Polemic Paper, 2016
Government Size and Function
The Failures of Reaganomics and Neoliberalism
By Fred Haggerson; September, 2016
Abstract: President Ronald Reagan promoted and passed into law provisions of an economic plan that came to be known as Reaganomics.The principles of his plan were based on the neoliberal economic theory originally developed by Friedrich Hayek and Ludwig Von Mises of the Austrian school of economics.The major principles followed by Reaganomics were as follows:1) totally free markets, devoid of government intervention are the best way to promote economic growth and personal freedom, 2) the government should refrain from any interference economic matters, 3) taxes should be kept at as low as possible to stimulate economic growth, 4) government regulations should be eliminated except those that ensure contracts, 5) government should not own businesses or property and should privatize those that it does own, and 6) international trade should be promoted by removing all tariffs and quotas.Laws and policies based on neoliberalism were passed from 1981 through 2008 and have had influence on the economy down to the present.Based on analysis of economic results and political developments during the period this paper argues that Reaganomics and neoliberalism has failed to improve economic growth and the preserve personal freedom above that provided by of the Welfare State which has developed in the US and OECD countries for more than a hundred years.Furthermore the neoliberal agenda is highly correlated with the undesirable unintended consequences of a rapidly rising national debt and balance of trade deficit.
During his presidency (1981-1989) Ronald Reagan adopted a neoliberal or “free market” economic platform which promoted the following actions:laissez faire policytowardgovernment intervention in business, reduction in the size of government and the services that it provided, reduction in taxes, free international trade, and privatization of government owned land and services.The neoliberal economic philosophy adopted by President Reagan captured the hearts and minds of many conservatives.It appealed to core conservative principles and it held out the promise of getting rid of the economic malaise that gripped the nation at the time and what they considered the excesses of the welfare state and big government that had been growing since the Great Depression.
The authors of neoliberal theory, Ludwig Von Mises and Friedrich Hayek, asserted that adopting these policies would increase economic growth andpreserve individual freedoms.The theory was called neoliberalism because it emphasized the concept of freedom, which was a precept of classical liberalism that came out of the Enlightenment.Classical liberalismstated that the preservation of individual freedoms was central to good government.The “neo” part referred to Hayek’s application of liberalism to economic theory.The press called Reagan’s version of the theory, Reaganomics.
Neoliberalism and Reaganomics disparaged government activities outside national defense, policing, and maintaining the rule of law, and lionized free markets as the best and only way to manage economic activity.Von Mises and Hayek argued that the greater role of the government in the economy the greater the chance that it would devolve into tyrannical rule over the people (just as it had in the USSR).On the other hand employing free markets exclusively to run the economy would (especially in the long run) achieve the most efficient allocation of resources while ensuring personal freedoms.
From 1981 thru 2009 presidents Ronald Regan, George H.W. Bush, Bill Clinton, and George W. Bush were able to passmany laws to implement parts of the neoliberal agenda.From 1995 to 2007 the Republicans also controlled both houses of Congress for all but two years, which also helped the passage of the neoliberal agenda into law.In the more recent past, Republican presidential candidates, like Mitt Romney andDonald Trump have continued to promote neoliberal policies as the best way forward for the American economy.
After more than thirty five years under the influence of neoliberal policies we are beginning to acquire experiences and data on how wellthey have worked.Has Reagan’s platform for economic reform improved GDP growth and prevented the loss of individual freedom?Has it lived up to conservative’s expectations that it would vastly improve the economy over what the welfare state had done in the US until that point?This paper will review some of the major neoliberal policies that were implemented from 1981 through 2008,determine what effect that they have had on economic growth, and identify unintended consequences that they may have had.In the section on privatization we will see if the size of government participation in the economy has reduced political and civil liberties as Hayek claimed.
Reagan and subsequent Republican presidents have promoted cutting taxes as possibly the most important piece of the neoliberal agenda.According to the theory lower taxes will give citizens and businesses more money to invest and spend, which will stimulate the economy to grow faster.Many also contend that lower tax rates will actually generate increased tax revenues as they stimulate faster growth (supply side theory).
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Figure 1: Source: Taxes from CBO, GDP from Bureau of Economic Analysis (BEA)
President Reagan passed large tax cutsin 1981 and 1986and George Bush Jr. did the same in 2001 and 2003.On the other hand, during Bush Sr. and Clinton’s administrationsaverage federal tax rates (income+payroll+estate+excise tax revenues/total income) increased after Congress passed several tax hikes.Chart 1 showsGDP growth (Bureau of Economic Analysis)1 overlaid on the average taxes Americans paid each year(Congressional Budget Office)2.Economic growth acceleratedor was above the period (1981-2009) average (2.7%) from 1983 to 1988 after Reagan’s 1981 tax cuts.But GDP also accelerated or was at or above the period average as taxes rose during all of Clinton’s administration from 1993 to 2000.The Bush tax cuts in 2001 and 2003 brought American’s average tax rates below those of 2001 when he took office and this continued through the end of his second term in 2009.GDP growth rates from 2003 to 2008 were at or above the period average except for 2007 and 2008 when the Financial Crisis sent the US into recession.Average GDP growth during the non-recession years of Bush Jr (2002-2006) was 2.9% and average tax rates were 19.9%.Comparatively, average GDP growth during the Clinton years (1993-2000) was 3.9% and average tax rates were 22.3%.
