The Complicated Legacy and Future of Voodoo Economics
An enduring conservative icon, the late former President Ronald Reagan’s name has been invoked in every single Republican primary debate since 1999. Ardent supporters proudly point to his long-term involvement in ending the Cold War as one of the most defining aspects of his nearly decade long legacy. A more contested component of his administration among economists and historians alike is the set of neoliberal economic policies he implemented, which the press has dubbed Reaganomics.
During the 1980 presidential race, which Reagan ended up winning, George H.W. Bush colorfully characterized his then-rival’s economic policies as “voodoo,” attempting to paint the agenda as impractically absurd. Alternatively, in the wake of the Gipper’s death in 2004, former British Prime Minister Margaret Thatcher spoke at his eulogy reminding the American people that “he transformed a stagnant economy into an engine of opportunity.” On which side of this highly politicized matter does the banner of truth ultimately fly?
In order to begin examining Reagan’s economic policies, it’s critical to look into the state of the economy before he took office. After all, Reagan sold himself on the notion that his leadership could rectify the economic predicament he would inherit from President Jimmy Carter, plagued by what economists coined as stagflation. Stagflation was a nasty confluence of double-digit inflation, economic stagnation, and morbid unemployment rates. Moreover, America’s steel and automobile industries at the time couldn’t meaningfully compete in the global markets. Even as unions launched a “Buy American” campaign after Japanese-imported cars began dominating the U.S. market, American Motors and Chrysler were on the brink of bankruptcy. Japan’s booming economy and its prolific exports of Toyota and Honda became an inflamed concern, especially for the blue-collar workers in manufacturing who were most devastated.
Notably, the mutual rise in unemployment and inflation during the ’70s left Keynesian economists befuddled as they subscribed to the idea that the two were inversely related. The Keynesian school of thought, pioneered by English economist John Maynard Keynes, held that the promotion of economic growth and an increase in employment rates was inevitable through the growth of the money supply. Yet the unemployment rate in 1980 was at 7.2%, up 1.2% from the year prior while the GDP growth rate was at -0.3%. At the same time, the inflation rate was 13.5%, 2.15 points higher than the year prior. Business and employee income couldn’t keep pace with rising costs and prices.
No small part of Reagan’s victory against Jimmy Carter’s reelection could be attributed to an iconic optimism he seemed to radiate, the sort of thinking and rhetoric desperately needed by a nation facing an uncertain economic future. Once elected, Reagan needed to deliver on his promise and legitimize the relentless optimism he had impressed upon his supporters.
His coordinated response was fourfold: reducing federal spending, reducing federal income and capital gains taxes, reducing government regulation, and tightening the money supply to reduce inflation. The foundation of Reagan’s solution was the Laffer Curve, a theoretical relationship between tax rates and the amount of tax revenue collected by governments. This supposed relationship was defined by American supply-side economist and Reagan advisor Arthur Laffer of the University of Southern California. Up until that point, Keynesian economics greatly influenced policymakers. It championed hefty government spending which would increase demand but also require higher taxes. Laffer found this problematic, contending that onerous taxes and regulations impeded producers’ motivation to produce more. This is also referred to as the trickle-down theory, emphasizing that these tax cuts on the rich will produce benefits that will trickle down the socioeconomic pyramid.
In accordance with Laffer’s theories, Reagan sought to reduce income taxes. This, in part, was to encourage the wealthy to use that untaxed, disposable wealth to invest in private enterprise which would translate to an increase in the number of available jobs. Besides incentivizing the wealthy to invest in factories, the stock market, and businesses, those lower on the socioeconomic ladder also have more disposable income. This allows them to spend more, creating demand for goods in the economy and therefore spurring economic growth. Since lower taxes translates into keeping more of that hard-earned money, people will also be motivated to work harder, thereby increasing the supply of labor. Ultimately, it is supposed that this economic growth, although prompted by lower tax rates, would actually amount to greater total tax revenue since the tax base would be expanded.
Unsurprisingly, Reagan’s initial proposal of tax cuts garnered skepticism and resistance from both sides of the aisle. Many, including moderates within his own administration, felt this would merely line the pockets of the rich at the expense of the poor. However, Reagan’s nickname of the “Great Communicator” was well deserved. His incredible ability to articulate his ideas to people, developed through his years as an actor and spokesperson, served him well to gather overwhelming public support from the American people and subsequently persuade Congress to pass his tax legislation. His survival from an assassination attempt in March of 1981 also resulted in a rise in popularity that likely contributed to this endeavor.
