The International & Domestic Impact of Reaganomics 25 Years Later

An August 12 Wall Street Journal editorial entitled Reaganomics at 25 (available for a fee) highlights the enduring positive international effect of President Reagan's supply-side economic policies:

Twenty-five years ago this weekend, Ronald Reagan signed the Economic Recovery Tax Act. The bill cut personal income tax rates by 25% across the board, indexed tax brackets for inflation and reduced the corporate income tax rate. The anniversary is worth commemorating as a seminal moment that continues to influence policy for the better in the U.S., and around the globe.

The achievement of Reaganomics can only be fully understood by recalling the miserable state of affairs a quarter-century ago. Newsweek summarized the national mood when it wrote in 1981 that Reagan "inherits the most dangerous economic crisis since Franklin Roosevelt took office 48 years ago."

That was no exaggeration. The economy was enduring a cycle of rising inflation with growing levels of unemployment. Remember 20% mortgage interest rates? Terms like "stagflation" and "misery index" entered the popular vocabulary, and declinists of various kinds were in the saddle. The perception of American economic weakness encouraged the Soviet empire to ever bolder adventures...

The reigning Keynesian policy consensus had no answer for this predicament, and so a new group of economic ideas came to the fore. Actually, they were old, classical economic ideas that were rediscovered via the likes of Milton Friedman and the Chicago School, Arthur Laffer, Robert Mundell, and such policy activists in Washington as Norman Ture and Jack Kemp...

For every policy goal, you need a policy lever...Monetary restraint was needed to break inflation, while cuts in marginal tax rates would restore the incentives to save and invest. With Paul Volcker at the Federal Reserve and Reagan at the White House, those two levers became the essence of the "supply-side" policy mix.

The results have been better than even some of its supporters hoped. The Dow Jones Industrial Average first broke 1,000 in 1972, but a decade later it was barely above 800 -- one of the worst and most enduring bear markets in history. In the 25 years since Reaganomics, however, the Dow has climbed to about 11,000, accounting for an increase in national wealth on the order of $25 trillion...American living standards have risen steadily, and U.S. businesses have created entire industries that didn't exist a generation ago.

Obviously, the economic policy path from 1981 to the present day has not been a straight line. The biggest detour occurred from 1990 through 1994, when George H. W. Bush and Bill Clinton forgot the Gipper's lesson and raised marginal income-tax rates; they suffered for it in the elections of 1992 and 1994. The arrival of the Gingrich Republicans in Congress stopped this slow-motion repeal of Reaganomics, however, and even helped to extend it at the margin with a cut in the capital-gains tax rate to 20% in 1997.

Adherents of Rubinomics -- after Clinton Treasury Secretary Robert Rubin -- are still not converts, arguing that tax increases are virtuous if they reduce the deficit...But even the Rubinites haven't dared to repeal indexing for inflation (which pushed taxpayers via "bracket creep" into ever-higher tax rates), and even the most ardent liberals don't propose to return to the top pre-Reagan income tax rate of 70%. They also now understand that, at some point along the Laffer Curve, high rates begin to yield less tax revenue. The bipartisan consensus in favor of sound money has also held.

Thus today, the top marginal personal and corporate tax rates are 35%, compared with 70% and 48% in 1981. In the late 1970s the tax on dividends was 70% and the capital gains rate was 50%; now they're both 15%. These reductions have increased the rate of return on capital, and hence some $3 trillion more was invested by foreigners in the U.S. between 1981 and 2005 than was invested by Americans abroad. One result: 40 million new jobs, more than the rest of the industrialized world combined.

The rest of the world, meanwhile, has followed the Gipper down the tax-cut curve. Daniel Mitchell of the Heritage Foundation finds that the average personal income tax rate in the industrialized world is now 43%, versus 67% in 1980. The average top corporate tax rate has fallen to 29% from 48%. This decline in global tax rates has been the economic counterpart to the fall of the Berlin Wall. Most of Eastern Europe has adopted flat tax rates of 25% or lower, and the Russians now have a flat income tax of 13%. In Old Europe, Ireland's corporate and personal income tax rate cuts have helped generate the swiftest economic growth in the EU.

...In his 1989 farewell address, Reagan said that "People say that I was a great communicator. It would be more accurate to say that I communicated great ideas." He was right, and a remarkable global prosperity has followed in his wake. The challenge for current and future political leaders is not to forget it.