This data shows GDP accelerating or above average both during periods of tax increase and decrease.Furthermore, they show that reducing taxes, as in the case of the Bush tax cuts, doesn’t necessarily protect the economy from a recession which causes a major downside in GDP growth.Therefore, US taxation and growth during the thirty year period 1981 to 2011does not corroborate the neoliberal assertion that lowering taxes is the best or only way to increase GDP growth.Additionally, the data for this period shows that the economy can grow at a vigorous pace even when taxes go up.
In his paper entitled, “Income Tax Changes and Economic Growth”, William Gale of the Brookings Institute reviewed the historic research of many economists on this topic.This included the study of taxes and GDP growth from 1870 to 2010.He found that the growth rate from 1870-1912 (no income taxes during this period) and from 1947-2000 (top marginal income tax rates averaged 66%) was identical, 2.2%.He also reviewed studies on the relationship between tax rates and economic growth in OECD countries from 1960-2010.He concluded the following:“Thus, a reasonable summary from the simple correlations of economic growth and income tax policy over long periods is that the presence of strong tax effects on economic growth is hard to reconcile with observations from the U.S. historical record and international comparisons.”3
This comprehensive historic analysis and conclusion that tax rates don’t have a strong effect on economic growth further overturns the pervasive Republican-neoliberal assertion that high tax rates are necessarily detrimental to economic growth and that tax cuts are needed to increase economic growth.
On the other hand,in the period 1981 through 2011 lowering the average percentage of taxes has shown a strong correlation to increases in the relative size of the national debt.In the cases where average tax rates fell considerably below 22%, like the Reagan administration (81-88) the federal debt increased from 31.7% to 50.5% of GDP, the Bush Jr. administration (2001-2008) it increased from 54.6% to 67.7% of GDP, and the Obama administration (2009-2011) it increased from 82.4% to 96% of GDP of GDP4.
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Figure 2: Source: Taxes from CBO, Debt from OMB
Republicans controlled the presidency and the Congress or just the Congress for most of the period 1981 to 2011.They did not take measures to decrease the size and cost of government necessary to ensure that the national debt wouldn’t grow when government revenues fell due to lower tax rates.Instead they hopefully advocated that the tax cuts would stimulate the economy which would raise tax revenues to offset the revenue reductions caused by their tax cuts.Unsurprisingly, government revenues did not increase enough to offset growing government expenses.This led to large yearly deficits and a rise in the national debt from 31.7% of GDP in 1981 to 96% in 2011.
Figure 2 shows effective tax rates trending down from approximately 22%.1 in 1981 to 17.6% in 2011.In all years where the average tax rate is below 22%, except 2001, the national debt as a percent of GDP increased.This data strongly associates the growth of the national debt with average tax rates below 22% for this period.
According to the CBO and other experts, increases in the national debt burden risk causing the following problems: 1) reduced economic growth due to higher interest rates and reduced capital formation, 2) higher taxes for future generations, 3) reduction in government programs, 4) restrictions on the government’s ability to use fiscal stimulus programs to mitigate downturns in the economy, and 5) increased risk of fiscal crises.5
1.Bureau of Economic Analysis, GDP percent change from preceding period.Online available at the following web address:http://www.bea.gov/national/xls/gdpchg.xls
2.Congressional Budget Office, November 2014 report:“The Distribution of Household Income and Federal Taxes, 2011”.Online data available at the following web ad-dress:www.cbo.gov/publication/49440
3.“Effects of Income Tax Changes on Economic Growth.”William G. Gale, Brookings Institution and Tax Policy Center.February 2016, p 13.This report is available online at the following web ad-dress:https://www.brookings.edu/research/effects-of-income-tax-changes-on-economic-growth/
4.Table 7.1--Federal Debt at the Year End: 1940-2021.Office of Management and Budget.Online data available at the following web ad-dress:https://www.whitehouse.gov/sites/default/files/omb/budget/fy2017/assets/hist07z1.xls
5.Congressional Budget Office report:“The 2016 Long-Term Budget Outlook”, p 4.This report is avail-able online at the following web address:https://www.cbo.gov/publication/51580.
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