Tuesday, July 19, 2011

Rethinking Reagan

I've been posting a lot lately about tax rates and wealth inequality, in part because the debt ceiling issue has dominated the news, but also because I view these issues as critically important.

My thinking is largely Keynesian, which explains my frequent reliance on Paul Krugman as a source. Briefly, Keynesian economics refutes the laissez-faire concept, arguing that public involvement -- particularly from the government in the form of fiscal policy -- is critical to economic growth as it can help correct irregularities in the private sector business cycle.

Keynes fell out of favor during the 1970s when the economy came to a standstill and inflation rates soared, largely due to the energy crisis at that time.

Enter Reagan and supply-side (or trickle-down) economics, which aimed to reduce inflation, cut taxes, decrease government spending and limit regulation.

Reagan unquestionably presided over a period of intense economic growth and he, along with his policies, has been deified to some degree by the modern Republican Party.

So now, when I question Reagan Almighty, several figures get thrown back at me to which I would like to add a bit of needed context.

Here are some commonly highlighted statistics from the Reagan years that I've seen praised by conservatives:
  1. The top marginal individual income tax rate dropped from 70% to 28%
  2. Unemployment fell from 7.1% to 5.5%
  3. The growth rate in America's GDP rose from -0.3% to 4.1%
  4. The federal deficit decreased from around 6% of GDP to 2.9% of GDP
These numbers are all true, and to some extent remarkable, but they don't tell the whole story.

Since America was founded by wealthy aristocrats who didn't want to pay taxes, we'll start there first -- out of respect. First, it's questionable how much tax cuts led to economic growth considering the effects of other policies.

That point aside, however, it's also important to remember that the 42% decrease in the highest tax rate didn't happen overnight. In 1981, Reagan cut the rate from 70% to 50%. The cut to 28% didn't happen until 1986, meaning that for the bulk of his administration -- including the worst Reagan recession years of 1982 and 1983 -- the highest marginal tax rate was 50%.

That 50% is well above the current rate of 35%, an increase to which is apparently off the table and unconscionable because we're currently in a recession. Go figure.

On to unemployment and the GDP. While Reagan did cut unemployment 1.6% during his two terms, it's important to remember that unemployment initially increased to around 9.5% in 1982 and 1983. Most economists credit this spike in unemployment to increased interest rates imposed to control inflation.

I actually have no problem with this policy since controlling for inflation was critically important. Once that problem was under control, interest rates were lowered which in turn led to an economic upturn, job growth, and the subsequent swelling of GDP.

I would, however, like to point out two things. First, statistical regression to the mean is pretty common. In other words, things can only get so bad until, eventually, the only way to go is up. Still, point Regan.

Second, and perhaps more importantly, increasing interest rates to control inflation in order to provide an environment for job growth is a Keynesian approach. It's a good idea, but not Reagan's. Point Keynes.

Finally, there's the deficit. First, it's worth noting that a deficit can be relatively meaningless. It's simply the annual difference between what the government takes in and what the government spends -- and notably negative. Deficits only really become problems when they are consistent as they add to the national debt.

All debt come with interest, and it's a bitch. It really eats at your income, and in the case of America, our annual interest payments on our debt total 6% of the budget. As a reference, consider that education spending accounts for only 3%. That's half for those of you who went to public schools.

I guess what I'm saying is that debt is the bigger issue, and Reagan created a lot of that. During his two terms the national debt rose from $712 billion to $2.05 trillion. Again, for the public school grads, he tripled it.

And how do you accrue so much debt? By spending a hell of a lot of money, particularly in the Department of Defense. Again during Reagan's two terms, government spending averaged 22.4% of GDP compared to the 20.6% average from 1971 to 2009 -- and remember that last number takes the Reagan years into account.

So looking back on what supply-side economics is supposed to achieve, it looks like Reagan got 3 out of 4. He lowered taxes, controlled inflation, and decreased regulation. Government spending, on the other hand, went through the damn roof.

I, however, am not against government spending -- particularly during recessions. Recessions typically occur when private sector funds dry up, causing economic stagnation that can in turn be offset by increased public spending for a limited period. This is the Keynesian approach.

Reagan followed this approach to a degree, but the greatest problem with Reaganomics is that our national love affair with it never really ended. The dual cycle of ever-decreasing taxes and ever-increasing expenditures creates a crippling debt. Raising taxes and limiting certain expenditures during times of prosperity creates a surplus that can be used to pay down debt accrued during recessions. Point Clinton.

I guess what I'm saying is that I prefer a "tax and spend" approach to the Reagan "don't tax and spend like a drunk teenager" approach as a sustainable economic model. Also, I'm wondering how drunk we must be as a nation to consider such a model fiscally responsible.

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