What about the enduring effect of these supply-side economic policies on domestic policies? That question is answered by Christopher DeMuth, President of the American Enterprise Institute, in Reaganomics: How’s It Going?: Two wins, a draw, and two losses (also available for a fee) published in the September 11 issue of National Review:

When Ronald Reagan came to Washington, he brought with him a conservative school of economics. This school emphasized, much more thoroughly and systematically than those associated with previous presidents of either party, the advantages of private markets, the disadvantages of government spending and regulation, and the role of private economic incentives in advancing or undermining government policies. As we pass the 25th anniversary of the August 1981 tax cuts, it is appropriate to assess Reagan’s economic record. My scorecard shows two wins, one draw, and two losses.

The first win was monetary policy. In the late 1970s, liberal economists such as James Tobin and Robert Solow argued that monetary policy should aim primarily to achieve low unemployment; this, they said, would inevitably generate some inflation, but we would have to live with it as the price of strong employment. Conservative economists like Milton Friedman and Allan Meltzer argued that monetary policy should aim for price stability; this, they said, would provide the framework for efficient investment and productivity growth, thereby raising employment.

The Friedmanites won a brilliant victory. Since the inflation-breaking year of 1982, the Federal Reserve Board has pursued a consistent low-inflation policy, and inflation has averaged less than 2.6 percent — as compared with 7.6 percent for the decade before 1982. Over the same periods, unemployment fell from an average of 7 percent to less than 6 percent, and continues to fall. No one is arguing today that inflation is something we should tolerate in order to achieve low unemployment or other economic goals...

The second big win was regulatory and antitrust policy. Deregulation, like stable money, began as a staple of conservative economic thought, and was a tenet of Reaganism. Reagan’s first, flamboyant act as president was to abolish federal price controls on oil and gasoline — a step that the media and many Democrats said would lead to soaring prices but instead lowered them, exactly as Reagan had predicted. He also presided over the decontrol of natural-gas prices and the abolition of the Civil Aeronautics Board, signed legislation putting the Interstate Commerce Commission on track to extinction, and never missed an opportunity to highlight and ridicule the perverse effects of government rules. His policy toward environmental and safety regulation was to require that rules pass a cost-benefit test showing that their social value outweighed their economic price.

Both economic deregulation and economics-based reform of social regulation proved to be durable contributions...

As in the case of monetary policy, one is struck by the emergence of an intellectual consensus — beginning before the Reagan years and including both politicians and economists — around what had once been conservative positions...

Most impressive of all was the revolution in antitrust policy. In the early 1970s, University of Chicago economist Aaron Director and legal scholars Robert Bork and Richard Posner mounted a root-and-branch critique of then-prevailing antitrust doctrines that tightly restricted mergers, price competition, and product distribution. Antitrust, they said, should be guided by the criterion of consumer welfare, not that of balancing the interests of rival producers....With Reagan’s inauguration they became official policy at the Justice Department’s antitrust division and the Federal Trade Commission.

The economic benefits of antitrust reform have probably been as great as those of price stability: Much of the industrial restructuring of the past 20 years, and many of the pricing and product-distribution practices that have emerged in the new information economy, would have been illegal before the 1980s....But today’s arguments, grounded on all sides in considerations of market competition and consumer welfare, are worlds away from the pre-1980s mishmash of populism and armchair industrial planning.

Tax policy has absorbed more conservative political energy than any other economic issue in the past 25 years, but has produced only a draw with liberals. The achievements have been substantial. Reagan won steep reductions in marginal income-tax rates that proved durable through several subsequent tax revisions authored by both Democrats and Republicans. The reductions have affected not only the highest earners...but taxpayers across the income spectrum...The arguments of liberal critics that sharp tax reductions would generate a wave of price inflation proved unfounded and have disappeared from the policy debate. And Reagan, in league with Dan Rostenkowski and other House Democrats, forged the Tax Reform Act of 1986, which made the tax code simpler and more efficient by broadening the tax base in exchange for reduced rates and the elimination of loopholes.

