Reaganomics - Change through continuity

Reganomics

Change Through Continuity

The election of Ronald Reagan in 1980 represents a decisive turning point in American political development of the twentieth century. America was said to have experienced a rather disappointing economic “malaise” during the previous decade and the general public mood was demanding that something had to be changed. By promising these changes Reagan claimed the people’s trust and occupied the White House. He inherited an economy with a relatively but not critically high unemployment rate, a modest budget deficit, and a small trade surplus. However, the nation was also saddled with double-digit inflation and interest rates, as well as a general depression caused by economic and non-economic factors. When President Reagan left office at the end of the eight years, the economy had witnessed both the longest peacetime expansion in history and the most severe economic crisis in the post-war period. Clearly the Reagan economic legacy is one of both major accomplishments and serious anomalies. When asking different people about what they think of or connect to the Republican administration during the 1980s, opinions vary. Some say the strict economic policies of retrenchment and monetarism, the effective shrinking of the government’s responsibilities in the economy, Reagan’s major tax cuts, and the increased armament spending contributed to the successful rescue of America as the world’s greatest economy and should be seen as a positive wind of change to the United States. To the contrary, some say that all these policies represented America’s shift towards the political right, the accelerating shift of power to private corporations and the rich, increasing inequality to unprecedented levels, and destroying the social fabric, which had been held together by an increasingly intense welfare state.

Praise and critique have been projected on to these certainly crucial political, social, and economic developments under the Reagan administration. And both sides have valid points. Ronald Reagan’s economic policies of retrenchment, tax cuts, budget deficits and monetarism, coined by the media as Reaganomics, had both positive and negative consequences, brought about change, and contributed to the enforcement and lasting continuity of conservative politics in the years to come. A Reagan Revolution arguably happened, which changed America’s fundaments. But does empirical data really show this fundamental change in the basic structure of the American economy, which would legitimate speaking of a revolution? To what extent were Reaganomic policies “successful”? And what consequences did they actually have, both in the short and in the long run?

This paper will focus on domestic policies introduced and tried to be introduced by the Reagan administration between 1980 and 1988, their success, and their consequences. The focus will be on taxation policies and retrenchment policies in government spending, particularly looking at the welfare state. First, the historical background and economic legacy of the 1960s and 1970s will be outlined in order to then analyze policies in the 1980s. A systematic three-step analysis will examine the goals, the actual measures, and the effects of policies within the fields of analysis. A concluding assessment will hopefully contribute to a clearer understanding of this important political era.

Before 1980

In order to analyze and understand economic policies under the Reagan administration, the state of the economy and its historical background faced by the new administration have to be examined.

“The 1960s and 1970s were decades of dramatic growth in legislation, government regulation, public sector spending, and bold policy initiatives in a host of social arenas. We have learned by now that we cannot solve social problems by throwing money at them. Too, we have reaped a harvest of rising inflation, waste, and inefficiency in government, and of declining productivity among workers. All this is vividly reflected in ever-increasing disenchantment with a distrust of the government. Special interests have come to prevail at the expense of the general interest.”^[1]

“Malaise” is the word of choice of many to describe the situation and condition America was and had been experiencing in and previous to 1980. Government intervention into the economy, suggested by the school of Keynesian economics, was reaching levels of inefficiency and increased spending, which were pushing the limit in various aspects. A high level of income taxation had become a general and very powerful source of resentment and opposition, and an ever-increasing rate of inflation combined with a soaring level of unemployment was the major concern of workers, capitalists, and politicians.

