically".

Negative interpretations

A common criticism 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.^[54] 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.^[55] In 2006, the IRS's National Taxpayer Advocate's report highlighted the AMT as the single most serious problem with the tax code.^[56] As of 2007, the AMT brought in more tax revenue than the regular tax which has made it difficult for Congress to reform.^[55]

Economist Paul Krugman argues the economic expansion during the Reagan administration was primarily the result of the business cycle and the Keynesian monetary policy of Volcker.^[57] Krugman argues that there was nothing unusual about the economy under Reagan because unemployment was reducing from a high peak and that it is consistent with Keynesian economics for the economy to grow as employment increases if inflation remains low. Says Krugman:^[58]

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.

Krugman also notes that federal spending during Reagan's two terms (FY 1981-88) averaged 22.4% GDP, well above the 20.6% GDP average from 1971 to 2009. In addition, the public debt rose from 26.1% GDP in 1980 to 41.0% GDP by 1988. In dollar terms, the public debt rose from $712 billion in 1980 to $2,052 billion in 1988, a three-fold increase.^[4] Krugman therefore argues that these policies, combined with the temporary reduction in taxes during the early 1980s recession, is consistent with Keynesian stimulus theories.

According to William Niskanen, former chairman of the Cato Institute, the Reagan years left three major adverse economic legacies. First, privately held federal debt increased from 22% to 38% of GDP, despite a long peacetime expansion. Second, failure to address the savings and loan problem early led to an additional debt of about $125 billion. Third, trade barriers increased drastically – the share of U.S. imports subject to trade restrictions increased from 12% in 1980 to 23% in 1988.^[2]

Deregulation

A controversial issue concerning Reaganomics is the issue of how much deregulation took place during the Reagan administration. 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."^[59] Furthermore, economists Paul Joskow and Roger Noll argue that the changes in economic regulation did not reflect a sudden ideological change in federal executive branch views and that that many significant reductions in government regulation of the economy occurred during the Carter administration. ^[60]

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.^[61] The number of pages in Federal Register is however criticized as an extremely crude measure of regulatory activity, because it can be easily manipulated (e.g. font sizes have been changed to keep page count low).^[62] 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).

See also

Footnotes

References

External links

• Laffer, Arthur. "The four pillars of Reaganomics". The 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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