Reaganomics after Twenty Years
George J. Viksnins
Georgetown University

 On Feb. 18, 1981, President Reagan announced his tax plans, the Economic Recovery Tax Act of 1981, loosely based on the so-called Kemp-Roth proposal, for cutting income tax rates, which was first introduced in 1977 by Senator William V. Roth, Jr.,  of Delaware and Congressman Jack Kemp of New York.  The tax cuts proposed by Reagan initially totaled $53.9 billion, proposing a 10-percent cut in rates in mid-1981, to be followed by additional 10-percent reductions on July 1 of the two succeeding years.  After a good deal of political infighting, a much more modest $37.7 billion cut in fiscal 1982 receipts was eventually signed into law on Aug. 13.  Total tax reductions for the Reagan program over the next five years were estimated at about $750 billion – the centerpiece of the argument of the supply-side school.  While fear of mounting deficits led to a tax increase a year later, which led to the resignations of a number of “true believers” in the administration, marginal rates were reduced further in President Reagan’s second term – to a low of 28% in 1988.  A key theoretical argument behind the supply-side revolution was the so-called Laffer Curve, the idea that a cut in marginal tax  rates could actually lead to a rise in total revenues.  It is interesting to note that in 1980, when rates were high, the top 1% of income taxpayers paid 19.1% of total income taxes, but by 1988, when marginal rates had been roughly cut in half, the top one-percent paid 27.5% of the total.  (In part because of higher rates, but also due to higher incomes, the top 1% today pays about one-third of total individual income taxes).
 While Spiro Agnew certainly does not deserve a favorable assessment in history books, one nugget from his speeches ought to be retained: “the nattering nabobs of negativism.” That reference is to the distinct liberal bias of both the media and academe.  A recent book by former Reagan speechwriter Peter Robinson notes that a 1992 survey of 139 reporters and bureau chiefs in Washington found that 89% had voted for Clinton and only 7% for Bush.  Similar statistics could easily be generated about social sciences professors, movie stars, and rock singers. Robinson discusses at some length the reasons why the Hollywood establishment is so heavily biased toward the left – in part, it may be the fear of censorship.  For the liberal left, anything is allowed – except business transactions between consenting adults.  Despite the fact that President Reagan left office with a public approval rating close to 70 percent, twenty years of media effort have left the term “Reaganomics” today with a definite negative spin, a bad aftertaste.  The average college sophomore would probably say something about “increased defense spending, at the expense of social programs and welfare for the poor, coupled with lower taxes for the rich.” These unwise and uncaring policies contributed to huge budget deficits throughout the decade
(“$200 billion a year, as far as the eye can see...”) and a large rise in income inequality.  She might also mutter something about “the decade of greed” and “welfare for the rich.”
 It is certainly true that the public debt rose by more under Reagan than in the two hundred years of all previous administrations added together.  However, it is important to pause for a moment and reflect on the economic situation which had been inherited from Mr. Carter.  First, measured on a year-to-year basis, the country was beset by double-digit inflation in 1979, 1980, and 1981.  Second, that inverse harbinger of confidence in all paper currencies, the price of gold, was pushing $900 – and silver was also at an all-time high.  Third, the U.S. dollar had weakened steadily, since its link to gold had been severed by Nixon in Aug. 1971.  For example, the dollar fetched 360 Japanese yen at the start of the decade, but only half of that by 1980.  Fourth, the tax system was becoming punitive even for middle-class families, “bracket creep” raised rates from 22% in 1965 to 49%  in 1980 – and the highest income taxpayers faced a 70% federal marginal rate, and an 11% D.C. tax on top of that.  Tax shelters, anyone?  Moreover, the U.S. was faring very badly in the battle for the “hearts and minds” of the younger generation of the whole world.  As Roberts points out, to be anti-American was becoming a badge of honor; it was “. . . to be against imperialism, neo-colonialism, racism, sexism, commercial exploitation (particularly of the environment and the Third World), pollution, poverty, inequality, and war.”  Not only was the image of America as a “shining city on the hill” and “beautiful for spacious skies and amber waves of grain” losing its luster to Soviet spin doctors, the historically pre-ordained march of Marxist-Leninist regimes was triumphant in Southeast Asia, in much of Africa, and – where was the Monroe Doctrine? – in Cuba and Central America.
