The True Story of Reaganomics
Note: This is a research piece and I must therefore cite my sources. Since, however, the use of footnotes or endnotes is not available to me on this blog, I am forced to use parentheticals, which are ugly.
At the end of President Jimmy Carter’s four years, the American economy (and America in general) was in crisis. Rate of change of productivity was only a quarter of what it had been under Nixon and Ford (the only Presidents of the century who have performed more poorly in this department than Carter were Clinton and Hoover) (Cato 6). Real median family income was declining steeply (Cato 5-6). Worst of all was the combination of a stagnant economy and high inflation (“stagflation”) which seemed to violate Keynesian economic principle (D’Souza 90).
Keynes’s economics was the mainstay of the failed Carter policy. It had been developed by John Maynard Keynes during the great depression and enjoyed great success during the WWII era. It was “premised on the notion that experts can control the ups and downs of the economy by manipulating government spending and money supply” (D’Souza 90). Central to Keynesian theory was the Phillips Curve, which states that there is an inverse relationship between inflation and unemployment (D’Souza 90). The simultaneous double-digit inflation and the high unemployment rates of the Carter administration was baffling to the Keynesians -- fortunately, the American public had a chance to hurl Carter out of office just in time for Reagan to come in and clean things up.
Reagan had three major economic theories to choose from. First, the tried and untrue Keynesian view. Second, Monetarism, championed by Milton Friedman. The Monetarists believed that the bad economy (specifically high inflation) was the result of having too much money in circulation (D’Souza 90). They therefore favored strict control of money supply as a means of lowering inflation.
The last school of thought was supply-side economics. Supply-siders wanted to cut tax rates, thereby increasing the incentive of workers to produce, and “invigorating the economy from the production or ‘supply’ side” (D’Souza 90). Supply-side economics encourages growth “arising from a free response (e.g. investment, hard work, etc.)” (Bartlett 3).
Supply-side economics is identified with economists Robert Mundell and Arthur Laffer. The Laffer Curve, central to supply-side theory, predicts that there are two different rates of taxation that will generate the same government revenue, and that there is a single optimal rate that generates the most revenue (D’Souza 91). For example, if the government were to tax the people at 0% or 100%, the revenue generated would be zero dollars in either case -- at 0% the government will not be collecting, at a 100% the people will have no incentive to produce (D’Souza 91). The idea therefore was to achieve increased government revenue with tax rates lower than they had been under the Carter administration. Interestingly enough, this theory had been advanced by President Coolidge in 1924 (quoted in Bartlett 211). It is also worth noting that Reagan would achieve the second-longest period of sustained economic growth in the 20th century with the second-largest tax cut. JFK had achieved the longest period of sustained economic growth in the 20th century with the largest tax cut (Cato 13).
Supply-side economics has often been unfairly caricatured as “trickle-down” economics by its opponents. They claim that Reagan’s tax policies were designed to stimulate the economy by giving all riches to the richest people, and letting the effects of their increased spending “trickle down” to the lower classes. This is not what Reagan’s tax cuts achieved -- his first and biggest tax cut was the same percentage for all income brackets. Needless to say, this resulted in a greater increase in wealth for the wealthier brackets, simply because they had been paying far greater taxes.
Reagan wanted to use a combination of monetarist and supply-side economics in a Friedman-Mundell compatibility theory that was the subject of heated debate among the leading economists of the day (Niskanen 8). The proposed economic policy had four main parts: 1) A supply-side 25% tax cut across the board; 2) Tight control of money supply as per monetarist theory; 3) A limit on domestic spending to control the budget; 4) A reduction of government regulation (Cato 2). This is Reaganomics.
Reagan predicted that his program would end the “economic woes” of the Carter administration and bring the US “lasting economic growth and prosperity” (D’Souza 85). Reagan’s plan was revolutionary -- “the most ambitious program for America since the New Deal” (D’Souza 85). Its core was tax cuts, which involved Reagan most directly and had been the main plank of his campaign platform (JEC 1).
