When Ronald Reagan ran for president in 1980, he wanted to change the nation’s economic path. He rejected the prevailing economic theory that had dominated American economic policy since World War II. That theory held that the federal government should influence the actions of the business world with its policies. It also called for deficit spending by the federal government. Deficit spending is the gap between what the government spends and what it takes in as income (mostly but not exclusively from taxes). To make up the difference between spending and income, the federal government borrows money from the private sector or from other governments, sometimes in the form of bonds. Therefore, every year that the government runs a deficit it adds to the national debt, the total amount of money owed by the government because of borrowing.
During the campaign of 1980, Reagan announced a recipe to fix what he considered the nation’s economic mess. His economic policies, dubbed “Reaganomics”, advocated tax rate reduction to spur economic growth, economic deregulation, and reduction in government spending. He claimed an undue tax burden, excessive government regulation, and massive social spending programs hampered growth. Reagan proposed a phased 30% tax cut for the first three years of his Presidency. The bulk of the cut would be concentrated at the upper income levels. The economic theory behind the wisdom of such a plan was called “Supply-Side” or “Trickle-Down” economics. Tax relief for the rich would enable them to spend and invest more. This new spending would stimulate the economy and create new jobs. Reagan believed that a tax cut of this nature would ultimately generate even more revenue for the federal government. During the primary battle for the 1980 Republican presidential nomination, George Bush called Reagan’s economic ideas “voodoo economics”.
Among the academic experts who embraced supply-side thinking was Arthur Laffer of the University of Southern California. Laffer popularized the idea that tax cuts could increase government revenues or even pay for themselves, using a simple diagram known as the Laffer Curve. Another prominent advocate of supply-side economics was Rep. Jack Kemp (R-NY), who devised a plan to encourage economic growth through tax reductions that was implemented in the Economic Recovery Tax Act of 1981, which enacted a 27% across-the-board federal income tax cut over three years.
In place of using the federal government to regulate business, provide a basic social safety net, protect civil rights, and promote infrastructure, Reagan Republicans promised that cutting taxes and regulation would free up capital, which investors would then plow into new businesses, creating new jobs and moving everybody upward. Americans could have low taxes and services both, they promised, for “supply-side economics” would create such economic growth that lower tax rates would still produce high enough revenues to keep the debt low and maintain services.
Reagan proposed a four-pronged economic policy intended to reduce inflation and stimulate economic and job growth. First, he planned to reduce government spending on domestic programs. In accordance with his suspicion of government intervention, Reagan cut or reduced funding to multiple domestic welfare programs, including Social Security, Medicaid, Food Stamps, education, and job training programs. In a deeply controversial move, he also ordered the Social Security Administration to tighten enforcement on disabled recipients, ending benefits for more than a million recipients. Second, he reduced taxes for individuals, businesses, and investments. In the first year of his presidency, Reagan lowered taxes significantly. Income taxes on the top marginal tax bracket dropped from 70% to 50%, along with sharp cuts to corporate and estate taxes. Another tax reform was passed in 1986, reducing both the number of tax brackets and the highest marginal tax rate. Third, Reagan started a program of reducing regulations on business. Reagan removed price controls on oil and gas, reduced restrictions on the financial services industry, and relaxed enforcement of the Clean Air Act. The Department of the Interior also opened large areas of public land for oil drilling. Finally, Reagan supported slower money growth in the economy. Reagan encouraged the Federal Reserve to tighten the money supply. The contraction was intended to reduce inflation, which had already reached double-digit figures by the start of the Reagan presidency.
Inflation was one of the country’s biggest economic problems during the Carter and Reagan years. Chairman of the Federal Reserve Paul Volcker, a Carter appointee who was retained by Reagan, aimed to bring inflation under control by tightening the nation’s money supply. The result was higher interest rates for borrowing money, which squeezed small businesses and middle-class Americans. Interest rates on home mortgages approached an astounding 20%. Volcker believed that this painful economic medicine was necessary to break the back of inflation. Volcker succeeded, but at considerable cost. Inflation plunged, but the economy fell into the worst recession since the Great Depression. Unemployment climbed to 10.8 percent; business failures reached the highest levels since the 1930s.
Another major economic problem during the Seventies and Eighties was growing wealth inequality. This trend began during the 1970s; it continued during the Reagan years and after. Between 1977 and 1989, the wealthiest 20 percent of Americans saw their pretax income increase by 29 percent, whereas the pretax income of the poorest shrank by 9 percent. Those in middle-income categories enjoyed only a modest increase. Between 1970 and 1995, the richest 1 percent of American households saw their share of the nation’s wealth increase from 20 to 40 percent. These trends reversed the pattern from the 1950s and 1960s, when the largest income growth had occurred among the poorest 40 percent of American households. The data suggest the United States had become “the most economically stratified of the industrial nations.” “The gap between rich and poor grows from a gully to chasm” stated Garry Wills in his book Regan’s America.
Economists disagreed over the overall effects of Reagan’s economic policies. Tax cuts plus increased military spending cost the federal government trillions of dollars. Reagan advocated paying for these expenses by slashing government welfare programs. In the end, the Congress approved his tax and defense plans, but refused to make any deep cuts to the welfare state. Even Reagan himself was squeamish about attacking popular programs like Social Security and Medicare which consume the largest percentages of taxpayer dollars. The results were skyrocketing deficits.
The national debt tripled from one to three trillion dollars during the Reagan years. The President and conservatives in Congress cried for a balanced budget amendment, but neither branch had the discipline to propose or enact a balanced budget. The growth that Americans enjoyed during the 1980s came at a huge price for the generations to follow.
Although economists and politicians continue to argue over the effects of Reaganomics, it ushered in one of the longest and strongest periods of prosperity in American history. Between 1982 and 2000, the Dow Jones Industrial Average (DJIA) grew nearly 14-fold, and the economy added 40 million new jobs. From December 1982 to June 1990, Reaganomics created over 21 million jobs—more jobs than have been added since,” wrote Arthur Laffer. But, Paul Krugman wrote in the New York Times. “…[W]hile the rich got much richer, there was little sustained economic improvement for most Americans. By the late 1980s, middle-class incomes were barely higher than they had been a decade before and the poverty rate had actually risen.