So six months into his first term, Congress passed the Economic Recovery Tax Act of 1981 (ERTA), the largest tax cut in history. The new tax code reduced the top tax rate from 70% to 50% and reduced the overall marginal tax rate by 23% over a period of 3 years. Well into his second term, Reagan got Congress to pass the Tax Reform Act of 1986 which was meant to increase fairness and incentivize economic growth. The comprehensive tax reform legislation effectively reduced the top tax rate for ordinary income from 50% to just 28% and increased the bottom tax rate from 11% to 15%. This was historically significant because lowering the top tax rate while increasing the bottom rate was unprecedented. It also increased the maximum tax rate on long-term capital gains from 28% to 20%, so that the tax rates for capital gains and ordinary income were equal. Additionally, the corporate tax rate was dropped from 50% to 35%.
These tax cuts were aimed at revitalizing entrepreneurship and innovation as well as greater investment in human and venture capital. The first 4 years of Reagan’s presidency saw the rise of tech companies like Microsoft and Intel as well as IBM’s first introduction to its personal computer. This was unsurprising since his tax cuts primarily catered to “idea” industries like software.
Alongside tax cuts, Reagan reduced the burden of regulations on business, a process previously in place under President Carter. He eliminated and reduced regulations on the domestic oil and natural gas industries, interstate bus service, long-distance telephone services, ocean shipping, and cable television. This was all in line with his overarching message that big government was the main issue, not the antidote.
Opponents of his policies frequently cite the fact that the beginning of Reagan’s term suffered a deep economic recession. As aforementioned, Reagan campaigned on combating mounting inflation. With this aim in mind, the Federal Reserve Board enacted a contractionary monetary policy, increasing the short-term interest rate, which was at a high in 1981. This raised the value of the dollar in the international exchange market, which raised the prices of American products overseas, invariably leading to a decrease in exports and an increase in imports. When Federal Reserve Board Chairman Paul Volcker made this decision, he knew that it would dampen economic growth but saw this possibility as a necessary evil. The resulting early 1980s recession gave way to alarming rates of homelessness, increased bankruptcies, and the unemployment rate reaching 10% which hadn’t been observed since the Great Depression. After the economy finally stabilized in 1983 though, it rebounded and experienced impressive prosperity and growth.
By the end of Reagan’s second term, the tax revenue collected by the U.S. government in 1988 was a whopping $392 billion more than the tax revenue received in 1980, matching the predictions of the advocates of trickle-down theory. The inflation rate in 1988, Reagan’s last year as president, was 4.14%. During the same year, the unemployment rate was 5.3% with 13 million new jobs created. As poverty declined, median earnings and standard of living flourished. Reagan’s deregulation efforts enabled consumers to save approximately $100 billion annually in lower prices. The Dow Jones Industrial Average, having endured a drop from 1967 to 1982, nearly grew threefold in the span of Reagan’s presidency and would continue to expand nearly fourteenfold until 2000. All the while, the ’80s saw consistent GDP growth. It would seem that the chronic unemployment, galloping inflation, and high-interest rates that afflicted the ’70s dissolved in the wake of the Reagan Revolution. The economy’s recovery under Reagan lasted 92 months until 1990, breaking the previous record (58 months) for the longest peacetime expansion. Reagan’s policies and, some argue, his indomitable optimism, broke the cycle of stagflation and supported substantive economic growth. This, nevertheless, came at a price.
Firstly, Reagan’s deregulation efforts towards banks, savings and loan associations contributed to the aptly named Loans and Savings Crisis, a $160 billion bank collapse that encompassed the failure of at least a thousand of the country’s savings and loans by 1989.
