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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Understanding "Reaganomics"

Ronald Reagan, the 40th President of the United States (1981-1989), was a busy man. A former actor and governor of California, Reagan negotiated a treaty with the Soviet Union to eliminate intermediate-range nuclear missiles, exacted punishment against Libya for its involvement in a Berlin attack on American soldiers, and supported anti-Communist insurgents in Central America, Asia, and Africa.

But he also left his mark on fiscal policy, too. In particular, a style of economic thinking -- dubbed "Reaganomics" -- is still cited and championed by many policy makers today. So what exactly is meant when referring to "Reaganomics"?

The Fundamental Actions

Reagan was a Republican who supported the notion of small government and the individual's right to chart their own path. This formed the foundation of his Reaganomics, which was an effort to stimulate the stagnant economy.

The program, which was famously dubbed "voodoo economics" by George H.W. Bush (before he became Reagan's vice president), had four goals: reduce the growth rate of government spending, lower taxes on income and capital gains, reduce regulation, and reduce inflation by tightening the money supply. The idea was to improve the economy by encouraging people to spend and invest, by ensuring the health of the financial markets, and by rewarding entrepreneurship.

Few argue that Reagan's actions on these four fronts weren't sweeping. But Reagan's approach to government spending, for example, showed how Reaganomics somewhat differed from theory in practice. The administration didn't abolish or eliminate any federal agencies or major federal programs and defense spending reached historic highs. This in turn kept Reagan from getting the huge reductions he expected in federal spending as a percentage of GDP.

Reagan's tax-code changes also constituted sweeping reform in the name of economic stimulus. Most notably, he reduced the top marginal income-tax bracket from 70% to 28% and lowered the corporate income tax rate from 48% to 34%. He also exempted most lower income earners from income taxes. Reagan paid for some of these tax breaks with increases in Social Security taxes, increases in some excise taxes, elimination or reduction of some deductions, and a gradual broadening of the income tax base.

Another key component of Reaganomics was deregulation, which stemmed from the notion that government should interfere in free enterprise only where absolutely necessary. The biggest act in this vein was to significantly cut price controls on oil, cable TV, phone service, shipping, bus travel, and natural gas. Reagan also allowed banks to own certain assets for the first time.

The Effects of Reaganomics

By many accounts, Reaganomics revived the drooping American economy. For example, the rate of growth in real GDP per working-age adult more than doubled from the Carter administration. Unemployment fell from 7.0% to 5.4%, inflation fell from 10.4% to 4.2% in just eight years, the rate of new business formation increased, and the stock market boomed.

Though many economists and taxpayers were happy with these changes, many of those changes were not as far-reaching as Ronald Reagan had hoped. Some "side-effects" were truly problematic, too. For instance, interest rates went way up. There was still a very large federal deficit. And despite Reagan's opposition, the number of new trade barriers Congress erected put about a quarter of U.S. imports under trade restraints. Worst of all may have been the criticism over the tax cuts -- many economists argued that higher social security taxes actually increased taxes on the middle class, or at best, made their tax savings negligible.

In any case, Reaganomics demonstrated that lowering tax rates could actually increase -- or at least sustain -- the government's revenue for social programs and discretionary spending because allowing people to keep more of their own money encouraged them to use that money for investing, spending, and starting businesses, which in turn generated more taxable revenue. Reagan's idea was to cut taxes and then basically "make it up in volume," and his namesake economic theory has become one of the most prominent and hotly debated ones in modern American history.