Reaganomics

vodoo economics

Reaganomics or ‘voodoo economics’ is a negative term which critics use to criticize supply-side economics. The term originated from George H.W. Bush, who criticized Ronald Reagan’s plan for the economy during the Republican presidential primaries in 1980. Reagan’s attitude towards the Federal Government Budget was to drastically reduce taxes – primarily for the wealthy – while greatly increasing spending – primarily for the military. Bush Sr. and others recognized that this could not possibly produce a balanced budget, and would result in great national debt.

The four pillars of Reagan’s economic policy were to reduce the growth of government spending, reduce the federal income tax and capital gains tax, reduce government regulation, and control the money supply in order to reduce inflation.

Reagan was an adherent to a policy known as supply-side economics (derisively referred to as ‘trickle-down economics’), which argues that economic growth can be most effectively created using incentives for people to produce (supply) goods and services, such as adjusting income tax and capital gains tax rates. Accordingly, Reagan promised an economic revival that would affect all sectors of the population. He said that cutting tax rates would actually increase tax revenues because the lower rates would cause people to work harder as they would be able to keep more of their money. Reagan also called for a drastic cut in ‘big government’ programs and pledged to deliver a balanced budget for the first time since 1969.

Of course, Reagan was elected president in 1980 with George Bush Sr. as his Vice-President. In his eight years as President, Reagan would fulfill his campaign promises of lowering taxes – primarily on the wealthy – and greatly increasing spending – primarily on the military. Like Bush Sr. had recognized before Reagan captured the White House, this would lead to large Federal Budget deficits. In 1989 when George Bush Sr. became the 41st US President, this great national debt/budget deficit had to be dealt with. Even though Bush Sr. famously pledged during the 1988 Presidential Election, ‘Read my lips, no new taxes,’ after gaining the White House, he was forced to renege on that pledge and raise taxes. This is one of the reasons that led to Bush Sr. not winning reelection in 1992.

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 phased out. The federal oil reserves were created to ease any future short term shocks. President Jimmy Carter had begun 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 (continued by Reagan), and long-term easing of supply and pricing in oil during the 1980s oil glut.

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, which is why George H. W. Bush had derided Reaganomics as ‘voodoo economics.’ 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.

In his 1980 campaign speeches, Reagan presented his economic proposals as 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, which formed in opposition to Keynesian demand-side economics. This movement produced some of the strongest supporters for Reagan’s policies during his term in office.

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. Economist 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.

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.

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. 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. This led to the U.S. moving from the world’s largest international creditor to the world’s largest debtor nation. Reagan described the new debt as the ‘greatest disappointment’ of his presidency.

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. 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. Reagan ultimately raised taxes more times than he cut them. 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.’ 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.

Some economists have stated that Reagan’s policies were an important part of bringing about the second longest peacetime economic expansion in U.S. history, though the even longer 1990s expansion that began under George H.W. Bush in 1991 occurred after a rejection of the Reagan-era tax plan by Congress in November 1990 and continued through the Clinton administration, resulting in a 42% decrease in unemployment.

During Reagan’s first term, critics pointed to homelessness as a visible problem in America’s urban centers. 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.’ His policies became widely known as ‘Trickle-down economics,’ due to the significant cuts in the upper tax brackets. Supporters pointed to the drop in poverty by the end of his term to validate that the tax cuts did indeed trickle down to the poor; opponents noted that the rate quickly shot up even higher in the first year of his successor’s term, implying that the full effect of Reagan’s policies led to a net increase in poverty.

According to a 1996 study by William A. Niskanen (a member of Reagan’s Council of Economic Adviser) and conservative economist Stephen Moore: 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 lower in the post-Reagan years.

Moore stated, ‘No act in the last quarter century had a more profound impact on the U.S. 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 U.S. government spending budget, cutting useless programs, scaling down the government workforce, maintaining low interest rates, and keeping a watchful inflation hedge on the monetary supply was Ronald Reagan’s formula for a successful economic turnaround.

Liberal economist Paul Krugman argued the economic expansion during the Reagan administration was primarily the result of the business cycle and the monetary policy by Paul Volcker. Krugman claims 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. William A. Niskanen noted that during the Reagan years privately held federal debt increased from 22% to 38% of GDP, despite a long peacetime expansion. Second, the savings and loan problem led to an additional debt of about $125 billion. Third, greater enforcement of U.S. trade laws increased the share of U.S. imports subjected to trade restrictions from 12% in 1980 to 23% in 1988.

Economists Raghuram Rajan and Luigi Zingales pointed out that many 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 stated, ‘The move toward markets preceded the leader [Reagan] who is seen as one of their saviors.

Niskanen wrote that deregulation had the ‘lowest priority’ of the items on the Reagan agenda 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. 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). 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).

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