 Before returning to the nitty-gritty of economics and dry, boring statistics, Reagan’s greatest accomplishment was the decisive reversal of the Soviet triumph in rhetoric as well as reality.  “Mr. Gorbachev, tear down this wall . . .” was a punch-line in President Reagan’s speech in Berlin that survived the best efforts of the State Department bureaucrats to remove it (reportedly Colin Powell was against this confrontational sentence as well).  The use of the term “Evil Empire” was also very helpful, as well as the intervention on behalf of the “contras” – though the financial aspects of this operation (Iran!?) were dubious, to say the least.  Although the senior Mr.  Bush did not help matters by trying to support the Moscow hegemony (suggesting to Ukrainians in Kiev that independence was really not necessary!), the dismantling of the Berlin Wall, the dissolution of the Comecon in 1991, and the implosion of the USSR itself are closely related to a shift in the public perception of the U.S. – “it is morning again in America . . . ”, said President Reagan, and many people here and overseas really believed him.
 Returning to economic statistics, a very significant accomplishment was the remarkably rapid decline in inflationary expectations.  Using a weighted-average method of estimating expected price increases, expected inflation fell from about 12% in 1981 to only 2.5% in 1988 (before rising again to as much as 5.3% under Bush senior in 1991).  As Lawrence B. Lindsey (nowadays one of Bush junior’s key economic advisers) writes: “A new and very important word crept into the economic jargon of the time – credibility.  While the neo-Keynesians in the Carter administration had talked about a variety of anti-inflation strategies, the markets simply did not believe them.”  Going after the air traffic controllers and refusing to increase the minimum wage gave President Reagan lots of credibility in establishing the administration’s anti-inflation stance, which was also greatly bolstered by the actions of Chairman Volcker at the Federal Reserve.  This decline in inflationary expectations took place despite significant budget deficits.  A detailed analysis of the causes of the deficits is beyond our scope here.  Were they caused primarily the Reagan tax cuts?  A simple answer would be in the negative, since government spending rose by $450 billion during the 1981-1989 period.  In passing, it should be noted that the rise in defense spending was relatively modest; it was about 23% of total government expenditures and 4.8% of GDP in 1980 – but rose to 26% of government spending and 5.5% of GDP in 1989 (and is about 3% today). There was no massive rise in defense spending (E. Ray Canterberry says: “an explosion in military spending”) and few government social programs were subjected to a brutal slashing, despite what leftist authors continue to tell us.   Taxes, of course, did not fall; they rose by $375 billion.  What they might have been in 1989, if rates had remained at 1980 levels, is anyone’s guess, but my guess is that the revenue total would have been a good deal lower.  As an aside, the Reagan tax bill indexed the personal exemption to inflation rates, thinking that Congress could be “shamed into limiting spending . . . .”  Let us say it bluntly – politicians are not familiar with the concept of “shame...”
 In terms of economic accomplishments, perhaps the most significant positive aspect of the Reaganomics program of lower taxes and regulatory reforms is the tremendous increase in employment. The atmosphere of expansion and innovation created by the Reagan program continued to affect economic activity in the next decade as well.   It is estimated that 24 million new jobs have been  created in the 1980-1995 period in the U.S. – compared to only about 9 million in the European Union, which has a one-third larger population than America. After the 1981-82 recession (inherited in large part from the Carter years), and largely caused by the Fed hitting the monetary brakes very hard,  real GDP rose by about four percent per year in the 1982-88 period.  During this period, overall employment rose by 17%, but . . . “Hispanic employment has grown by more than 45 percent, black employment by nearly 30 percent, and female employment by more than 20 percent.”  Although there was a distinct shift from manufacturing jobs (in part due to a strong rise in productivity in that sector) to employment in services, 90% of the new jobs were full-time positions and 85% were in skilled occupations (not “flipping burgers”).
 The strong appreciation in the U.S. dollar was a vote of confidence in the economic policies of the Reagan administration.  Looking again at the Japanese yen, the exchange rate rose from 180 in 1980 to 260 yen in 1985.  From 1980 to 1985, the dollar also  rose by 37% against a basket of ten major currencies, with significant negative implications for the U.S. export sector’s competitiveness.  This led to the so-called Plaza Accord, where the G-5 agreed to bring the dollar down to a more competitive level.  While the target depreciation in the agreement  was only about 10%, the dollar declined by nearly 20% by the end of the decade (and continued falling against a number of currencies -- the Japanese yen reached an all-time high of about 80 in the spring of 1995).  In part, of course, the strong dollar in the first half of the 1980's was due to very high interest rates in the U.S.  The “prime rate” stood at above 20%, the Fed’s discount rate reached 14%, and new home mortgage rates were in the 15-18% range.  Even at the end of the decade of the 1980s, long-term government bond yields in the U.S. were approximately twice as high in Japan.  A somewhat weaker dollar and high interest rates attracted significant inflows of foreign investment, which led to a strong recovery in the stock market after its “sinking spell” in October 1987. 
