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Fiscal Policy at the Beginning of 1980s
In 1982, Reagan suggested several changes in policies that addressed the problem of inflation, slow economic growth, and the increase in national output. The President suggested four major changes that policies needed: a cutback in nondefense spending, increase in defense spending, 30% reduction in marginal tax rates (personal income), and tax depreciation of capital expenditures (Congressional Budget Office, 2016). According to Reagan’s propositions, growth in outlays had to be held below 6% annually, while the share of defense was to be increased from 24.7% (1981) to 33.2% (1984). Moreover, Reagan also proposed 30% reduction in individual income tax rates to reduce taxes in 1982 and 1986 ($43.9 billion vs. $172.6 billion). Business taxes were also to be reduced by means of increased business depreciation allowances (Congressional Budget Office, 2016).
These tax cuts were expected to help the economy grow. However, the administration did not expect drastic changes; in 1982, high inflation and high unemployment rates were still expected. Since the economy was in a state of stagflation, Reagan needed a specific approach to overcome recession.
In 1983, Social Security tax increase was signed into law. This bill addressed the rising unemployment rate, especially among Old-Age, Survivors, and Disability Insurance users, by protecting them with coverage and improvements in benefits. For example, employees in non-profit organizations were protected, as well as divorced, remarried disabled widowers, and disabled widowers (Congressional Budget Office, 2016). However, this reform brought additional tax increases and benefit cuts to other citizens, which allowed Reagan take first steps to reduce inflation.
Fiscal Policy Actions
To provide a solution to the problems in the economy, the Administration reduced tax rates, used the Federal Reserve to ensure that money growth was reduced and raised interest rates so that they could slow down inflation. However, the level of nondefense spending was not reduced, and a deregulation policy was not engaged as well (Campagna, 1994). Annual GDP began to grow only by the end of 1983.
Reagan’s aims and policies were built on Keynesian fiscal policy. According to Keynesian consumption function, consumer spending relies on changes in income; therefore, the GDP will grow proportionally to increase of the aggregate savings (Campagna, 1994). Both consumption function and independent investment need to remain stable so that national income can reach equilibrium (Chugh, 2015). Thus, Reagan aimed to encourage investment via tax incentives. However, Reagan’s policy was based on optimistic assumptions, and investments could not increase unless savings had the chance to increase as well.
Reagan’s economics were supply-side economics that allowed economic growth if barriers in the production of goods and services were lowered. Reagan assumed that the tax cut he had proposed would not only stimulate the government to generate more revenue but also help business spend and invest. However, the Congress was not as optimistic as the President was, but Reagan’s propositions eventually resulted in Tax Equity and Fiscal Responsibility Act of 1982.
Another goal of Reagan’s administration was to increase defense spending. Although not stated as a part of the economic program, this goal was supported by different policies (e.g. program of nuclear defense) (Campagna, 1994).
Fiscal Policy Impact
As it can be seen from the macroeconomic data, Reagan’s economic policies were not as successful as he had expected. First, his decision to engage the laissez-faire theory led to the recession at the beginning of Reagan’s term. Although Reagan’s intentions were good, and with the help of this theory he aimed to resolve the problems that stagflation had triggered, it did not help him avoid recession. By 1984, Reagan was still unable to fulfill the promises that he had announced previously: to reduce government spending and balance the budget (Campagna, 1994). What is more, budget deficit increased in 1984. During Reagan’s administration years, the budget increased by 2.5%; policy changes that were provided either by the Administration or the Congress led to 1.5% increase (Campagna, 1994).
While some may state that Reagan’s policies helped reduce unemployment rates, Campagna (1994) argues that this effect was small and had a rather modest impact. The unemployment rate continued to grow until 1983, although Reagan signed TERFA that was developed to reduce unemployment rates. Due to economic actions of previous presidents, the country was not able to adjust to these changes at first. Nevertheless, labor supply did begin to increase later. Nevertheless, the increase was quite modest. Campagna (1994) states “percentage change in the labor force was 3.8%” (p. 77).
Thus, although Reagan’s actions did influence unemployment rates, they were not significant or of a big scale.
Those achievements that are usually seen as positive (tax cuts and investment in military defense) had brought additional costs to the government and resulted in financial cuts in welfare programs. Employment rates began to increase in the year 1983 until 1988, where they reached their peak under Reagan’s administration. However, before that, in 1982 and 1983, unemployment rates were the highest, which led to electorate’s rising dissatisfaction with the President. While some assume that increased labor supply was one of the best achievements of Reaganomics, others claim that these results seemed good because they were compared to Carter’s presidency. Longley, Mayer, Schaller, & Sloan (2015) argue that the success of Reagan’s presidency relies on “the 18 million jobs that the American economy produced during the 1980s” (p. 55). In 1980, the unemployment rate was 7%, while in 1990 it dropped to 5.7%. However, between 1981 and 1982, approx. 1.9 million jobs were lost (Longley et al., 2015). Nevertheless, although the unemployment rate was over 7% in 1984, Reagan was reelected that year (Flanigan, Zingale, Theiss-Morse, & Wagner, 2014). However, during the 1970s and 1990s, the economy of the USA produced more jobs compared to 1980s, which makes Reagan’s achievements less striking.
It should also be noted that personal savings of Americans averaged 4.5% in the 1980s. Gross national savings also declined, from 19.2% to 15.6% (1980 vs. 1989) (Longley et al., 2015). Consumption increased, which made consumer debt grow to 96.9% in 1990 (Longley et al., 2015). Nevertheless, foreign investment helped the consumption-driven economy of the USA to avoid any catastrophe. What is more, Reagan’s tax cuts allowed citizens of the USA enjoy the prosperity that continued into the 1990s (Longley et al., 2015). Reagan’s ability to adapt and shift from one approach to another helped him to achieve success.
References
BLS. (2016). Web.
Campagna, A. (1994). The economy in the Reagan years: The economic consequences of the Reagan administrations. Westport, CT: Greenwood Publishing Group.
Chugh, S. K. (2015). Modern macroeconomics. Cambridge, MA: MIT Press.
Congressional Budget Office. (2016). Web.
Flanigan, W. H., Zingale, N. H., Theiss-Morse, E. A., & Wagner, M. W. (2014). Political behavior of the American electorate. Washington, DC: CQ Press.
Longley, K., Mayer, J., Schaller, M., & Sloan, J. W. (2015). Deconstructing Reagan: Conservative Mythology and America’s fortieth president. New York, NY: Routledge.
TradingEconomics. (2016). Web.
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