From a Cato Policy Analysis (covering up to the end of Clinton's first term):
The 1980s: Facts versus Fables
In this section we depart from the purely factual presentation of the economic and fiscal performance of the 1980s presented above and interpret what these data say about the Reagan years. We find in many cases that the historical evidence contradicts much of the most commonly cited conventional wisdom of the Reagan years. Specifically, there are 12 common fables about the 1980s that are at odds with the facts.
Fable 1: The Reagan Administration Relied on "Pie-in-the-Sky" Predictions That Tax Rate Cuts Would Pay for Themselves
Supply-siders predicted their tax cuts would pay for themselves. This was nonsense from day one, because the credible evidence overwhelmingly indicates that revenue feedbacks from tax cuts is 35 cents per dollar, at most. Are we really gullible enough to accept a free dinner while still suffering the indigestion from our "free" lunch? [23]
This is one of the great enduring myths of Reaganomics: that the White House relied on wild supply-side assumptions regarding the revenue impact of the tax cuts. The Reagan administration never assumed that the tax cuts would pay for themselves. In fact, "America's New Beginning: A Program for Economic Recovery," the White House budget plan released on February 18, 1981, included a table entitled "Direct Revenue Effects of Proposed Tax Reductions." [24] That table predicted a huge $700 billion revenue loss from the tax cuts through 1986, as shown in Table 4.
Fable 2: The Reagan Tax Cuts "Caused" the Budget Deficit to Explode in the 1980s
Fifteen years ago, marginal tax rates and the progressivity of the tax system were dramatically reduced. Some suggested that these policies would so spur economic growth that tax revenue would actually increase. The outcome of that experiment is now a matter of record: not only did this response not occur, but the national debt quadrupled in the span of a dozen years. [25]
This is the most common and overly simplistic interpretation of the budgetary events of the 1980s. Further, it is factually untrue that the Reagan tax cuts were a major cause of the budget deficits of the 1980s and the "quadrupling" of the debt. (In the 1980s the real debt doubled; it did not quadruple.) Real federal revenues grew at a faster pace after the Reagan tax cuts than after the Bush and Clinton tax hikes. From 1982 to 1989, they expanded by 24.1 percent. Over a comparable seven-year period, 1990-97, a period that accounts for both the Bush and the Clinton tax increases, real federal revenues will have grown by 19.3 percent (see Table 5). The lesson of the 1980s and 1990s is consistent with the supply-side theory that there are behavioral and investment responses to changes in tax rates.
Figure 8 shows that, as a share of GDP, federal revenues fell from 20.2 percent in 1981 (the peak year for taxes as a share of GDP in the post-World War II period) to a low of 18.0 percent of GDP in 1984, and rose back up to 19.2 percent by 1989. This would suggest that the Reagan tax cuts were a small contributing factor to the increase in the budget deficit over the course of the 1980s. From 1950 to 1995, federal receipts have averaged 18.4 percent of GDP. Hence, throughout most of the Reagan years and clearly by the end, taxes as a share of national output were substantially above the postwar average.
If the Reagan tax cut was not the major contributing factor to the increasing deficit in the 1980s, what was? There were two primary explanations: (1) a large and sustained defense build-up; and (2) the unexpected rapid decline in inflation and the recession in the early 1980s.
The Defense Buildup and the Deficit. Table 6 shows that the cumulative increase in defense spending from 1981 to 1989 ($806 billion) was larger than the entire cumulative increase in the budget deficit ($779 billion) in those years. That is, if defense spending had been held to the rate of inflation from 1981 to 1989, the total real deficit would have fallen in the 1980s rather than risen. It is also true that the decline in the military budget accounts for almost the entire fall in the deficit from 1988 to 1996. [26]
If the entire accumulation of debt in the 1980s went to finance the Reagan defense build-up, the key policy question would shift to whether it was appropriate to borrow for those large military expenditures. Was the Reagan administration justified in paying for this one-time increase in "public investment" spending through debt rather than taxes? Or, put another way, was it appropriate to have asked our children and grandchildren to help defray the cost of defeating the Soviet menace?
The answer to that question rests to some extent on the issue of whether the defense build-up materially contributed to the collapse of the Soviet Union and, if so, on the discounted present value to our children and grandchildren of no longer having the "Evil Empire" imperiling the security of the planet. The figure could easily be in the trillions of dollars.
In any case, Reagan's critics were proven right when they said that the administration would not be able to cut tax rates, increase the defense budget, and balance the budget all at the same time.
The Fall in Inflation and the 1981-82 Recession. The unexpectedly steep decline in inflation in 1981 and 1982 contributed significantly to the rise in the deficit in the early 1980s. [27] When inflation falls sharply and unexpectedly, so too do nominal revenues while real expenditures rise sharply and unexpectedly. Both Reagan and Congress had approved spending increases for 1982-85 on the assumption, mostly due to erroneous inflation forecasts, that nominal GDP would be some $2.5 trillion higher than it was between 1981 and 1986. The abrupt reduction in inflation created an estimated $300-$400 billion spending windfall for defense and domestic programs. [28]
Fable 3: The Federal Reserve, Not Ronald Reagan, Deserves the Credit for Ending the 1970s Era of High Inflation
One man is more responsible for the political success of the Reagan presidency than any other, and his name is not Ronald Reagan. It is Paul Volcker, the man Jimmy Carter appointed as chairman of the Federal Reserve Board. A relatively stable currency has been the basis . . . for the economic boom of recent years. . . .
