In the 1980's America enjoyed its best-ever economic cycles; by 2008, we are facing substantial economic difficulties. How did this happen? Two factors seemed to have injured our economy: government regulation of free markets, and government spending. [Note: this post was greatly influenced Lara Khadr, who wrote and posted a text making some of the same or similar points. I have shamelessly stolen both ideas and actual paragraphs of text from her posting. Lara did, at some points, take a very different view of things, so no assumptions about her convictions should be taken from this post. Whatever is worthy about this post is probably her thinking, whatever is deficient about it is probably mine.]
Ronald Reagan is simultaneously considered one of the greatest and most controversial presidents in United States history. His presidency was marked by many political transformations, especially in the realm of economics. The economic doctrine Reagan adopted during his presidency, commonly referred to as “Reaganomics,” contributed to an era of Great Expansion in the mid-1980s. However, some argue that the effects of economic expansion, and the long-term growth that Reagan had envisioned, were undermined by later fiscal and monetary policy decisions made after Reagan left office.
Ronald Reagan’s economic program consisted of four major pillars: reduce the rate of growth of federal spending, carry on with deregulation, attain a low stable growth of money supply, and reduce tax rates. The goal of Reaganomics was to reduce government interference with the economy and develop an entrepreneurial-based self-sufficient market. His goals and the pillars that outlined his program embraced the principles of supply-side economics that gained popularity during the 1970’s and 1980’s. Supply-side economics focused more on creating supplies versus worrying about demand. Reductions in taxes did this, as more businesses could afford to open and they would increase productivity. An increase in productivity brought more jobs and reduced unemployment that had reached a record high at the time Reagan initially took office.
Reagan used deregulation to ease inflation, which was also very high at the time, by lowering the cost to start a business. Prices were reduced and as a result, competition increased, in the trucking, airline, railroad, and telecommunications industries. Growth in prosperity in these industries spread to other industries, as transportation and telecommunications are central to society.
By deregulating the communications industry, there was a burst in technological innovation, which helped the United States become competitive on an international level in that arena. This correlated perfectly with the technological revolution of the 1980’s, as personal computers and video games burst in popularity. A further conversation on deregulation and its possible effects is beyond the scope of this paper, and the aspects of it that pertain directly to supply-side economics have been discussed.
As a result of the implementation of Reaganomics, the 1980’s saw a tremendous growth in jobs and businesses, and a reduction in inflation in a short period of time. Tax cuts helped bring 19.3 million jobs during the decade, with the majority of them being highly paid. The unemployment rate fell from 10.8 percent in 1981 to 5.3 percent in 1989. When Reagan first entered office in 1981, the United States was in the worst recession the country had seen since the Great Depression. By 1982, the recession was alleviated, and the country entered a period of sustained economic growth.
In early 1983, economists saw the first signs that the economy was recovering. It would soon take-off with dramatic force. Lasting 93 consecutive months, it was the biggest peacetime economic expansion in U.S. history.
The background of Reaganomics can be traced back to post-war economies, a vague term that roughly describes the economies of the 1950’s and 1960’s, which leaned towards the Keynesian theory. This “demand-side” theory, presented by British economist John Maynard Keynes in his 1936 book The General Theory of Employment, Interest, and Money, focuses on short-term economic fluctuations due to the belief that unemployment results from insufficient demand for goods and services. Keynes ultimately believed that government action could directly influence demand for goods and services by altering tax policies and expenditures.
The 1970’s brought an increase in the popularity of supply-side economics, which greatly challenged Keynesian theory and was a term that Reaganomics would make a household name. Jack Kemp, a New York representative and an intern in California for then-governor Ronald Reagan’s staff, was an adamant proponent of supply-side economics. He believed that growth allowed social problems “to take care of themselves.” In his opinion, tax reduction was a key to economic growth and could be done by affecting supply-side incentives. In 1977, Kemp and Delaware senator William Roth introduced the Kemp-Roth Tax Reduction Bill, calling for a 30% reduction in personal income rates over a three-year phase. Due to large inflation accompanied by stagflation at the time, there was large public support for the bill. Although the tax cut did not pass, it was influential due to new intellectual ideas appearing at the time.