Reagan was expected to have trouble getting his policies enacted -- tax cuts in particular. Republicans had only a slim majority in the Senate, and the Democrats controlled the House under Speaker Tip O’Neill (who turned out to be the major obstacle to Reagan’s tax plan). Reagan used the “acumen and experience of his aides, especially Chief of Staff James Baker…to win the support of moderate Republicans in the Senate and Conservative Democrats in the House,” without which he would not have had the votes he needed (D’Souza 93). In his most effective move, Reagan made a remarkable national TV address in which he requested that Americans write and call their representatives and demand passage of his tax plan. “The response was overwhelming” (D’Souza 93).
The 25% tax cuts were passed in the Economic Recovery Tax Act of 1981 (often called the Kemp-Roth Tax Cut after its sponsors in the House and Senate respectively). The tax cut was introduced gradually, with the first cut of 5% in 1981 and the last in 1983 (JEC 1). The act also included a provision to index tax rates for inflation starting in 1985, ending the phenomenon of bracket creep (when a person earns the same in real terms but moves into a higher bracket because he is paid in devalued dollars) (D’Souza 93). Getting the act passed was, in the words of Reagan critic Ronnie Dugger, a feat that “no ordinary person could have achieved” (D’Souza 89).
In the final year of the tax cuts’ implementation (1983) the United States “commenced a seven-year period of uninterrupted growth…the biggest peacetime economic boom in US history" (D’Souza 109). As Reagan biographer Dinesh D’Souza continues:
At a growth rate of 3.5%, well above the nation’s historic average, the gross domestic product expanded by nearly a third in real terms. Measured in 1990 dollars, median family income, which had declined during the 1970s, climbed from $33,409 in 1980 to $38,493 in 1989, a 15 percent increase. While European countries were facing chronically high unemployment rates, in America 5 million new businesses and 20 million new jobs were created, largely solving the nation’s unemployment problems. Interest rates fell from 20 percent in 1980 to less that 10 percent. Despite sporadic ups and downs, including the steep fall of Black Monday in October 1987, the stock market more than doubled in value. Most spectacular, these results were achieved with low inflation. The double-digit price increase of the Carter years simply vanished; inflation became an insignificant problem in the Reagan era.
Former CEA chairman Murray Wiedenbaum made some interesting comparisons between the Carter and Reagan administrations in an op-ed for The Christian Science Monitor: “Real GDP declined by one-half of 1 percent in 1980, President Carter’s last year, and rose 3.9 percent in 1988, President Reagan’s last year…the unemployment rate declined from 7.0% in 1980 to 5.4% in 1988...real national wealth rose from $11.9 trillion in 1980 to $14.2 trillion in 1988” (Wiedenbaum 1).
The productivity rate during the Reagan administration increased two and a half times faster than it had during the Carter administration (Cato 5-6). The “Reagan Recovery” lasted 92 months -- the “second longest uninterrupted economic expansion of the century” (Cato 20). Furthermore, the supply-side theory of greater revenues from lower tax rates, along with lowered burden on the lower brackets, was vindicated. The wealthiest 1% of all Americans had paid 18% of all Federal income taxes in 1981, but by 1990, with their taxes substantially reduced, they paid 25% of all Federal income taxes (Cato 20). Similarly, the wealthiest 5% of Americans, who paid 25% of all Federal income taxes in 1981, paid 44% of all Federal income taxes in 1990 (Cato 17).
There are three chief criticisms of Reaganomics. The first is that the Reagan expansion was the result of Keynesian, not Supply-Side economics (“Reagan’s economic program actually amounted to the longest and most successful Keynesian recovery the world has yet seen” ran an erroneous editorial in Newsday) (quoted in Cato 12).
The most obvious argument against this claim is in the fact that, if this were a Keynesian recovery, the Keynesian economists would have predicted it. As D’Souza writes, most Keynesian economists “had warned instead that Reagan’s policies would lead to higher rates of inflation. Not only did this prove to be false, but the very economic facts of the recovery had once again falsified the Phillips curve” (D’Souza 110). Furthermore, since Keynesian economics operates under the belief that the economy is demand-driven, demand should have grown rapidly during the 1980s; in reality, the rate of demand growth fell (Cato 12).
