President Ronald Reagan’s stature will grow as his achievements come to be more widely recognized. It was Reagan’s confidence in capitalism, not his defense buildup that caused Soviet leaders to lose their confidence in further pursuit of destructively devastating state-controlled economy. Ronald Reagan took away the Soviets’ comfort factor when he said that the “Phillips curve” and falling US productivity were the results of the wrong policy mix, not inherent features of a market economy. The U.S. economy, in other words, could be easily fixed, but the Soviet economy could not. Later I will speak about Reagan’s slashing of tax rates from 70 to 28 percent. After imposing genius liberal economic reforms, Margaret Thatcher achieved similar results in reforming Keynesian legacy of British economy. Surprisingly, even French followed and pursued fueled privatization of their socialized economy. Reagan revitalized the U.S. economy. He abandoned the Keynesian policy mix of monetary expansion to stimulate demand and high tax rates to restrain inflation--which was obviously not being restrained by Keynesian demand management. Reagan got the supply-side message that high tax rates were restraining real output while money growth pumped up demand, thus causing inflation. Reagan’s policy was a success. But at the time it was misunderstood. Accustomed to thinking of tax cuts as a demand-side measure to stimulate consumer spending, the entire economics profession, along with the Federal Reserve, the Republican Senate, and most of Reagan’s own government, predicted accelerating inflation. Reaganomics is probably the only economic doctrine that made its way into a pop song. In 1985, the British group Simply Red criticized the antisocial policy of Reagan in their song “Money’s Too Tight To Mention” (actually, a cover version of an original American song by the Valentine Brothers from 1982). The popular perception of Reaganomics is clear: an antisocial policy with a curtailment of social expenses. But criticizing Reaganomics is not the monopoly of the left. Even classical (i.e. pro free market) liberals and libertarians are convinced that although Reagan stimulated the economy, it came at the cost of an enormous budget deficit. Even George Herbert Walker Bush was initially very sceptical of the economic ideas of Reagan. In 1980 he spoke about “voodoo economics”. He changed course when Reagan chose him as running mate for the presidency. In the sixties and seventies, Keynes economic theory was applied on a large scale. Keynes developed his ideas in the deep economic recession of the thirties, with its high unemployment. Keynes argued that governments should stimulate aggregate demand by massive spending and infrastructure works in order to invigorate the economy. Through the “multiplier” effect every dollar spent by the government would create a multiple in income. Unemployment would vanish, the tax base would broaden, and the budget deficit would disappear, Keynes argued. But during the oil crisis of the seventies, it became clear that Keynesianism did not work. Higher public spending did not resolve unemployment. On the contrary, unemployment increased in line with the increase of government spending. Moreover, unemployment and inflation appeared simultaneously, a fact which could not be explained by the dogmas of Keynesian thinking. The only thing they were able to do, was to give it a name: “stagflation”, which meant that we had a combination of creeping inflation, recession and unemployment. During the Carter years, inflation was at a staggering 13%. Huge interest rates were necessary to fight it. The interest rate on credit facilities reached the unbelievable level of 21%. The drama was complete when taxes were increased to fight both inflation and government deficits. During the Carter years, the top marginal tax rate on personal income rose to the insane record level of 70%. Experts in Economic & Tax Policy did not know how to agree on any economic policy. They simply had no solution! Many of the recent studies have indicated that high public spending as Keynes had advocated does not stimulate the economy. The main reason is that money that could otherwise be spent by private sectors, shags off with public jobs which offer very little or even zero return. Money to pay the deficit must come from somewhere else to paid-off and usually it is the taxpayer who must pay it. The fundamental basis of Keynesian logic is that it hardly makes sense to tax money away from productive people, thereby reducing their rewards, so as to spend it on unproductive goals. The United Kingdom which is the home of Keynesianism experienced it long years after the war. Keynesian economic policy was sticking and sticking and everybody seemed that there’s no way to