Reaganomics

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Reagan gives a televised address from the Oval Office, outlining his plan for Tax Reduction Legislation in July 1981
Reagan gives a televised address from the Oval Office, outlining his plan for Tax Reduction Legislation in July 1981

Reaganomics (a portmanteau of "Reagan" and "economics") refers to the economic policies promoted by United States President Ronald Reagan. The four pillars of Reagan's economic policy were to:[1]

  1. reduce the growth of government spending,
  2. reduce marginal tax rates on income from labor and capital,
  3. reduce government regulation of the economy,
  4. control the money supply to reduce inflation.

In attempting to cut back on domestic spending while lowering taxes, Reagan's approach was a departure from his immediate predecessors.

Reagan became president during a period of high inflation and unemployment (commonly referred to as stagflation), which had largely abated by the time he left office. It continues to be a matter of debate to what extent this was caused by Reagan's fiscal policies and to what extent it was due to other factors, such as the inflation-fighting monetary policies of the Federal Reserve under Paul Volcker and a large decline in oil prices caused by the resolution of supply shocks in the Middle East.

Contents

[edit] Historical context

Prior to the Reagan Administration was a roughly ten year period of economic stagnation and inflation, known as stagflation. Political pressure favored stimulus resulting in an expansion of the money supply. Nixon's wage and price controls were abandoned.[2] Under Ford the problems continued, but policy was more prudent. The federal oil reserves were created to ease any future short term shocks. Carter started phasing out price controls on petroleum, but 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 under Paul Volcker, initiated in the last year of Carter's presidency,[3] and to long term easing of supply and pricing in oil during the 1980s oil glut. By the time Reagan took office, stagflation was near its end and for the remainder of his presidency the economy performed well. There was a renewed emphasis on prudent macroeconomic policy; Nixon's price controls and similar heavy handed species of government intervention had fallen out of favor, while subtler forms such as prudent monetary policy gained favor.

[edit] Policies

The Reagan era was marked by cuts to social programs, and large-scale deficit spending on the military. Reaganomics had its roots in two of Reagan's campaign promises: lower taxes and a smaller government. Reagan reduced income tax rates, with the largest rate reductions on the highest incomes; in a time of battling inflation, Reagan raised deficit spending to its highest level (relative to GDP) since World War II. As a result, there has been endless debate on whether the economic trends of the Reagan years actually came from the free market, or from government stimulus of the kind advocated by Keynesian theorists.

He lifted remaining domestic petroleum price and allocation controls on January 28, 1981[4] 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.

With the Tax Reform Act of 1986, Reagan and Congress sought to broaden the tax base and reduce perceived tax favoritism. 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. Economists of most affiliations favor cleaning up the tax code, since tax preferences and exceptions distort economic decisions.[citation needed]

Nobel Prize-winning 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.[5]

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."[6] Economist William 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[7] and that Reagan "failed to sustain the momentum for deregulation initiated in the 1970s." The apparent contradiction with Friedman's data may be resolved by seeing Niskanen as referring to statutory deregulation and Friedman to administrative deregulation. 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."[8]

[edit] Economic record

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

During Reagan's tenure, income tax rates of the top personal tax bracket dropped from 70% to 28% in 7 years,[9] while payroll taxes increased as well as the effective tax rates on the lower two income quintiles.[10][11] Real Gross Domestic Product (GDP) growth recovered strongly after the 1982 recession and grew during Reagan's remaining years in office at an annual rate of 3.4% per year,[12] slightly lower than the post-World War II average of 3.6%.[13] Unemployment peaked at over 10.7% percent in 1982 then dropped during the rest of Reagan's terms, and inflation significantly decreased.[14] A net job increase of about 16 million also occurred (about the rate of population growth).

