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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.[2]
Contents
Historical context
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 real (inflation adjusted) 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.
Justifications
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-stimulus 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. 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. He ended the oil windfall profits tax in 1988.[7] Reagan followed his 1981 tax cuts with the Tax Reform Act of 1986, which sought to eliminate deductions, lower marginal rates for the wealthy, and significantly raise taxes on those earning less than $50,000.[8][9] 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.[10]With the Tax Reform Act of 1986, Reagan and Congress sought to raise taxes on lower incomes, eliminate many deductions, and reduce tax rates on the wealthy. In 1983, Democrats Bill Bradley and Dick Gephardt had offered a proposal; 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 the increase in tax rates on lower incomes and decrease in deductions raised revenue equal to about 4% of existing tax revenue.[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.[14] 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%.[15] The federal deficit under Reagan peaked at 6% of GDP in 1983, falling to 3.2% of GDP in 1987[16] and to 3.1% of GDP in his final budget.[17] The inflation-adjusted rate of growth in federal spending fell from 4% under Jimmy Carter to 2.5% under Ronald Reagan; however, federal deficit as percent of GDP was up throughout the Reagan presidency from 2.7% at the end of (and throughout) the Carter administration.[2][17] 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.[18] This led to the U.S. moving from 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.[20]
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][21] 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.[22] Reagan ultimately raised taxes more times than he cut them.[23] 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."[10] 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.[24]
Results
Overview
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,[26][27] 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.[28] 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),[29] 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.[28][30] 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.[31] 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).[32] The latter contributed to a relatively brief recession in 1982: unemployment rose to 9.7% and GDP fell by 1.9%.
The misery index, defined as the inflation rate added to the unemployment rate, shrunk from 19.33 when he began his administration to 9.72 when he left, the greatest improvement record for a President since Harry S. Truman left office.[33] In terms of American households, the percentage of total households making less than $10,000 a year (in real 2007 dollars) shrunk from 8.8% in 1980 to 8.3% in 1988 while the percentage of households making over $75,000 went from 20.2% to 25.7% during that period, both signs of progress.[34]
Unemployment rates
Growth rates
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 versus 3.4% under Carter. Following the recession, the unemployment rate had averaged slightly higher (6.75% vs. 6.35%), productivity growth lower (1.38% vs. 1.92%), and private investment as a percentage of GDP slightly less (16.08% vs. 16.86%). Real wages were lower following the recession, while real median family income grew by $4,000 during the Reagan period.[36][37]Poverty level
Federal income tax and payroll tax levels
During the Reagan administration, federal receipts grew from $618 billion to $991 billion (an increase of 60%); while outlays grew from $746 billion to $1144 billion (an increase of 53%).[43][44] 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.[45] 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.Tax revenue
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 accounting indicated nominal tax receipts increased from $599 billion in 1981 to $1.032 trillion in 1990, an increase of 72% in current dollars. In 2005 dollars, the tax receipts in 1990 were $1.5 trillion, an increase of 20%.[49] From 1991 to 2000, receipts increased by 90% in current dollars, or 60% in 2005 dollars. An analysis from the Center on Budget and Policy Priorities calculated that the average annual growth rate of real income-tax receipts per working-age person eventually rose over the two decades from 0.2% (1981–90) to 3.1% (1990-01).[50]
Fiscal consequences
The nominal national debt rose from $900 billion to $2.8 trillion during Reagan's tenure, an average national budget deficit per year of $237.5 billion, as compared to an average national budget deficit per year of $56.9 billion during Carter's tenure. The federal deficit as percentage of GDP rose from 2.65% of GDP in 1980, Carter's final budget year, to 3.04% of GDP in 1988, Reagan's final budget year.[51]Analysis
Stephen 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 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.[36]
Milton Friedman stated, "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."[52] Entrepreneurs flourished as a result of Reaganomics[citation needed]: 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.[citation needed] Further, the Heritage Foundation stated, "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."[53]
The Tax Reform Act of 1986 and its impact on the Alternative Minimum Tax (AMT) reduced nominal rates on the wealthy and eliminated tax deductions, while raising tax rates on lower-income individuals.[52][53][54][55] The across the board tax system reduced marginal rates and further reduced bracket creep from inflation. The highest income earners (with incomes exceeding $1,000,000) received a tax break, restoring a flatter the tax system.[56] In 2006, the IRS's National Taxpayer Advocate's report characterized the effective rise in the AMT for individuals as a problem with the tax code.[57] Through 2007, the revised AMT had brought in more tax revenue than the former tax code, which has made it difficult for Congress to reform.[56][58]
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.[59] 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.[60]
The CBO Historical Tables indicate 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 argued in June 2012 that Reagan's policies were consistent with Keynesian stimulus theories, pointing to the significant increase in per capita spending under Reagan.[61]
William 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.[2]
Economists Raghuram Rajan and Luigi Zingales pointed out that many deregulation efforts had either taken place or had 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."[62] Economists Paul Joskow and Roger Noll made a similar contention.[63]
Economist William A. Niskanen, a member of Reagan's Council of Economic Advisers wrote 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.[64] 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).[65] 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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