stop it. Finally, Margaret Thatcher stopped putting continued Keynesian economic policy into practice. Another, more recently observed example is Japan. This country has provided one of history’s best demonstrations that the Keynesian demand stimulus is a deeply flawed economic philosophy. Despite huge government outlays, the Japanese economy is still wallowing in the slump that has afflicted it for more than ten years. According to the analysis of the relationship between and the size of governments in 16 European countries, the two main causes leading to poor growth performance are excessive government spending and a demotivating tax structure, which put a heavy burden on work, income and profit. This study has recently been confirmed and underpinned by multiple regression analysis, using econometrics tools to show the results. There were four young economists who convinced Reagan to completely reserve the economic policy of that time. Those four economists were: Paul Craig Roberts, Robert Mundell, Norman Ture and Steve Entin. And there was another Journalist Jude Wanninski who contributed a great portion to the turnover of economic policy when Ronald Reagan started running his first mandate. The very basic point of view was that tax rates very extreme, too high and worked like a barrier, embodying a strong disincentive to work, risk and save. In a very popular point of view, “Economics of Discouragement” had to be translated into “Economics of Encouragement”. People are producing because it pays to do so. Consumption will not result in increased production when there are no incentives to do so. The logic is simple. When tax rates are becoming higher, people are loosing their interest in taxed working activities such as risk-taking, work and entrepreneurship. When tax rates fall down, people are starting to increase their participation in those activities since they see more incentives to participate in productive behavior and raise their incomes on a permanent basis. Only few people knew that Reagan had a major in Economics from Eureka College (Illinois) in 1932 The economic theory he was taught was untouched by Keynesian thinking and, as a consequence, very appropriate to the problems of the eighties. Reagan immediately took action. He lowered marginal tax rates from 70% in two phases: to 50% (Economic Recovery Tax Act of 1981) and in a later phase to 28% (The Tax Act of 1986). These tax cuts created 18 million new jobs in 8 years, lowered inflation to 4.3% and cut unemployment from 9.7% to 5.4%. One of the longest and strongest economic expansions since World War II had begun, with an average annual growth rate of 3.5%. But the first two years (1981 and 1982) were lost for Reagan. Fed chairman Paul Volcker fought inflation with a tight monetary policy and high interest rates. The Reagan administration urged Volcker to decrease monetary growth by a maximum of 50%, in order not to kill the tax cut program. But as the Federal Reserve is totally independent, Volcker cut money growth by 75% in 1981. The recession became even worse, and unemployment rose further. But after inflation had been defeated, money growth resumed and the Reagan expansion took shape. Many leftist critics claim that Reagan gave money away to the rich at the expense of poor. Under Reagan’s leadership the so called rich people paid-out comparatively more through income and corporate taxes than ever before. The economic position for the poor was suitable and enabled them to move-up because tax revenues paid by the poor went down. But the reason for that is very simple. Lowering tax rates enabled instant participation in productive behavior. If the rich worked more, they saved more and logically they paid more. Reagan’s tax policy was followed by a principle in which increasing tax rates will not result in an increase of tax revenue. If you want to increase tax revenue you must expand the tax base and consequently lower marginal rates in order to let the economy grow. It is often claimed that the budget deficit had risen to enormous proportions during the Reagan years. But between 1981 and 1989 the budget deficit increased only slightly, from 2.6% to 2.9% of GDP. The deficit peaked in 1983 to 6.1% of GDP (the Volcker recession with tight money). During the same years the Belgian budget deficit varied between 7% and 13% of GDP. The average budget deficit for the G-7 countries was only slightly lower than that of the US. The public debt of the US as a percentage of GDP, remained below that of the G-7 countries, i.e. below 32% of GDP. But Belgian public debt, the result of years of Keynesian policy, was higher than 100% of GDP and remains around 100% at this moment.
Posted on: Tue, 09 Sep 2014 10:08:55 +0000
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