The policies were derided by some as "Trickle-down economics,"[15] due to the facts that the combination of significant cuts in the upper tax brackets. There was a massive increase in Cold War related defense spending caused large budget deficits,[16] the U.S. trade deficit expansion,[16] and contributed to the Savings and Loan crisis,[17] as well as the stock market crash of 1987. In order to cover new federal budget deficits, the United States borrowed heavily both domestically and abroad, raising the national debt from $700 billion to $3 trillion,[18] and the United States moved from being 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.[18]

Donald Regan, the President's former Secretary of the Treasury, and later Chief of Staff, criticized Reagan for his supposed lack of understanding of economics: "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.”[20] However, Reagan's chief economic advisor Martin Feldstein, argues the opposite: "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."[21]

[edit] Tax receipts

According to a United States Department of the Treasury non-partisan economic study,[22] the major tax bills enacted under Reagan, as a whole, significantly reduced (~-1% of GDP) government tax receipts. Separated out, however, it is clear that the Economic Recovery Tax Act of 1981 was a massive (~-3% of GDP) decrease in revenues (the largest tax cuts ever enacted)[23], while other tax bills had neutral or, in the case of the Tax Equity and Fiscal Responsibility Act of 1982, significant (~+1% of GDP) government revenue-enhancing effects:

Revenue effects of major tax bills enacted under Reagan (as percentage of GDP)[22]
Number of years after enactment
Tax bill 1 2 3 4 First 2-yr avg 4-yr avg
Economic Recovery Tax Act of 1981 -1.21 -2.60 -3.58 -4.15 -1.91 -2.89
Tax Equity and Fiscal Responsibility Act of 1982 0.53 1.07 1.08 1.23 0.80 0.98
Highway Revenue Act of 1982 0.05 0.11 0.10 0.09 0.08 0.09
Social Security Amendments of 1983 0.17 0.22 0.22 0.24 0.20 0.21
Interest and Dividend Tax Compliance Act of 1983 -0.07 -0.06 -0.05 -0.04 -0.07 -0.05
Deficit Reduction Act of 1984 0.24 0.37 0.47 0.49 0.30 0.39
Omnibus Budget Reconciliation Act of 1985 0.02 0.06 0.06 0.06 0.04 0.05
Tax Reform Act of 1986 0.41 0.02 -0.23 -0.16 0.22 0.01
Omnibus Budget Reconciliation Act of 1987 0.19 0.28 0.30 0.27 0.24 0.26
Total 0.33 -0.53 -1.63 -1.97 -0.10 -0.95

[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 belief by some proponents of Reaganomics that the tax rate cuts would more than pay for themselves was influenced by the Laffer curve, a theoretical taxation model that was particularly in vogue among some American conservatives during the 1970s. Arthur Laffer's model predicts that excessive tax rates actually reduce potential tax revenues, by lowering the incentive to produce.

Before Reagan's election, Reaganomics was considered extreme by the moderate wing of the Republican Party. While running against Reagan for the Presidential nomination in 1980, George Bush had derided Reaganomics as "voodoo economics".[24] Similarly, in 1976, Gerald Ford had severely criticized Reagan's proposal to turn back a large part of the Federal budget to the states. Since Reagan's presidency, however, Republican federal politicians have for the most part continued to support his program of low taxes and private sector growth.

[edit] Empirical support

According to a 1996 study[25] from the 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-Reagans years.

[edit] Criticisms

Reagan's tax policies were accused of pushing both the international transactions current account and the federal budget into deficit and led to a significant increase in public debt. 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 billion in 1990), so that the deficits were actually caused by an increase in government spending. However, critics argue that the doubling of revenue is significantly smaller when looking at real inflation-adjusted figures ($1,077.4 billion in 1981 to $1,235.6 billion in 1988, measured in FY2000-dollars). Furthermore, 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.

A recession occurred in 1982, his second year in office. This was central to Volcker's campaign against inflation: applying either the Phillips Curve or the NAIRU theory, high unemployment (more than 10 % of the labor force in both 1982 and 1983) undercuts inflation. Reagan benefited from the fact that Volcker relented (shifting to more expansionary monetary policy) after inflation had largely been beaten. Further, the sudden fall in oil prices around 1986 helped the economy attain demand growth without inflation in the late 1980s.

The job growth under the Reagan administration was an average of 2.1% per year, which is in the middle of the pack of twentieth-century Presidents.[citation needed]

[edit] Humor

Reagan himself made light of the term "Reaganomics." In a July 10, 1987 White House Briefing for Members of the Deficit Reduction Coalition, he said, "America astonished the world. Chicago school economics, supply-side economics, call it what you will — I noticed that it was even known as Reaganomics at one point until it started working — all of it is fast becoming orthodoxy. It’s not just that Milton Friedman or Friedrich von Hayek or George Stigler have won Nobel Prizes; other younger names, unheard of a few years ago, are now also celebrated."