 There exists something called the “misery index,” invented by Carter’s speechwriters to attack President Ford’s record in 1976.  This measure involves adding the unemployment rate and the rate of inflation.  Since that index stood at nearly 20 in 1980, Mr. Carter “was hoisted by his own petard . . . .”  Under Reagan, this index declined significantly, to just under 10 by 1989.  Today it is well below 10% (about 7% in 2000), in large part because of the sound economic base built by Reaganomics.  Lower marginal tax rates created jobs and unleashed entrepreneurial activity in the New Economy.  While Mr. Gore claims to have invented the “Internet,” it could more plausibly be argued that Reaganomics led to the expansion of “e-commerce.” 
  The one area in which Reaganomics appears to be vulnerable is the charge of “unfairness.” There are two aspects to this argument.  First, over the past twenty years – or during the 1980's, if you like – it is often argued that the standard of living for the average American deteriorated. The hourly wage rate appeared to fall, after correcting for inflation. In other words,  ordinary people were working hard, but not benefitting from GDP growth and improvements in productivity (a bit more on that issue below).  Second, and closely related to this,  the distribution of income worsened – with the share of the bottom 20% falling, while the share of the top 1%, 5%, or 20% rose. There were obscene increases in corporate profits and the personal incomes of the filthy rich. 
 The liberal left is incensed by the rising incomes and wealth of the upper one percent – in 1998, there were 192, 000 tax returns filed with a yearly income of a million dollars or more.  The upper 1% of income recipients receive nearly 20% of adjusted gross income, according to the IRS (but, as mentioned above, also pay a bit more than 33% of total income taxes).  In the last twenty years it is true that the Gini Coefficient for income before taxes has risen significantly (from about 0.34 in the 1970's to 0.44 in 1999), and is a good deal higher than in most other capitalist democracies.  According to E. Ray Canterberry, the distribution of marketable wealth is even more unequal.  The share of the “super-rich” stood at about one-third of the total in the 1930s, declined to a low of about one-fifth by 1969, and fluctuated a bit below 30% in the 1970s.  “. . .Then,  fortunes reversed.  The share owned by the super-rich soared to 37 percent in 1989 on the way to 38.5 percent in 1995.  The dramatic dislocation of wealth to the top reflected the staggering trundling of financial wealth upward during the 1980's.”  Canterberry goes on to claim that the financial wealth of the bottom 40 percent of households has declined absolutely, and – an even more shocking statement – that “. . . 95 percent of American families have become not only relatively but absolutely worse off.”  While rising Gini Coefficients and a smaller percentage of incoming going to the bottom 20% can used by the liberal left to score debating points, there are significant limitations in the statistics.  As Robert L. Bartley points out, an income distribution is “a snapshot in time.”  A banker’s  graduate student son may show up in the bottom quintile for a few years – “ . . .  Even movements in and out of the poverty population are far more dynamic than usually supposed.”  There are a number of objective factors, which account for the rise  in the Gini –for example, a larger number of households is elderly now than in 1970, and average incomes of the elderly are lower. Also,  the nature of  households is changing. “...In 1970, 18.7 percent of the households had a householder either living alone or with nonrelatives.  By 1990, that figure grew to 29.2 percent.”  The income level of that group is only about one-half of family households, thus,as families fall apart,  the Gini rises.  Perhaps an even more important demographic trend is the growing percentage of female-headed households (no husband present), which rose from 10.8% to 16.5% over this period, and which typically have incomes lower than average. Finally, income can be redefined in many different ways – with or withour taxes and transfers, with or without capital gains, with or without the imputed income from housing, and so on.  The most obvious adjustment, of course, would be  to account for taxes and transfers.  Bartley notes that such an adjustment  “. . . tripled the income share of the lowest quintile while reducing the share of the top quintile by 6.8 percentage points.”  