And Volcker did it. In October 1979 he persuaded his colleagues to starve inflation of the dollars it feeds on. President Reagan did little to help. In fact, his deficits worked against Volcker's efforts. [29]
The conquering of inflation in a very short time was primarily a result of tightening monetary policy under Federal Reserve Board chairman Paul Volcker. Volcker deserves high praise for the change in policy. But Reagan clearly warrants a large part of the credit for endorsing the overdue correction in Federal Reserve policy from the high-inflation 1970s. A major element of Reaganomics, in addition to the tax cuts, was sound money--a policy the nation had not followed since the late 1960s. The Federal Reserve's policy of sweating out inflation took place with the explicit approval of the Reagan administration, even though that policy contributed to the deep recession of 1981-82 and the unexpectedly large and immediate fall in inflation was a major factor in the budget deficit explosion in the early 1980s.
The Reagan-Volcker anti-inflation policy may seem noncontroversial today, but it is noteworthy that at the time the decisions were made, there was very little consensus about how to defeat inflation. [30] In 1980, for example, economist Paul Samuelson wrote that "two-digit price inflation is a distinct possibility for much of the decade of the 1980s." [31] He predicted an inflation rate from 1982 to 1987 of 9.4 percent a year. The Democratic party was endorsing a host of inflation-fighting measures that were economically wrongheaded and almost certain to fail. During the 1980 Democratic presidential primaries, Jimmy Carter's anti-inflation policy included credit controls and gas rationing while Ted Kennedy, his opponent, endorsed wage and price controls.
Most Keynesian economists had predicted that Reaganomics would make inflation worse, not better. Hobart Rowen of the Washington Post stated the conventional wisdom by arguing that the Kemp-Roth tax cuts would be "dangerously inflationary." [32] He added, "There is nothing in the [Reagan] fiscal program--in the view of those not addicted to supply-side theory--that works against inflation." James Tobin, a Nobel prize winner and an informal Clinton administration adviser, also had warned of the inflationary impact of Reagan's tax cuts and had called instead for "a five-year period of gradually declining wage-increase guide-posts." [33] The late Walter Heller, a Keynesian who had served as John Kennedy's chief economic adviser, summarized the conventional wisdom most succinctly in 1980: "The [Reagan] tax cut would simply overwhelm our existing productive capacity with a tidal wave of demand," thus accelerating inflation. [34]
Amazingly, even after inflation had fallen by more than half by late 1982, Reagan's skeptics believed the progress on prices was a temporary aberration. Economist Paul Krugman, now of Massachusetts Institute of Technology, and Larry Summers of the Clinton Treasury Department warned in November 1982 of a coming "inflation time bomb." "It is reasonable to expect a significant reacceleration of inflation in the near future," they wrote. "A significant portion of the slowing of consumer price inflation since 1980 does not represent a reduction in the underlying rate." [35]..........
Fable 7: The Robust Reagan Economic Expansion Was Only a Result of the Steep Economic Decline in the Early 1980s
Reagan's political adversaries maintain that the economy expanded rapidly from 1983 to 1989 only because of the underused resources from the severe recession of 1981-82. This interpretation of the 1980s expansion is contradicted by two facts. First, even taking into account the deep recession years of 1981-82, the economy grew at a faster rate over the entire Reagan period than it did over the Ford-Carter years and the Bush-Clinton years.
Second, the economic expansion of the 1980s was notable for not only its strength but also its length. Figure 10 demonstrates that the Reagan recovery lasted 92 months, making it the second longest uninterrupted economic expansion in the century--outlasted only by the 1961-69 boom. [40]
Fable 8: Bush and Clinton Inherited a Future of High and Rising Deficits from Reagan
The supply-side turkey has come home to roost. [41]
It is a popular misconception that Presidents Bush and Clinton inherited large deficits "baked in the cake" from Reagan policies. When Reagan left the White House in January 1989, the fiscal outlook was expected to continue to improve rather than worsen. In that month, the CBO released its long-term forecast for the economy and the budget deficit.
Table 7 shows that the deficit was expected to continue to fall steadily to $110 billion and 1.5 percent of GDP by 1995. [42] These forecasts reflected in large part a continuation of the modest fiscal progress achieved during Reagan's second term. The CBO concluded that continued deficit reduction would occur even if Bush were to do nothing to improve the budget outlook and simply left fiscal policy on automatic pilot. In reality, the national debt was $622 billion higher than anticipated and as a share of GDP, the budget deficits were nearly 2 percentage points higher. Measured in real dollars, the 1990-94 period showed the worst five-year deficit performance in the post-World War II era. [43].......
Conclusion
The 1980s were years of economic progress, not decline. Real GDP grew by about one-third in the 1980s. The economic gains were widely distributed among income groups, with every income quintile, from the richest fifth to the poorest fifth, gaining ground in the Reagan years.
The Reagan tax cuts were not a primary cause of the eruption of the deficit in the 1980s. The main two causes were an unexpectedly sharp reduction in inflation in the early 1980s that led to large real increases in federal spending, and a nearly $1 trillion military build-up during the last phase of the cold war.
Most significantly, the economy of the 1980s outperformed that of the 1990s in virtually every measurable category. Economic growth was higher, job creation was faster, incomes rose much faster, and productivity climbed at a healthier pace.
cato.org |
