Reaganomics refers to economic policies put forward by US President Ronald Reagan during his presidency in the 1980s. The policies were introduced to fight a long period of slow economic growth, high unemployment, and high inflation that occurred under Presidents Gerald Ford and Jimmy Carter. Reaganomics was built upon four key concepts: (1) reduced government spending, (2) reduced taxes, (3) less regulation, and (4) slowdown of money supply growth to control inflation.  Background of ReaganomicsRonald Reagan’s economic policies are based on supply-side economics, which is a macroeconomic theory that states economic growth can be created by reduced taxes and lower regulation. Reagan believed a tax cut would ultimately generate more revenue for the government. The idea is that consumers will benefit from cheaper goods and services and unemployment will decrease. Tax cuts will put more money in the consumer’s wallet, which they spend, and this will stimulate business growth and lead to more hiring. The end result is a larger tax base, and thus more revenue for the government. The policy is also called trickle-down economics as lower taxes on businesses and the wealthy will increase investments in the short term, and the benefits will trickle down to society as a whole. Reagan’s policies were a drastic change from his predecessors such as Presidents Johnson and Nixon, who both looked to increase the government’s role in the economy. On the other hand, President Reagan promised to reduce the government’s role and adopt a more laissez-faire approach. Implementation of Reaganomics1. Reduced government spendingGovernment spending still grew but at a slower pace. Instead of funding domestic initiatives, Reaganomics focused on national defense, as Reagan believed the US was exposed to a “Window of Vulnerability” to the Soviet Union and their nuclear weapons. 2. Reduced taxesThe bulk of tax cuts were aimed at the top income earners. Reagan cut top bracket income taxes from 70% to 28%, and he indexed each tax bracket for inflation. However, the tax cuts were offset elsewhere by increases in social security payroll taxes and excise taxes. Reagan also cut corporate taxes from 48% to 34%. 3. Reduced regulationReagan eliminated the price controls on US oil and gas prices implemented by President Nixon. He also deregulated cable, long-distance telephone service, interstate bus service, and ocean shipping. 4. Slow down money growth to control inflationA contractionary monetary policy was used to control inflation. In a contractionary policy, the central bank raises interest rates to make lending more expensive. Results of ReaganomicsEconomists still argue the results of Reaganomics until this day. Naysayers call it “voodoo economics” and supporters call it “free-market economics.” However, from the early ‘80s to the late ‘90s, the Dow Jones Industrial Average (DJIA) rose fourteen times, and forty million jobs were added to the economy. Reaganomics did ignite one of the longest and strongest periods of economic growth in the US. The result of tax cuts depended on how fast the economy was growing at the time and how high taxes were before they were cut. Cutting taxes only increases government revenue up to a certain point. Once taxes get low enough, cutting taxes will decrease revenue instead. Tax cuts were effective during President Reagan’s time because the highest tax rate was 70%. The effect would’ve been much weaker if the tax rate was less than 50% like it is in the present time. The increase in interest rates initially pushed the economy into a recession as high interest rates caused demand for the US dollar to increase, thus increasing the value of the US currency. As the price of USD increased, exported goods became more expensive and imports increased. However, the economy did eventually become less volatile, and the economy entered into a period of strong growth. Related ReadingsCFI offers the Financial Modeling & Valuation Analyst (FMVA)® certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:
Reaganomics is a popular term referring to the economic policies of Ronald Reagan, the 40th U.S. president (1981–1989). His policies called for widespread tax cuts, decreased social spending, increased military spending, and the deregulation of domestic markets. These economic policies were introduced in response to a prolonged period of economic stagflation that began under President Gerald Ford in 1976.
