Reaganomics: Policies, Outcomes, and Long-Run Legacy

The Economic Backdrop: Stagflation and the Reagan Mandate

The post-war decades of the 1950s and 1960s saw steady economic gains, but this run was disrupted in the 1970s, in particular by shocks to oil prices. For an economy built on cheap oil, these price shocks created significant turmoil across all aspects of the economy. When Reagan was sworn in in 1981, the country was suffering through what was known as stagflation — a condition where inflation rates were high, accompanied by persistent high unemployment (Investopedia, 2017). After such a long period of low inflation and low unemployment, stagflation was not only unfamiliar to Americans but was also politically unacceptable. Reagan was swept into power over incumbent Jimmy Carter, and this decisive election victory, combined with the poor economic conditions he inherited, gave Reagan the mandate to make significant changes to fiscal policy.

The Core Elements of Reaganomics

Reaganomics contained several key elements that had long been on the agenda of conservative politicians and economists. Years of stagflation were essentially the shock needed to bring this doctrine to power, as American voters were apparently willing to test these theories and break what seemed to be a cycle of economic negativity. Poor outlooks on jobs and inflation made investing difficult, and if companies were not investing, they were not creating jobs either.

The first element of Reaganomics was to lower taxes. The general philosophy behind this was that lower taxes would create more incentive to invest — that the wealthy and corporations were being held back from investing because tax rates were too high. Lowering taxes was also thought to reduce unemployment by increasing business investment, and sparking growth was expected to help bring down inflation (Blanchard, 1987). Lowering taxes became known as "trickle-down" economics because the theory held that creating opportunities for the wealthy to invest more would mobilize more capital. Corporations and the wealthy would eventually spark economic growth, since an uptick in investment would create jobs. Those jobs would increase consumer spending, which would in turn create still more jobs. In part, the doctrine of lowering taxes to spark economic growth was something conservatives had long desired; in part, it was also intended as a means of breaking the economic cycle that had produced stagflation. Simply encouraging people to invest would, in theory, be enough to break that cycle.

At the time, most economists were opposed to this plan. Samuelson (1984) noted that the Laffer Curve shows that tax receipts approach zero both when tax rates are near zero and when they are near 100%. The reasoning behind Reaganomics held that tax rates were so high as to diminish tax revenue, and that lower rates would actually increase revenue. There was no evidence for this contention, yet it became the prevailing wisdom within the Reagan administration regardless of the lack of evidentiary support — either before or after rates were cut.

Regulation was seen as another barrier to investment, and one of the core ideas of Reaganomics was not even strictly fiscal policy, but rather a reduction in the regulations governing business. This is a fairly straightforward principle: regulations typically lead to higher costs for businesses, which reduces both investment and profit. Reducing regulations was believed to spur economic growth that would offset the reduction in tax revenue. Combining multiple pro-growth measures meant that tax cuts would theoretically be compensated for by a much higher rate of economic growth — tax rates would be lower, but profits would be higher, and the cuts would ultimately pay for themselves.

Regulations were reduced across a number of different areas, including financial and environmental sectors. In both 1982 and 1984, regulations surrounding mergers were eased, reducing the reach of the Clayton Act in an attempt to encourage more merger and acquisition activity. This was part of a broader vision of bringing the U.S. economy into a more streamlined, efficient state — an objective aimed less at short-term gains than at the long-run health of the American economy (Adams & Brock, 1988).

Alongside reduced regulation came cuts to government spending. Whether these cuts were ever large enough to materially affect the economy, they were at least intended to signal that the Reagan administration was committed to making it easier for American businesses to operate. Underlying this principle is the idea that government spending is economically inefficient, and that more money in the hands of corporations and wealthy individuals would lead to greater spending and investment than the same money channeled through government.

