Thursday, August 2, 2007

Reagbushonomics Essay 1

This post is intended to be a first in a series of posts that deal with the economic viability of Reaganomics and it’s 21st century variant, Bushonomics. This first essay will talk a little about definitions and touch on the history behind these economic policies as they’ve been proposed and passed into law.

In 1981, Ronald Reagan assumed the presidency and proposed a dramatic shift in the role and size of the federal government. Assuming the presidency during a time of double digit inflation and interest rates, there were also deep-seeded economic rumblings that were occurring in major industries in the United States such as steel, automobiles, and other heavy industries that were capital intensive and burdened with large numbers of relatively well paid working class jobs.

Reagan’s first and foremost objective was to lower taxes. Most of the tax cuts were earmarked for the wealthy. There is no doubt, that marginal rates had become out of control in the higher income brackets. If I remember right, the highest marginal rates were around 80%. The results were, extensive and pervasive tax avoidance strategies among those in the higher brackets. The result of such a high bracket could also be seen as federal redirection of resources. With such high marginal rates, investment and consumption decisions were being based more and more on their tax impacts rather than the NPV (net present value) of expected returns on investments.

Even so, any proposal for a tax cut faced a daunting reality. The last year of the Carter administration, the federal budget deficit increased to $57 billion, at the time a most alarming amount. Republican economists argued that this deficit was driving down the value of the dollar and helping to fuel the inflationary pressures that ultimately did in the Carter administration.

How to resolve that problem came to the heart of an ongoing debate regarding the impacts of tax policy on economic growth. Reagan’s argument was that a dramatic decrease in the tax rate, especially for those in higher tax brackets, would fuel economic growth that would actually raise income tax revenues and bring down the deficits the U.S. experienced during the Carter years. This assumption was derived by Arthur Laffer, and was articulated in what came to be known as the “Laffer Curve.” Ironically, while making this claim during the Republican party’s presidential nominating process, Reagan’s opponent, George H.W. Bush, referred to this philosophy as “voodoo economic.” The second essay in this series will talk about the impacts of the Reagan tax cuts and whether those assumptions panned out.

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