Would Reaganomics Work Today?

Did Reaganomics Get Us Out of Recession?

Ronald Reagan
President Ronald Reagan's economic policies were soon named after him. Photo: Getty Images

What Is Reaganomics?

Reaganomics describes President Ronald Reagan's conservative approach for dealing with the 1980 recession. Voters were being pummeled by stagflation. That's an economic contraction combined with double-digit inflation.

Reaganomics attacked stagflation by reducing government. That policy was dramatically different from the status quo. Reagan promised to reduce:

  1. The growth of government spending.
  1. Both income and capital gains taxes.
  2. Regulation.
  3. The growth of the money supply.

Reaganomics grew from the theory of supply-side economics. It states that corporate tax cuts give companies more cash. With it, they hire new workers and expand their businesses.  Income tax cuts give workers more incentive to work, increasing the supply of labor. The resultant economic growth expands the tax base. Over time, that replaces the government revenue lost from the tax cuts.

Did Reaganomics Work?

President Reagan delivered on each of his four major policy objectives, although not to the extent that he and his supporters had hoped. That's according to William A. Niskanen, a founder of Reaganomics. He was also a member of President Reagan's Council of Economic Advisers from 1981 to 1985. Inflation was tamed, but it was thanks to monetary policy, not fiscal policy. Reagan's tax cuts did end the recession.

But government spending wasn't lowered, just shifted from domestic programs to defense. The result? The Federal debt almost tripled, from $997 billion in 1981 to $2.857 trillion in 1989. (Source: William A. Niskanen, "Reaganomics," Library of Economics and Liberty.)

Taxes Were Cut

Tax rates were cut significantly, stimulating consumer demand.

By Reagan's last year in office, the top income tax rate was down to 28% for those making $18,550 or more. Anyone making less paid no taxes at all. That was a significant drop from the 1980 top tax rate of 70% for individuals earning $108,000 or more. Also, Reagan made sure tax brackets were indexed for inflation. These tax cuts were somewhat offset by several tax increases. The Social Security payroll tax and some excise taxes were raised, and several deductions were eliminated.

The corporate tax rate was also cut, from 46% to 40%. But the effect of this break was unclear. Reagan changed the tax treatment of many new investments. The complexity meant that the overall results of his corporate tax changes couldn't be measured.

Growth in Spending Was Reduced

Government spending still grew, just not as fast as under President Carter. Reagan increased spending by 2.5% a year, mostly for defense. Cuts to other discretionary programs only occurred in his first year. Reagan did not cut Social Security or Medicare payments at all.

In fact, Reagan's budget was 22% of Gross Domestic Product (total economic output). That's higher than the standard 20% of GDP. Nevertheless, the growth in spending was less than President Carter's 4% annual increase. Note: figures are adjusted for inflation).

Regulations Were Reduced — Somewhat

Reagan eliminated the Nixon-era price controls on domestic oil and gas in 1981. These constrained the free-market equilibrium that would have prevented inflation. Reagan also removed controls on cable TV, long-distance telephone service, interstate bus service, and ocean shipping. Bank regulation was eased, helping to create the Savings and Loan Crisis of 1989. (Source: "President Abolishes Last Price Controls on U.S.-Produced Oil," The New York Times, January 29, 1981.)

Reagan increased, not decreased, import barriers. He doubled the number of items that were subject to trade restraint from 12% in 1980 to 23% in 1988. He did little to reduce other regulations affecting health, safety, and the environment. Although Reagan reduced regulations, it was at a slower pace than under Carter.

Inflation Was Tamed — at a Cost

Reagan was fortunate Federal Reserve Chairman Paul Volcker was already in place. Volcker vigorously attacked the double-digit inflation of the 1970s. He used contractionary monetary policy, despite the potential for a double-dip recession. In 1979, Volcker began raising the Fed funds rate. By December 1980, it was at a historically high 20%.

Although inflation was tamed, these rates also choked off economic growth. Volcker's policy triggered the recession of 1981-1982. Unemployment rose to 10.8% and stayed above 10% for ten months.

Why Is Reaganomics Relevant Today?

Reaganomics is the economic policy advocated by conservatives. 2016 Presidential candidate Donald Trump, 2012 Tea Party followers, and other Republicans claim its heritage. But the theoretical basis of Reaganomics reveal why it worked so well in the 1980s, but could harm growth in 2016.

Reaganomics and supply-side economics follow the theoretical underpinning provided by the Laffer Curve. It was developed in 1979 by economist Arthur Laffer. The curve showed how tax cuts could stimulate the economy to the point where the tax base expanded. That's because tax cuts reduced the federal budget immediately, and dollar-for-dollar.

These same cuts have a multiplier effect on economic growth. Tax cuts mean more money in consumers' pockets, which they spend. That stimulates business growth and more hiring. The result? A larger tax base. But the effect that tax cuts have depends on whether the economy is growing or not. It also depends on how high taxes were to begin with, and which taxes are cut.

For example, President Bush cut taxes in 2001 (EGTRRA) and 2003 (JGTRRA). The economy grew, and revenues increased. Supply-siders, including the President, said that was because of the tax cuts. Other economists point to lower interest rates as the real stimulator of the economy. The FOMC lowered the Fed Funds rate from 6% at the beginning of 2001 to 1% in June 2003. (Source: New York Federal Reserve, Historical Fed Funds Rate.) 

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