It is worth noting that during Reagan's tenure, government spending actually increased — largely due to a substantial rise in military expenditures. This reveals that the rhetoric about wasteful government spending was set aside when the spending in question concerned the Department of Defense. The problem was not government spending per se, but rather a shift in its priorities. With declining tax revenues, these military outlays and the borrowing required to finance them ultimately served as the catalyst that pulled the economy out of recession (Peterson, 1988). Reagan increased military spending while reduced government spending remained a stated pillar of Reaganomics. In failing to adhere strictly to his own doctrine, Reagan inadvertently helped the U.S. economy in ways that strict adherence to that doctrine was not achieving.

Reagan also sought to tighten the money supply in order to reduce inflation. In practice, however, the government borrowed heavily — shifting the United States from a creditor nation to a debtor nation — in order to finance the broader Reaganomics program, since the tax cuts did not in fact pay for themselves. This element is particularly interesting because inflation did decline even as the money supply increased. An expanding money supply should, in theory, have sparked some economic growth and reversed the contractionary trajectory that preceded Reagan's inauguration.

As noted, Reagan actually increased the money supply, contrary to what his own doctrine prescribed. It has been said that Reagan regretted the growth in the national debt, yet it was precisely that spending which helped pull the U.S. out of recession — not the tax cuts. The increased military spending was driven by Cold War strategists seeking to counter the Soviet Union, not by any recognition that expanded government expenditure could serve as an economic stimulus. Acknowledging the latter point would have run directly counter to Reaganomics and to supply-side economics more broadly.

Analysis of Reaganomics

One of the most striking features of Reaganomics is that the tax cuts Reagan enacted remain largely in place today. Hartmann (2014) argued that they need to be rolled back, contending that those cuts represent an effort by the wealthiest members of society to erode the economic strength of the middle class. By leaving reduced tax rates on the wealthy in place — and given the persistence of a false narrative that the United States is overtaxed — the expected outcomes of those cuts continue: a widening wealth gap and economic stagnation for the middle class (Hartmann, 2014). George H.W. Bush is widely believed to have suffered the political fallout from the Reagan tax cuts; as the deficit expanded, he raised taxes, and many analysts believe that decision cost him a second term (Ungar, 2012).

Another significant problem with Reagan's tax policy is that its fundamental premise works somewhat backwards. The claim that increased risk-taking and entrepreneurship would spark economic growth reverses the actual causal relationship: it is economic growth that sparks risk-taking and entrepreneurship. In the absence of growth, money sits on the sidelines waiting for the right opportunity. Investors do not pour capital into a stagnant market. And even if the Reagan tax cuts did eventually contribute — in combination with other measures — to creating some economic growth, the national debt generated by those cuts remains, and the United States has never fully recovered from it.

Reduced regulation carried a similar underlying premise — lower the cost of doing business and risk-taking will increase. There is some truth to this: the 1980s did see the emergence of junk bonds, leveraged buyouts, and other financial instruments that represented new ways of accumulating wealth. However, these were not economically sustainable mechanisms. In the long run, acquisitions that reduced consumer choice and increased the risk of monopolistic behavior are fundamentally anticapitalist — a well-functioning capitalist system depends on striking a balance between encouraging risk-taking and preventing abuse of market power.

The apparent successes of Reaganomics also warrant scrutiny. Reagan faced high unemployment and high inflation at the outset of his term, and these two issues, more than any others, were what got him elected. When he was re-elected, it was because both appeared to be coming under control and the public viewed his economic performance favorably. Economists, however, tend to attribute the decline in inflation to borrowing costs rather than to monetary tightening, and attribute economic growth to deficit spending rather than to supply-side measures. It should be noted that this interpretation is consistent with Keynesian analysis and is therefore advanced most forcefully by Keynesian economists. The neoclassical economists more aligned with Reagan's thinking did not credit increased military spending or rising deficits as the drivers of economic recovery under his administration.

Conclusion

When Ronald Reagan came into power, he inherited an economy plagued by stagflation — a condition characterized by both high inflation and persistently high unemployment. After decades of relative economic stability, oil price shocks had forced the U.S. economy into a painful period of adjustment. Reagan swept into office with a mandate to remake the country's economic foundations. Rather than drawing on Keynesian principles as his predecessors had, he drew primarily on neoclassical visions of deregulation and supply-side economics.