Reagan also delivered on the anti-union rhetoric he employed in his campaign, which deeply hurt organized workers. In August of 1981, he fired 12,000 air-traffic controllers who had gone on strike to advocate for better working conditions. Successfully eradicating the Professional Air Traffic Controllers Organization (PATCO), his action invoked public outcry from union leaders. Nonetheless, this was drowned out by anti-union sentiment largely harbored by the public and a corresponding surge in popularity for Reagan. This also set a precedent for employers to merely replace striking workers. This was damaging to working families because the weakening of unions meant that real wages were leveling off. In the same vein, many on the liberal side of the spectrum outright condemn Reaganism for widening the gap between the rich and the poor. Three years ago, the New York Times published a chart, built on the work of several acclaimed economists, that detailed how the Reagan era may have led to alarming diverging income growth between the elite and everyone else. How exactly such policies affected the poor and the broader issue of wealth distribution remains in dispute as both sides are seemingly armed with data.
Also, to the aversion of environmental activists, the Environmental Protection Agency (EPA) loosened regulations on pollution, and the Department of the Interior opened public lands to private development, including logging and drilling for oil. A task force established by Reagan revised and eliminated countless EPA regulations. Reagan also went out of his own way to mandate substantial cuts to the EPA’s budget and staff.
Perhaps the biggest observable fault of Reaganomics harkens back to something that Reagan promised he’d prevent and be wary of. He had said at the beginning of his presidency “Government spends all the taxes it gets. If we reduce taxes, we’ll reduce spending.” He firmly stood by the idea that although the government would impose less odious taxes, it would compensate by cutting government programs. But the reality is government spending growth wasn’t slowed and it merely shifted from domestic programs to the Cold War-era military build-up. Tensions between the U.S. and the Soviet Union over the possibility of a nuclear war resulted in defense firms being awarded numerous government contracts to bolster the military. Each year, Reagan ramped up military spending by 11% until it was an enormous $1.1 trillion the year he left office. This also meant that overall spending increased throughout his administration — specifically, 9% annually. Although he managed to slightly cut spending for some programs like the Department of Education and the Department of Energy, he was ultimately unsuccessful in convincing Congress to do the same to welfare programs like Medicare, Social Security, and Medicaid. Resultantly, the nation accumulated skyrocketing deficits and saw a meteoric rise in national debt from $738 billion to $2.1 trillion.
So did Reaganomics work? The answer isn’t so straightforward. Research indicates that it certainly vanquished what it was meant to: stagflation. It also led to, among other things, consistent GDP growth, greater tax revenue collected, and arguably the advent of the Information Revolution. At the same time, it may have hurt the environment, contributed to a significant bank collapse, accelerated a gap between the rich and the poor that continues to widen today, and accumulated a gigantic national debt by means of a military spending binge. Upon carefully evaluating Reagan’s economic policies, several questions worth asking arise. Questions whose discourse shouldn’t be limited to politicians, historians, and economists. Questions like whether or not the economic growth enjoyed by Americans under Reagan outweigh the massive debt future generations of Americans are forced to resolve. Was the administration right, with respect to priority, in striving to reduce government spending on the welfare state while actively launching a military build-up? To what degree does economic growth, specifically via GDP, realistically reflect changes in standard of living? Should we choose economic growth over a chance to reduce income inequality?
Today, supply-side or trickle-down economics remains inseparable from conservative economic doctrine. For instance, within a year in office, President Donald Trump’s first tax cut bill was signed, which cut corporate tax from 35% to 21% and decreased taxes for about 65% of Americans. Voodoo economics remains well and alive in recent times and its effects, particularly under Trump, will continue to be measured against those of the diametrically opposed incoming Biden administration’s plans to raise taxes on the wealthy and corporations.
Sources:
https://www.thebalance.com/reaganomics-did-it-work-would-it-today-3305569
https://www.investopedia.com/terms/r/reaganomics.asp
https://hcpss.instructure.com/courses/53860/pages/reaganomics
https://www.macrotrends.net/countries/USA/united-states/gdp-growth-rate
https://www.ushistory.org/us/59b.asp
https://www.grc.nasa.gov/WWW/K-12/fenlewis/epa.htm
https://www.history.com/this-day-in-history/reagan-signs-economic-recovery-tax-act-erta
https://www.nytimes.com/2020/08/18/books/review/reaganland-rick-perlstein.html
https://www.investopedia.com/terms/e/economic-recovery-tax-act.asp
https://www.thebalance.com/savings-and-loans-crisis-causes-cost-3306035
https://www.nytimes.com/interactive/2017/08/07/opinion/leonhardt-income-inequality.html