University of Southern California professor Arthur Laffer, along with Columbia University’s Robert Mundell popularized their idea of ongoing and informal supply-side economics with politicians and journalists. Laffer is probably famous for introducing the Laffer curve, which emphasized tax reduction as a solution to economic issues. The curve starts at zero tax, but then shows an upside-parabolic curve to demonstrate that up until a certain point (the absolute maximum on the curve) an increase in tax rates will result in an increase in revenue. After this point, an increase in tax will hurt revenue. Despite sharp criticism from Keynesian economists, supply-side was given serious thought in various places. Joint Election Committee (JEC) chairman Lloyd Bensen liked supply-side economics, saying that it was “the start of a new era of economic thinking.” It provided policy makers with a novel way to envision the country’s economic problems versus the conventional way of aggregating demand in post-war America.
The nation first saw an outline of Reaganomics in August of 1979, when Martin Anderson, Reagan’s chief domestic policy advisor, drafted the Reagan for President Campaign’s “Policy Memorandum No. 1.” The plan included suggestions for the economy such as across-the-board tax cuts of at least three years duration accompanied by an indexation of federal income tax brackets. There would also be a reduction in rate of increase in federal spending, vigorous deregulation, and a strict monetary policy to deal with inflation. Reagan would attempt to implement these principles throughout his presidency, and would introduce acts, bills, reforms that would have long-term effects, reducing debt and deficit numbers even after he left the presidency.
In 1981, Reagan made two influential policy decisions that would increase investment by Americans over a long period of time. A general reduction in tax rates, one of the major pillars of Reaganomics, yields great feedback in terms of faster economic growth, a larger tax base, and larger tax revenues.
Reagan introduced a tax-cut bill in 1981 that established tax deductions for Individual Retirement Accounts (IRAs) that resulted in 12 million taxpayers contributing $28.3 billion towards their retirement. In addition, his administration established a principle that employees could have a tax-free income if matched by employers and channeled into their retirement accounts. As a result, the number of Americans with 401k plans increased. By implementing such policies, a massive class of small investors were created that were previously non-existent.
Not only did this new wave of investors create jobs by fueling business growth, but they also pro-actively addressed concerns about the ability of major employers to fund the retirement of the “baby-boomer” generation.
The economic growth, initiated by Reagan, was threatened, however by Congressional actions. Congress did not prepare itself properly for the outcomes of Reagan’s economic doctrines, as government spending increased. For example, Congress resisted cuts in domestic spending, and did not reform basic entitlement plans, which provide unearned payments to individuals. Increased spending in these programs, which include Medicare and Social Security, caused problems for Congress controlling the exact size of budget deficit and surplus. According to the White House’s website, the federal gross debt as a percentage of GDP rose when Congress acted by increasing spending (and therefore increasing both the deficit and the debt). With more businesses opening during Reagan’s presidency and a growing, aging population that relies on the benefits of Social Security and Medicare, federal spending has only increased at a pace far faster than domestic output has increased. Given the spending plans put forth in the mid-1990’s, the government can barely afford to sustain many of its programs. Because the experience of the 1980’s shows that higher taxes will hurt any potential economic growth, Congress must enact disciplined spending cuts.
To maintain sustainable economic growth, not only must Congress consistently reduce federal spending, but there must also be a supply of quality opportunities for new capital investment. During the 1990’s, the Clinton administration introduced policies centered on Fannie Mae and Freddy Mac; these policies diluted the quality of investment opportunities, and eventually culminated in the 2007/2008 “housing bubble.” Reagan’s deregulated mortgage market had allowed lending institutions to loan money to customers who were most likely to repay. Clinton’s policies forced the lenders to loan money to those identified as unlikely to repay. Clinton’s regulation of the market in the 1990’s created massive defaults in 2007 and 2008.
In conclusion, former President Ronald Reagan slashed tax rates by introducing bills in the early 1980’s that increased American investment and productivity. However, Congress did not make the necessary adjustments needed: spending cuts, and sustained deregulation of the mortgage market.
The lesson: free markets aren't free if the government is regulating them, and if the government is spending lots of money, it either creates debt which slows the economy, or it raises tax rates which slow the economy.