What is Reaganomics?
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 Reaganomics
Ronald 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 Reaganomics
1. Reduced government spending
Government 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 taxes
The 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 regulation
Reagan 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 inflation
A 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 Reaganomics
Economists 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 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 are 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.
CFI 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: