Reaganomics: Ineffectivness At Its Best

The national debt is as old as the nation itself. Alexander Hamilton, Treasury secretary in the George Washington administration, started running the country on borrowed money partly because he thought it was desirable for the government to owe money to the wealthy. However, Hamilton did not want the government to borrow money for the sheer thrill of being in debt.

When Hamilton ran the Treasury, the ink was just dry on the Constitution, and Hamilton did not know whether the new government would last two years or two centuries. So Hamilton thought it wise to give the wealthy a reason to root for the longevity of a new government.

If the government owed the wealthy money, Hamilton figured they would want the government to thrive and last long enough to pay them back.1 Similar to Hamilton, Ronald Reagan, president of the United States from 1981-1989, had a fiscal plan that significantly involved the use of the national debt. Reagan's economic plan, which is most often called Reaganomics, was tested, and in effect, throughout his two terms in office during the 1980s. At the time the economic plan was being used many felt that it was generating great affluence across the nation. However, the effects of Reaganomics, namely the national debt, are what prove its ineffectiveness. Reaganomics has caused much more harm to the present day economy than it did to that of the 1980s economy.

Moreover, few goals of Reaganomics were accomplished. The purpose of this paper is to prove that Reaganomics was an ineffective economic plan for the country. In order to understand how Reaganomics led to such severe economic issues, one must first understand the basic premise of Reaganomics, also called supply-side economics.

The overall assumption of Reaganomics was that taxes could be cut-even if slashing the government's income sent the budget deeply into deficit-because the tax cuts would stimulate so much economic growth that they would pay for themselves and bring the debt back down. This, unfortunately, did not happen.

Moreover, many of these tax cuts were to be given to the wealthy, and most often to corporations. This was done under the basis that if the corporations had more money, from paying less to the government in taxes, they would eventually "trickle down" some of this excess capital to those under them. Once again, this is not what transpired. There were many factors that led to the use of Reaganomics, and in some ways these factors played a role in the overall implementation of Reaganomics. When Reagan campaigned against Jimmy Carter in the 1980 presidential election, Reagan posed the question to the American public, "Are you better off than you were four years ago?" Soon, newspaper polls began to report a surge of support for Reagan, which led to a Reagan landslide one week later. Evidently, this question struck a cord with many in the country, which suggests that events prior to his administration effected how Reagan's fiscal plan would soon come to evolve. Reagan was right in the debate with Carter: the 1970s were tough by comparison with the 1960s. He was also right in observing that lower productivity growth and higher federal-benefit growth during the 1970s "squeezed out" defense spending in favor of privately earned spending on consumption. What looks quite significant in retrospect, however, is that at least the squeezing did take place. Few Americans watching the debate in 1980 ever imagined that over the coming decade we would just decide to ignore the law that limits consumption to production.

Ronald Reagan, however, was not one individual solely bent on the destruction of the economy. Many of his contemporaries believed that his plan would work, and more importantly so did a large portion of the American people.

For instance Reagan's Office of Management and Budget predicted that the economy would grow a robust 4.4 percent annually and produce a federal budget surplus of $28 billion by 1986. The application of Reaganomics, as shown with actual results, will eventually help to show why the effects of Reaganomics were so severe. One part of the overall plan of Reaganomics was to cut government spending. However, contrary to an early Reagan pledge, federal spending actually rose during his presidency. But the portion devoted to productive assets such as highways and schools declined.

Furthermore, the most crucial part of the plan, tax-cuts, were not applied effectively. Most of the 1981 tax cut was simply an across-the-board cut in personal income-tax rates and thus did little to alter the relative tax burden on savings versus consumption. In any case, what is truly inexcusable is the expectation that we could come out ahead simply by cutting the overall level of taxation while still allowing federal spending to grow. When tax cuts go unmatched by spending cuts, they must be accompanied by additional public borrowing from households and firms--thus by a dollar-for-dollar reduction in otherwise investable private savings. Therefore, in a near-full-employment economy only a tiny fraction of the cut is likely to show up as additional private savings.

If families and firms treat the tax cut just as they treat other income, the savings might be six or seven cents on the dollar--a tiny margin that can disappear entirely if there is a negative shift in the private sector's overall inclination to save.

In other words, because the tax cuts were applied outright to personal income-tax rates, what to the government was a macroscopic venture, was basically a small amount of extra capital to the average person. Furthermore, from 1979 to 1986 the total annual increase in workers' production amounted to about $100 billion (in 1986 dollars).

The comparable total for increases in personal consumption plus government purchases was about $300 billion. That leaves a difference of a bit more than $200 billion--just slightly more than the increase in annual federal deficits over the past six years.6 Basically, we were funding our nation with money that we did not have.
Whatever could not be paid, the deficit, would have to be rolled over into the national debt. Essentially Reagan was looking for economic action at a price we could not pay. This is why Democrats generally disparage the economic performance of the middle '80s as credit card prosperity.

In addition, in the 1980s economic growth as compared to wages behaved differently, and to a large degree unfairly, than it had in past years. Poverty rates in the U.S. fell very little from 15 percent of the population to 12.8 percent, during the seven-year economic expansion of the 1980s. After all, a comparable burst of growth during the 1960s slashed poverty from 21 percent to 12.1 percent. Wage growth during the 1980s simply exempted the poorest 10 percent of workers. In the 1960s, every 1 percent increase in the gross national product added $2.18 to the weekly wages of the working poor. By the 1980s, however, a 1 percent increase in GNP actually reduced their wages by about 30 cents, though their total income rose slightly because they worked longer hours. For the top 20 percent of workers, wages actually rose more in the 1980s than in the 1960s.

Budget deficits and the national debt are the most compelling pieces of Reaganomics. Each year that the government brought in less money from a loss in tax revenue, the government would end up spending more than it had, and as a result have a huge budget deficit. These deficits were complied into the mounting national debt. Whatever the effects of cuts in taxation and shifts in spending, they were more than offset by skyrocketing budget deficits.

Overall, the governments borrowing caused net national savings to collapse from 7 percent of the gross national product in the 1970s, to 3.5 percent in the 1980s. This resulted in a drop in net national investment from 7.1 percent to 5.2 percent.9 As a result of bad planning, poor implementation, and miscalculated statistics, Reaganomics resulted in many striking results. The fiscal policy in the 1980s accomplished exactly the opposite of almost every key economic promise made by Ronald Reagan early in his presidency.

Federal spending, which was supposed to shrink, grew from 21.1 percent of gross national product in the 1970s to 23.4 percent in the 1980s. Investment in factories and machines, which was supposed to blossom, contracted from 3.5 percent of national output to 3 percent. And the federal budget deficit, instead of being reduced as the Reagan administration promised, swelled from 1.8 percent of national output to 3.6 percent.

Loss of revenue to the federal government due to decreased tax rates led to many problems.

Overall, the Treasury Department lost $644 billion in forgone revenues, the federal debt doubled in size and there was no special burst in worker productivity. When Congress approved the sweeping reduction of income tax rates in 1981, it also enacted additional tax breaks, such as those for capital-gains, generous write-offs for business investment and expansive rules for individual retirement accounts. Despite the extra money in the system, there was no large stimulation of the economy. However, tax revenues fell steadily as a share of gross domestic product, and in 1986 alone the Treasury collected $171 billion less than Reagan administrators had forecast. Federal spending continued to grow, however, and the federal deficit soared to an unprecedented $221 billion in 1986. The theory that cutting taxes could increase government revenues seems to have been widely discredited.

Washington's deficits passed record levels, while public-sector credit demands smothered the promised gains in private-sector activity. Saving by individuals fell from about 5 percent of income in 1981 to 2.5 percent by the mid-1980s. Net business investment in new equipment and buildings also declined from 3.2 percent of the gross national product in 1981 to 1.9 percent in 1986. And though the massive tax cuts probably prolonged the economic expansion of the 1980s, overall growth averaged 2.8 percent annually, far below the promised spurt.

It can further be seen that tax-cuts effected different segments of the population differently. Perhaps the most dramatic of which was the shift in the burden of taxation. Families in the top fifth of the income distribution saw their prevailing federal tax rates fall from 29 percent in 1980 to 26 percent in 1985, while families in the bottom fifth saw their tax rates rise from 8 percent to 10 percent. In addition, in an attempt to cut government spending, Washington cut grants to state and local governments.
This led at least 26 states to raise their own income and sales taxes to make ends meet. By 1988, the states share of the national tax burden had risen to 27 percent, up from just 24 percent in 1980.