The term Reaganomics was used by both supporters and detractors of Reagan's policies. Reaganomics was partially based on the principles of supply-side economics and the trickle-down theory. These theories hold the view that decreases in taxes, especially for corporations, offer the best way to stimulate economic growth. The idea is that if the expenses of corporations are reduced, the savings "trickle down" to the rest of the economy, spurring growth. Prior to becoming Reagan's vice president, George H. W. Bush coined the term "voodoo economics" as a proposed synonym for Reaganomics. As Reagan began his first term in office, the country suffered through several years of stagflation, in which high inflation was accompanied by high unemployment. To fight high inflation, the Federal Reserve Board was increasing the short-term interest rate, which was near its peak in 1981. Reagan proposed a four-pronged economic policy intended to reduce inflation and stimulate economic and job growth:
As a believer in supply-side economics, Reagan regarded government intervention as a damper on economic growth, reducing economic incentives and distorting market signals. In order to clear the field for the free market, he proposed a number of measures designed to reduce government interference and make it easier to do business. 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. 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. Some of these cuts were partially reversed by later legislation. Another tax reform was passed in 1986, reducing both the number of tax brackets and the highest marginal tax rate. The goal of these reforms was not only to reduce tax burdens, but also to simplify the tax code. Some of Reagan's reforms eliminated write-offs, exceptions, and other loopholes for favored businesses. They also changed the way companies accounted for expenditure, thereby encouraging them to invest in equipment. In order to restore market signals in the economy, 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. As president, Reagan encouraged the Federal Reserve to tighten the money supply, which had already begun a three-year contraction during the term of President Carter. The contraction was intended to reduce inflation, which had already reached double-digit figures by the start of the Reagan presidency.
Some of the deregulation and monetary reforms associated with Ronald Reagan were actually initiated under President Carter. To the extent that these policies were consistent with Reagan's laissez-faire worldview, they are generally included with "Reaganomics." Although Reagan reduced domestic spending, it was more than offset by increased military spending, creating a net deficit throughout his two terms. The top marginal tax rate on individual income was slashed to 28% from 70%, and the corporate tax rate was reduced from 48% to 34%. Reagan continued with the reduction of economic regulation that began under President Jimmy Carter and eliminated price controls on oil and natural gas, long-distance telephone services, and cable television. In his second term, Reagan supported a monetary policy that stabilized the US dollar against foreign currencies. Near the end of Reagan’s second term, tax revenues received by the US government increased to $909 billion in 1988 from $517 billion in 1980. Inflation was reduced to 4%, and the unemployment rate fell below 6%. 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. Economists remain divided on the long-term impact of Reagan's policies. Unsurprisingly, those experts who are most favorable to laissez-faire policies also have the most favorable reviews. "From December 1982 to June 1990, Reaganomics created over 21 million jobs—more jobs than have been added since," wrote Arthur Laffer, whose work heavily influenced Reagan's tax cuts. Laffer also noted the decline in strike activity, Social Security liabilities, and a stock market that went "through the roof." Others are less favorable. Nobel laureate Paul Krugman downplayed the success of Reagan's policies. "Yes, there was a boom in the mid-1980s, as the economy recovered from a severe recession," Krugman wrote in the New York Times. "But while 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." In addition, many of the consequences of the Reagan era would not be truly understood until the end of the Reagan presidency. For example, the deregulation of the financial services industry would play a major part in the Savings and Loan crisis, as well as the financial collapse of 2008. There are plenty of people who believe that the same policies set in place by Reagan in the 1980s could help the American economy today. But critics object, saying that we aren't in the same situation and that any application could actually have the opposite effect. Reagan cut individual taxes when they were 70%, a far cry from where they are today. And cutting taxes even further may result in a decrease in revenues for the government. Reaganomics reduced taxes on individuals and businesses, as well as cutting federal regulations and domestic social programs. Reaganomics sought to reduce the cost of doing business, by reducing tax burdens, relaxing regulations and price controls, and cutting domestic spending programs. Reagan also sought to reduce inflation by tightening the money supply. The four main pillars of Reaganomics were tax cuts, deregulation, cuts to domestic social spending, and reducing inflation. While there is no record of President Reagan using the phrase "trickle-down," his economic philosophy was closely aligned with the idea that business-friendly policies would ultimately benefit the entire economy. By reducing taxes on the wealthy, Reagan hoped the benefits would "trickle down" in the form of increased unemployment and business activity. While economists remain divided on various elements of Reaganomics, the suggestion that wealth would "trickle down" has so far remained unrealized. On the contrary, economic studies have found that tax cuts, such as those enacted by Reagan, tend to increase economic inequality rather than reduce it. Reaganomics was regarded as a common-sense approach to the perception of stagflation and over-regulation that prevailed at the end of the Carter presidency. By reducing government spending and taxes, and making it easier to do business, President Reagan hoped to incentivize economic activity and reduce dependence on the welfare state. These policies were rewarded by reduced inflation, increased employment, and an entrepreneurial revolution that later became synonymous with the 1980s. However, some of the promises of Reaganomics did not materialize. Federal deficits grew, and the increased wealth gap left the poorest Americans in worse shape. |
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