The second main criticism of Reaganomics is that “the poor got poorer and the very rich grew fabulously richer, while middle-class incomes largely stagnated” (as my 11th grade history text, The American Pageant, falsely claims).
JFK once said that “a rising tide lifts all boats” and the Reagan recovery has shown this to be true. During the Reagan years, real family income increased in all five income brackets (Cato 15). During the Carter years, real family income decreased for the two poorest quintiles, stayed the same (“largely stagnated”) for the middle quintile, and increased only for the two richest quintiles (Cato 15). In other words, what the so-called textbook The American Pageant claims to have happened as a result of Reagan’s policies was actually going on during the Carter administration. The change in real family income of the poorest quintile was -5% during the Carter years and +6% during the Reagan years (Cato 16). 85.8% of those in the lowest quintile in 1979 were in a higher quintile by 1988 (Cato 16). In addition, a man who had been in the poorest quintile in 1979 was more likely to have moved to the highest quintile by 1988 than he was to still be in the lowest (Cato 15). Articles such as “The Disappearance of the Middle Class” (which appeared in the New York Times magazine) claimed that, since the middle class was getting smaller, the country must be getting poorer (D’Souza 111). This complaint ignores the fact that, while there was a fall in the percent of Americans in the middle class, there was a corresponding rise in the number of Americans in the upper class -- in other words, “a substantial number of middle-class Americans became rich” (D’Souza 113).
The last major criticism of Reaganomics is the claim that the tax cuts caused a huge increase in the budget deficit. This is untrue -- the main reason for the deficit was the increase in defense spending. The increase of $799 billion in the deficit during the Reagan years was actually smaller than the increase in defense spending of $806 billion (Cato 9). This increase in defense spending, however, was more than paid for by the Cold War victory that it helped to bring about. As D’Souza writes: “[Economist Lawrence Lindsey] calculates that the country’s defense savings since the collapse of the Soviet Union have more than compensated for the investment that Reagan made in the 1980s…In purely economic terms, the buildup was a ‘fantastic payoff -- the best money we ever spent’” (D’Souza 99).
One must also remember that it is incorrect to say simply that “deficits are bad.” All things being equal, we would rather not have a deficit. But all things are not equal: A deficit is better than a weak economy; it is better than having a communist superpower, and it is also better than having a surplus. (Remember that a surplus is actually government theft -- taking more money from the taxpayer than it needs to run the country). A deficit is also a indicator of a country that is economically strong -- it shows that people everywhere (our own citizens and foreign nations) are willing to invest in the United States. (Assuming that, as during the Reagan administration, the Treasury can keep interest rates low).
Reaganomics was tremendously successful. The “Reagan recession,” which was actually the tail-end of Carter’s great recession, ended when the tax cuts took effect, and America’s economy experienced an extraordinarily powerful recovery that lasted well into the 1990s (D’Souza 109,128). The “seemingly insoluble” problem of stagflation was solved (D’Souza 127). Reagan’s astonishingly simple solution turned out to be the best -- all we had to do was “give it back to the taxpayers” (D’Souza 67).
Bartlett, Bruce R. Reaganomics: Supply Side Economics in Action. Westport: Arlington House, 1981.
D'Souza, Dinesh. Ronald Reagan. New York: The Free P, 1997.
Moore, Stephan, and William A. Niskanen. "Supply Tax Cuts and the Truth About the Reagan Economic Record." The Cato Institute (1996).
Niskanen, William A. Reaganomics: An Insider's Account of the Policies and the People. New York: Oxford UP, 1988.
United States. Joint Economic Committee. The Reagan Tax Cuts: Lessons for Tax Reform. Apr. 1996.
Wiedenbaum , Murray. "Reaganomics - Its Remarkable Results'." The Christian Science Monitor. 18 Dec. 1997.