[edit] See also

[edit] Footnotes

  1. ^ William A. Niskanen. Reaganomics. The Concise Encyclopedia of Economics. Retrieved on 2007-05-22.
  2. ^ Alan Greenspan, The Age of Turbulence, Penguin Press, 2007.
  3. ^ alan greenspan, age of turbulence, Penguin Press, 2007.
  4. ^ "Executive Order 12287 -- Decontrol of Crude Oil and Refined Petroleum Products", January 28, 1981. 
  5. ^ Friedman, Milton (2004-06-11). "Freedom's Friend". Wall Street Journal. 
  6. ^ Saving Capitalism from the Capitalists p. 268.
  7. ^ Reaganomics by William A. Niskanen
  8. ^ American Economic Policy in the 1980s, ed. Martin Feldstein, NBER 1994, pp. 371-72.
  9. ^ Daniel J. Mitchell, Ph.D. (July 19, 1996). The Historical Lessons of Lower Tax Rates. The Heritage Foundation. Retrieved on 2007-05-22.
  10. ^ Social Security and Medicare Tax Rates. Social Security Administration (Jul 10, 2007).
  11. ^ Effective Federal Tax Rates: 1979-2001. Bureau of Economic Analysis (Jul 10, 2007).
  12. ^ Gross Domestic Product. Bureau of Economic Analysis (May 31, 2007).
  13. ^ John Miller (July/August 2004). Ronald Reagan's Legacy. Dollars and Sense. Retrieved on 2007-06-26.
  14. ^ Ronald Reagan. Microsoft Corporation (2007). Retrieved on 2007-07-27.
  15. ^ Danziger, S.H.; D.H. Weinburg (1994). "The Historical Record: Trends in Family Income, Inequality, and Poverty" in Confronting Poverty: Prescriptions for Change. 
  16. ^ a b Page not found 2008-05-24 Etebari, Mehrun (July 17, 2003). Trickle-Down Economics: Four Reasons why it Just Doesn't Work. faireconomy.org. Retrieved on 2007-03-31.
  17. ^ The S&L Crisis: A Chrono-Bibliography. Federal Deposit Insurance Corporation. Retrieved on 2007-04-08.
  18. ^ a b Cannon, Lou (2001) p. 128
  19. ^ Reagan Policies Gave Green Light to Red Ink. The Washington Post. Retrieved on 2007-05-25.
  20. ^ Regan, Donald T. (1988), p. 142
  21. ^ Lee, Susan. 1996. Hands Off: Why the Government is a Menace to Economic Health. Simon & Schuster. p. 223
  22. ^ a b Office of Tax Analysis (2003, rev. Sept 2006). "Revenue Effects of Major Tax Bills". United States Department of the Treasury. Working Paper 81, Table 2. 
  23. ^ Thorndike, Joseph J (14 June). Historical Perspective: The Reagan Legacy. Taxhistory.org. Retrieved on 2007-11-28.
  24. ^ Reagonomics or 'voodoo economics'?
  25. ^ Supply-Side Tax Cuts and the Truth about the Reagan Economic Record, by William A. Niskanen and Stephen Moore

[edit] References

  • Niskanen W.A. (1988) Reaganomics: An Insider's Account of the Policies and the People, Oxford University Press, Oxford.
  • Boskin Michael J. (1987) Reagan and the US Economy. The Successes, Failures, and Unfinished Agenda, ICEG.
  • Bienkowski Wojciech, Brada Josef, Radlo Mariusz-Jan eds. (2006) Reaganomics Goes Global. What Can the EU, Russia and Transition Countries Learn from the USA?, Palgrave Macmillan.

[edit] External links

Online Debate between Proponent and Opponent:

Proponent Think Tank Papers:

Opponent Papers by Economists:

Mixed Assessment

The President Reagan Information Page

PBS Commanding Heights: The Battle for the World Economy

Encyclopedia articles from the Concise Encyclopedia of Economics on Econlib:

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