Reagan was an advocate of laissez-faire economics, where a government’s role is reduced. He believed that a free market and capitalism would solve the nation’s woes.
Reaganomics Policies
America was in trouble when Ronald Reagan was elected to office. He inherited an economy mired in stagflation, a combination of double-digit economic contraction and double-digit inflation. He promised to slow the growth of government spending and deregulate business industries. At the same time, he encouraged the Federal Reserve to combat inflation by reducing the money supply. The Reagan administration developed the Program for Economic Recovery, which focused on four areas:
A reduction in the federal tax rateA substantial reduction in the growth of federal expendituresRelief from federal regulatory burdensA monetary policy for the Federal Reserve System that complimented the previous three policies
Reaganomics was based on the theory of supply-side economics. This theory proposes that tax cuts encourage economic expansion enough to broaden the tax base over time. The increased revenue from a stronger economy is supposed to offset the initial revenue loss from the tax cuts. Reagan also offset these tax cuts with tax increases elsewhere. He raised Social Security payroll taxes and some excise taxes.
Reaganomics and Tax Cuts
Unemployment was 8.5% in December 1981, then rose to 10.8% by December 1982. Congress cut the top tax rate from 70% to 50% in 1982. This helped spur growth in gross domestic product for the next several years. The economy grew 4.6% in 1983, with a decrease in unemployment to 8.3%. In 1984, growth rose 7.2%, and unemployment fell to 7.3%. In 1985, the economy grew 4.2%, and unemployment fell to 7% by that December. In 1986, growth was a healthy 3.5% by the end of the year, but the unemployment rate was 6.6%. It was still higher than the natural rate of unemployment. Reagan cut the tax rate again, to 38.5% this time, in 1987—growth remained similar at 3.5%, and unemployment fell to 5.7%. Corporate tax rates were cut from 46% to 40% in 1987, but the effect of this break was unclear. Additionally, the tax treatment of many new investments changed. In 1988, Reagan cut taxes again to 28%. Growth rose to 4.2%, and unemployment fell to 5.3% in 1988.
Reaganomics Spending Cuts
Despite campaigning on reduced government spending, Reagan wasn’t as successful with this as he was with tax cuts. He cut domestic programs, but he increased defense spending to achieve “peace through strength” in his opposition to Communism and the Soviet Union. Reagan increased the defense budget by 35% to accomplish these goals. As a result, defense spending grew faster than general spending, rising from $154 billion in FY 1981 to $295 billion in FY 1989. Overall, government spending still grew; From 1981 through 1989, Reagan increased the budget by $390 billion, according to the Office of Management and Budget’s historical tables.
Reaganomics and Deregulation
Reagan was applauded for continuing to eliminate Nixon-era price controls. They constrained the free-market equilibrium that would have prevented inflation. Reagan removed controls on oil and gas, cable television, and long-distance phone service. He further deregulated interstate bus service and ocean shipping. Congress passed the Garn-St. Germain Depository Institutions Act in 1982. The Act helped savings and loan banks deal with rising inflation and interest rates by further deregulating deposit rates, among other things.
Reaganomics and Monetary Policy
Federal Reserve Chairman Paul Volcker had steadily raised the federal funds rate to 20% in 1980. While very unpopular, these high interest rates worked to end double-digit inflation. Reaganomics took the stance that the supply of money had been growing too fast in the years previous, so the monetary policy developed to support the program was to reduce the growth rate of the money supply to more “modest” levels. This growth reduction complemented the Federal Reserves’ policy of raising interest rates to reduce borrowing and spending.
Reaganomics Effect on the Debt
Reagan’s first budget was for the fiscal year 1982. As the chart below reveals, he incurred substantial deficits for each year of his presidency. As a result, debt also increased each year. Reagan’s budgets tripled the national debt from $998 billion at the end of Carter’s last budget to $2.9 trillion at the end of Reagan’s final budget. Check the chart below to see how that debt contributed to the deficit as it related to GDP. Regardless of the argument for or against Reaganomics, the spending increases, and tax cuts, it’s difficult to challenge the economic results of the administration’s efforts:
GDP (growth): nearly doubledInflation: Increased slowlyUnemployment: Slowly decreased