At its heart, supply-side economics rests on the principle that government is less effective at stimulating economic growth than private enterprise. Private actors are believed to make more economically efficient decisions. Reagan therefore sought to redirect resources away from government and toward the wealthy and corporations, primarily through extensive tax cuts. Under the supply-side model, those cuts were expected to pay for themselves by stimulating growth — lower rates applied to a higher level of economic activity were projected to be roughly revenue neutral. As a complement, Reagan's plan added deregulation for further stimulatory effect, and cuts to government spending to reduce what was framed as the cost of inefficient public expenditure.

What occurred in practice was that the economy did ultimately escape stagflation, and certain sectors — most notably mergers and acquisitions — saw notable booms. But more problems were created than were solved, many of which persist today as a result of the shift in political discourse that the Reagan era produced. Perhaps more importantly, many economists — not supply-siders, but others — have concluded that the substantial increase in military expenditures was more responsible for reviving the American economy than any supply-side measure. In that sense, the recovery functioned more as a textbook Keynesian deficit-spending program than as a vindication of supply-side theory.

The long-run impacts were significant. Under Reagan, the United States shifted from a trade surplus to a persistent trade deficit, and the national debt rose substantially. Neither has recovered. In part, this is because the tax cuts were baked into the U.S. tax structure. Modest increases under George H.W. Bush and again under Clinton were insufficient to restore lost revenues, especially given the structural shifts in trade and the role of dollar overvaluation in accelerating those shifts.

The United States did experience economic expansions in the mid-to-late 1980s and again through much of the 1990s, and proponents of Reaganomics attribute those booms to his economic policies. Others point to technological advancement and geopolitical changes — most notably the end of the Cold War — as the more decisive factors.

At its core, Reaganomics is broadly viewed as a failure of economic policy: rooted in a misreading of how economies function, and ultimately unable to deliver on its central promise that large tax cuts could pay for themselves through increased revenue. Two troubling realities emerge from this era. First, Americans are still paying the cost — the debt has only grown, the deficit has persisted, the middle class has been hollowed out since 1980, and the wealth gap has widened substantially. Second, and perhaps more troubling, the ideas behind Reaganomics remain popular in conservative political discourse despite their demonstrated failures. The lesson of this era is an important one: policies such as massive tax cuts for the wealthy have already been tried at scale, and they failed. Promises of revenue neutrality and broad economic gains from such cuts should be treated with skepticism — not as untested theory, but as a hypothesis that history has already evaluated.

References

Adams, W. & Brock, J. (1988). Reaganomics and the transmogrification of merger policy. The Antitrust Bulletin, 33, 309.

Agnew, S. (1991). The U.S. trade and budget deficits in global perspective: An essay in geopolitical economy. Environment and Planning, 9(1).

Bergsten, F. (1981). The cost of Reaganomics. Foreign Policy, 44(Autumn 1981), 24–36.

Blanchard, O. (1987). Reaganomics. Economic Policy, 2(5), 15–56.

Hartmann, T. (2014). Reaganomics killed America's middle class. Salon. Retrieved October 23, 2017, from https://www.salon.com/2014/04/19/reaganomics_killed_americas_middle_class_partner/

Investopedia. (2017). Reaganomics. Retrieved October 23, 2017, from http://www.investopedia.com/terms/r/reaganomics.asp

Moffitt, M. (1987). Shocks, deadlocks and scorched earth: Reaganomics and the decline of U.S. hegemony. World Policy Journal, 4(4), 553–582.

Peterson, W. (1988). The macroeconomic legacy of Reaganomics. Journal of Economic Issues, 22(1), 1–16.

Samuelson, P. (1984). Evaluating Reaganomics. Challenge, 27(5), 4–11.

Ungar, R. (2012). The numbers don't lie — why lowering taxes for the rich no longer works to grow the economy. Forbes. Retrieved October 23, 2017, from https://www.forbes.com/sites/rickungar/2012/09/16/the-numbers-dont-lie-why-lowering-taxes-for-the-rich-no-longer-works-to-grow-the-economy/