 Equally  striking evidence about the dynamics of the income distribution is provided by two economists at the Federal Reserve Bank of Dallas, W. Michael Cox and Richard Alm.  While the share going to the top 20% rose (to nearly 50% of the total), and the share of the bottom quintile fell, over the 1975-1977 period, they cite a University of Michigan longitudinal study, which found that only 5% of those in the bottom income group in 1975 were still there in 1991.  Thus, “. . . low income is largely a transitory experience for those willing to work.”Over  this period, the Michigan study notes that “. . . the poor make the most dramatic gains when one looks at the income distribution . . .The rich may have gotten a little richer, but the poor have gotten much richer. . .”  Looking at these studies cited by Cox and Alm, Canterberry’s claim that 95% of the people are absolutely worse off today seems ludicrous.  As Cox and Alm say:  
“... For all the anguish about downward mobility and long-term poverty, the University of Michigan sample shows it’s a reality for only a tiny fraction of Americans.  A mere 2 percent of the bottom fifth failed to attain higher living standards by the early 1990s.”  There are also dynamic movements at the other end of the distribution.  John W. Sloan notes that “. . .only 171 of the original 400 richest Americans listed in Forbes magazine in 1982 were listed in the magazine’s 1991 issue.”
While lay-offs and “down-sizing” are prominently mentioned by the media,  creation of new jobs does not  appear on the 6 o’clock news.  The loss of jobs in the first few years of the 1990s made for frightening headlines: 74,000 jobs cut at General Motors, 60,000 at IBM, 50,000 at Sears, and 40,000 at AT&T.  However, capitalism is characterized by evolutionary change – what Joseph Schumpeter  called the “Gale of Creative Destruction.”  While Sears was down-sizing , Wal-Mart Stores added 624,000 jobs between 1985 and 1996 – and other publicly-held retailers (such as Home Depot, Circuit City, and others) created nearly 2 million jobs.  IBM lost jobs, but EDS and Microsoft added positions. While AT&T downsized , MCI and Sprint and other long-distance providers added at least 80,000 workers.  Many people cut by GM found employment with Honda, Toyota, and other foreign car manufacturers operating in the U.S.”
 Finally, let us look briefly at the biggest trump card held by the liberal left – falling real wages, which allegedly would affect “the average American worker.”  At first glance, the results seem grim.  After rising at an annual rate of about 2% from 1953 to 1973, “. . .they stagnated for five years before beginning a long slide, falling at an average rate of 0.7 percent through 1996.  The total decline over two decades exceeded 15 percent. . . “ A number of observations need to be made in order to reconcile this fact with the very visible signs of affluence all around us – larger homes with all the amenities, color TV (97.9%) and cable (63.4%), and other consumer durables.  A lot of people own items that did not exist in 1970 – videocassette recorder, answering machine, cordless phone, CD player, and so on (in 1970, less than 1% of households owned a microwave, but by the mid-1990s, 90%+ did).  There are three main factors helping this reconciliation.  First, in addition to wages, households also receive interest dividends, rent and profit.  Second, it is well known that the inflation index used to “deflate” wage increases, the Consumer Price Index (CPI), has a built in overstatement (“upward bias”) of about 1.1%.  Thus, the annual decline of 0.7% just mentioned above should have been corrected to a small gain of about 0.4% per year.  Third, and this is the most obvious point, many workers have chosen to take more of their compensation in the form of fringe benefits: “. . . additional health care, contributions to retirement savings, or employee assistance programs. . . .Overall, non- monetary  benefits as a percentage of wages have increased by a third since 1970.”  If we add these fringes to calculate “total compensation,” we find . . .”a cumulative gain in total compensation of more than 17 percent.  Gains in both  per capita income and total compensation, by creating  greater purchasing power, explain how Americans would be able to increase consumption quite visibly  over the past quarter century. 
 To conclude this brief assessment of Reaganomics, let us look at a relatively even-handed treatment of the topic by two distinctly liberal economists from the Urban Institute. There are three legacies, said the authors in a volume published in 1984, when policies were just beginning to work. First, a significant decrease in inflation had already taken place. The second was large budget deficits, which led the authors to be pessimistic about long-term growth. But, third, 
“...there was ashift in expectations about what the government should or will do. ...public opinion surveys suggest that the president has struck a responsive chord, and messages from the Rose Garden about the importance of entrepreneurship and individual initiative may yet have an impact on the way managers and workers behave...” Hindsight enables us to say quite clearly that the economy’s productivity and efficiency were greatly improved by the Reagan years, and continue to provide the basis for the functioning of the economy well into the 21st century.