But these gains have been offset by several adverse developments. Tax policy, in contrast to monetary, regulatory, and antitrust policy, has remained highly partisan. Successive rounds of legislation...have left the tax code with many anomalies that tend to entrench both sides and make reform more difficult. The introduction or expansion of tax deductions and credits for child care, education, retirement saving, and many other things, combined with the Clinton-era innovation of phasing out deductions and credits as income increases, has produced a pattern of effective marginal tax rates that economist Kevin Hassett has dubbed the "skyline tax."...Rates that rise and fall willy-nilly reflect nobody’s idea of tax equity or efficiency. They reflect, rather, the terms of ceasefire in the last several tax battles.

Another anomaly has arisen from the one thing conservatives and liberals have been able to agree on since Reagan: that it is desirable to exclude lower-income persons from the tax rolls altogether...The number of Americans who file a federal income-tax return but owe no tax has risen from about 19 percent when Ronald Reagan left office to about 32 percent today...The upshot is that a very large proportion of the adult American population...now provides zero direct support for the general operations of the federal government. This cannot be good for our political health, and has certainly complicated the task of tax reform. Every proposal that does not include a tax hike is immediately attacked as a giveaway to the rich. In one sense, the charge is accurate — because only the rich (very broadly defined) now pay any income taxes at all.

Now for the two losses. The first is spending restraint. In the 25 years since Ronald Reagan declared his intention to curb the growth of government, domestic spending has more than doubled in real terms. This growth has been especially pronounced during the years of unified Republican government since 2001...In power, Republicans have turned out to be just as profligate as Democrats. They have even cooked up a theory called "big-government conservatism" to justify themselves.

There is an unfortunate asymmetry between the conservative and liberal camps on the spending question. The liberals present a united front: Both their economists and their politicians tend to think that when money is taken out of the private economy and spent by the government, the result will be an improvement in social welfare. Conservative economists are highly dubious of that proposition — but they are now at odds with conservative politicians, who for the most part simply ignore them on spending issues.

The second loss has been voucherization and privatization. Even before the Reagan administration, conservatives were arguing that many public programs, such as schooling, Social Security, Medicare, and a long list of social-welfare services, would be much improved if the government relinquished its one-size-fits-all monopolies by providing vouchers for individuals to buy these services from private or government suppliers. The failure of these proposals is something of a puzzle...I believe there are three reasons they have failed to catch on.

First, the government programs in question have embedded within them a large number of hidden cross-subsidies, including many to the middle class. By far the largest subsidy in public education is to the teachers unions whose members constitute a near monopoly, a status that would be lost in a truly competitive school-choice program. And Democrats worry that making Social Security and Medicare highly progressive would erode political support for the programs among the middle class...

Second, many of the school-voucher programs that have been tried around the country provide only weak forms of choice; when parents move their children out of a school, the school suffers no financial loss and its average revenue per pupil may even rise. The result is to undermine school choice’s ability to affect public-school performance. When parents are able to deny resources to one school and give them to another, public schools will instantly begin to improve.

Third, many people are uneasy about applying the idea of personal choice to schooling, retirement policy, and welfare programs, which they regard as part of the essential fabric of government. Until the libertarian revolution arrives, conservatives should emphasize the social rather than the private advantages of vouchers — the tremendous improvements they would bring to school performance, pension programs, health care, and other services, as distinct from personal-choice benefits to individuals considered apart from the society they belong to...

DeMuth concludes with an opinion about the upcoming key battle in the future:

Standing at the intersection of our two greatest policy failures, spending control and voucherization, are the two mammoth health-care programs, Medicare and Medicaid, growing like Topsy. Health care is unique in featuring a sharp ideological divide between conservative economists and politicians on one hand and liberal economists and politicians on the other. Both breeds of conservative favor reforms to greatly reduce government regulation and financing of medical care, leaving the sector to be governed largely by competitive private markets with a social safety net. Liberal politicians and liberal economists who devote themselves to health-care policy for the most part favor outright socialism. Each camp fashions its every incremental proposal with a view toward its larger goal. Whether conservative economics is as successful in the next 25 years as it has been in the last 25 will depend largely on how this battle — so far unmediated by the emergence of any professional consensus — plays out.

You can read more about supply-side economics in these postings:

Guess What? Supply-Side Economic Policies Work...Again
Celebrating Reaganomics, 25 years later
Economics 101: Never Underestimate the Incentive Power of Marginal Tax Cuts