Once again, the most damaging effect of Reaganomics is the national debt. In the years since Reaganomics has been in effect, the national debt has grown to record levels. In 1985, the debt reached an all time record of almost $2 trillion. Since then this figure has more than doubled. Many blame decisions made early in the Reagan administration for current problems. Reaganomics has had many long-lasting and far reaching consequences, that extend well beyond the 1980s. In present day America, the task of paying off our national debt has been long and arduous. In many cases this is because not only did Reaganomics leave a legacy of indebtedness, but it also effected our potential, and thus has limited our economy today. For example, because of huge deficits, the US has lost over 2.5 percent to even 3.5 percent of potential gross national product.

This may not seem to be a very large number, but when contrasted to the billions of dollars in goods and services that we produce, one can see that in fact this percentage is staggering. Furthermore, a critical segment, the nation's productive capital, has also declined. This was an important target of supply-side economics. Because of declining investments in new assets, the nation's net capital stock in 1990 was 7 percent below what it would have been without Reaganomics. Even worse, when business investment in new factories slows down, so does industry's ability to bring new and innovative technologies to market. It has been predicted that the economy will continue to underperform without a reduction in the budget deficit, and increase in investment. All told, the national output will be fully 5 percent below what it might have been without Reaganomics.16 Today, both President Clinton and Congress are attempting to fix the errors made by Reagan and his administration. It is estimated that spending cuts will have to be truncated to the sum of over 700 billion dollars over the next five years. This will be a huge task, since Congress and the President have already trimmed off more than $247 billion in spending cuts in1993. All of these cuts in spending are being made in hopes to reduce, or even balance, the deficit.

However, the deficit only comprises what we cannot pay for each individual year, the national debt is made up of what we currently owe for every year that our budget has not been balanced. We pay the deficit mainly with treasury bonds, and loans. What is discouraging, is that Treasury bonds do not have an automatic debt-retiring feature built in. So the monthly payments to the holders of Treasury bonds pay the interest only. The full principal remains. When the bond matures, the government owes the bondholder the original face value. But no money is budgeted to pay the bondholder off. So the government must sell a new bond to raise the money to pay off the old bond. So even if the budget was balanced, the debt would not go down. For the debt to actually decline, the budget would have to go beyond balanced and into surplus.17 With the huge debt, and large deficits, this is not very practical. Reaganomics was a severely ineffectual economic plan. When Reaganomics was tested in the 1980s, taxes dropped, but there was no extremely effective boom in the economy to pay for the tax-cuts. Moreover, the tax-cuts not only did not help most Americans, but in many ways they actually hurt Americans. To a large extent Reaganomics led to the poor getting poorer and the rich getting richer. Most importantly, Reaganomics sacrificed long term economic prosperity, which can be seen by the nations current national debt of $5,088,829,415,488.70.18 Reaganomics was a severely poor economic plan, which did not accomplish any of its key concepts.

End Notes

1. Eric Black. "Forever Indebted." STAR TRIBUNE. August 23, 1993.
2. Black.
3. Peter G. Peterson. "The Morning After." THE ATLANTIC. October 1987.
4. David Hage. "Dropping of the Charts." U.S. NEWS AND WORLD REPORTS. June 29, 1992.
5. p.41. Peterson. David Hage. "Why poor workers lost ground in the 1980s." U.S. NEWS AND WORLD REPORTS. June 1, 1993. p.46.
6. Hage. "Dropping of the Charts." p. 41 David Hage. Robert F. Black. "The repackaging of Reaganomics." U.S. NEWS AND WORLD REPORTS. December 12, 1994. p. 50. 12. Hage. Black. 13.
7. Hage. Black. 14. Hage. "Dropping of the Charts." p. 41 15. Hage. 16. Hage. Black 17.
8. Black. 18. The Department of Treasury "The Public Debt"

Works Cited

1. Hage, David. "Why poor workers lost ground in the 1980s." U.S. News & World Reports 1 June.
2. 1992: 46-47 Hage, David, and Robert F. Black. "The repackaging of
3. Reaganomics." U.S. News & World Reports 12 Dec. 1994: 50 Hage, David. "Dropping off the
4. charts" U.S. News & World Reports 29 June 1992: 41 Black, Eric. "Forever Indebted." Star
5. Tribune 22 Aug. 1993 Peterson, Peter. "The Morning After." The Atlantic October 1987.
6. United States. Department of the Treasury. The Public Debt 9 May 1996