After the first oil shock in 1974 both inflation rate and unemployment rate reached some of the highest levels in post-WWII of the United States. The unprecedented phenomenon of stagflation – a parallel rise in both inflation and unemployment during stagnating growth– not only puzzled economists but was also costing millions of workers their jobs and their incomes, and thousands of employers their profits. Milton Friedman’s and other monetarists’ warnings were looking more realistic than the dominant school of Keynesian economics had been predicting. So wrote Tobin:

“No one foresaw in 1970 the main economic events of the decade or the formidable challenges those surprises would pose for macroeconomics and stabilization policy. We macroeconomists were caught unawares. It was not simply that our models, theoretical and econometric, now had to be applied to novel situations. Worse than that, the shocks of the 1970s required some fundamental rethinking and rebuilding.”^[2]

Soaring and accelerating inflation had become the number one problem for the American economy by 1980. The rise of the price level of consumer prices in 1979/1980 exceeded 12 percent. Compared to the 4 percent in the early 1970s and even less than 2 percent in the first half of the 1960s, this was a mounting problem causing insecurity and a loss of economic confidence. At the highest peacetime unemployment levels between 10 and 11 percent the public simply was not pleased.^[3]

To identify the reasons for the economic depression existent at the beginning of the 1980s is not the subject of this paper; however, it certainly was partly due or at least believed to be due to economic policies executed by the preceding administrations. Taxation had been continuously increasing over the previous decades. At the end of the 1970s marginal tax rates reached 49 percent for an individual with $25,000 of taxable income and exceeded 65 percent for taxpayers with incomes of $90,000 and above. The interaction of inflation with tax rules that did not distinguish between real and nominal interest incomes or real and nominal capital gains meant that many taxpayers (mainly the high income earner and especially wealthy capitalists) faced marginal tax rates over 100 percent on real interest or real capital gains.^[4] This generally high level of taxation has been argued to having reduced economic activity and motivation of workers, as well as investment incentives for financial actors and entrepreneurs.

Surely, one can argue – and not only Keynesian economists do so – that higher taxes are very likely to create higher tax revenue and, thus, greater ability of the government to inject money into the economy, leading to a multiplying effect in aggregate demand and, thus, to higher economic activity, growth, employment, and wealth. Well, for a lot of reasons (which cannot be discussed here) this was not the case by the end of the 1970s. Starting in the 1960s government spending had constantly been increased over the following decades up to 1980, but by that time public spending has been argued to be inefficient and even destructive to the laws of the free market economy. Government outlays as a percentage of GDP had increased from 19.3 percent in 1962 to 22.3 percent in 1980, representing large relative and absolute increases.

The greatest increase within the structure of public spending had been devoted to Social Security, Medicare, and related retirement, rising from 3.0 percent in 1962 to 6.9 percent in 1980. Entitlements and domestic discretionary also experienced a relative boost from 2.8 and 3.0 percent in 1962 to 4.1 and 4.9 percent in 1980 respectively. The welfare state was and continued to be a case of special importance.

As Feldstein summarizes: “the unusually high rate of inflation in the late 1970s and the rapid increase of personal taxes and government spending in the 1960s and 1970s had caused widespread public discontent. Ronald Reagan’s election in 1980 reflected this political mood and provided a president, who was committed to achieving low inflation, to lowering tax rates, and to shrinking the role of government in the economy.”^[5] The new president, his advisers, and the general public were convinced that something had to be done.

Promised change

President Reagan took office in 1981 with a plan to “put the nation on a fundamentally different course – a course leading to less inflation, more growth, and a brighter future for all of our citizens.”^[6] In February 1981 the new administration unveiled its Program for Economic Recovery. The plan called for a stable and restrictive monetary policy, a reduction in federal spending, a reduction in personal and business taxes, and substantial regulatory relief. Each element of the program was designed to reduce the role of government in the economy. A more limited federal presence was advocated largely because of its perceived benefits for overall economic performance, and a fundamentally conservative social philosophy for the responsibilities of the government was embedded within this economic program. After the fight against high levels of inflation, taxation policies and retrenchment policies within government spending have arguably been the main concerns of economic policy making. The following section will analyze these two areas separately after having given a short insight into the monetary measures against inflation.

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^[1] Duignan/Rabushka 1980, 3

^[2] Espinosa-Vega/Russell 1997, 18, quoting Tobin, 1980, 23

^[3] Feldstein 1994, 4

^[4] this was because the high rate of inflation was simply neglected in taxation accounting. See Feldstein 1994, 14

^[5] Feldstein 1994, 1

^[6] Presidential message to the Congress, February 18, 1981