Two Important Takes on President Reagan's Economic Legacy 
June 9, 2004

When Vice President Cheney quipped that "Reagan proved that deficits don't matter," he was talking about politics, not economics. 

Budget deficits are usually very good at quickly stimulating economic growth.  However, voters don't notice the negative consequences of deficits until they start to cause economic problems, which is usually long after the presidents and many of the members of Congress who initiated them are gone from the political scene.

The first President Bush paid the price for this political reality -- dutifully cleaning up after the Reagan deficits in 1990, and subsequently losing support within the increasingly rigid, anti-tax Republican Party.

Despite the deficits, however, even the most jaded observers generally agree that Reagan's push for business deregulation, tax reform (lower rates and fewer loopholes), and market forces helped pave a path toward higher productivity growth.  Ironically, productivity growth surged after Reagan's presidency ended and his successors started reducing the budget deficit.

Two recent articles help put Reaganomics into perspective.  First, Robert Samuelson's column Unsung Triumph makes a persuasive case that Reagan's most successful economic policy was a political stance:  providing moral support for the Federal Reserve when it precipitated a deep recession in an attempt to break the crushing grip of inflationary expectations. 

Second, a column (reprinted below) by Brian Nottage of Economy.com on The Dismal Scientist website applauds Reaganomics in many respects, but also argues that President Reagan's rhetoric fostered a "caricature of market economics."  Reagan's successors have taken his anti-government, pro-market, supply-side rhetoric to absurd lengths, creating unrealistic policy rigidity and thwarting sensible policy solutions.

Reagan Changed America

By Brian Nottage of Economy.com June 7, 2004

Like so many of Generation X, Ronald Reagan was the dominant figure shaping my early political thoughts. The power of Reagan’s words and the convictions behind them were infectious. Reagan’s impact on the nation’s economic policy was huge as well and lasts to this day through much of current Bush administration policy.

Reagan’s largest economic legacy was tax policy, for good and ill. The top marginal tax rate fell from 70% to 28% on his watch. One way to gauge how revolutionary that concept was is that even Reagan’s most ardent detractors don’t support raising taxes back to those levels. And, it should be noted, there was nothing inevitable about lower taxes. Indeed, one is left asking, if lower taxes were inevitable, why didn’t they come under Nixon, Ford or Carter?

The strength of Reagan’s words in this sea change cannot be overestimated. A country steeped to its bones in the communitarian rhetoric of the New Deal and Great Society had an eloquent champion making not simply the practical case, but the moral case, for lower taxes. Today John Kerry, a liberal Democrat, runs for president vowing to maintain most of President Bush’s tax cuts. This change is Reagan’s legacy.

But Reagan’s largest contribution to the economic debate was not any particular policy position; it was his optimism about the American economy. I recall a section from his farewell oval office address:

Well, back in 1980, when I was running for President, it was all so different. Some pundits said our programs would result in catastrophe. Our views on foreign affairs would cause war. Our plans for the economy would cause inflation to soar and bring about economic collapse. I even remember one highly respected economist saying, back in 1982, that 'The engines of economic growth have shut down here, and they're likely to stay that way for years to come.' Well, he [MIT professor Lester Thurow] and the other opinion leaders were wrong.

Is this recollection self serving? You bet, but it does contain some lessons worth remembering. One lesson is that expert consensus opinion is often too conservative, too negative. We saw that trait again in the 1990s as well when many economists (such as Paul Krugman) vehemently opposed the notion that there was any sort of New Economy.

Whatever problems Reaganomics brought (and there were problems), it is hard to make the case that lowering the tax and regulatory burdens did not contribute to the economic boom of the ensuing two decades. That world governments, left and right, have moved in this direction validates many of the policies he pursued. And even if they did nothing, predictions of catastrophe proved silly in hindsight.

A second lesson is that betting against the U.S. economy almost always turns out to be a bad idea. Even four months ago, trying to convince audiences that jobs were on the way was not easy. At that time, there were many reasons to believe that the large jobs gains we’ve seen in the past four months were imminent. Yet at some points, one felt like shaking the nearest person in exasperation and saying, “the economy always recovers, and it will again.” Recalling the pervasive pessimism of a few months ago makes one appreciate all the more Reagan’s sunny confidence.

But you simply can’t talk about Reagan’s economic legacy without talking about the shortcomings. The major shortcoming is that supply side economics simply didn’t work the way its proponents claim. The central tenet, that tax cuts pay for themselves through higher tax revenues, is simply not true. Moreover, proponents fail to acknowledge that lowering taxes would produce less benefit when the highest tax rate is south of 40% than when it was 70%. The default position is that lower taxes are always and everywhere the best policy.

Supply side economics took the Republican party from the “daddy party” that zealously fought deficits, to the Pollyanna party that ignored them, pretending that we could have massive tax cuts and massive spending at the same time. A more sensible policy synthesis would have concluded that there are dangers both to high taxes and high deficits. That we do not have a more balanced approach owes as much to Reagan’s absolutist rhetoric as anything else. (The irony is that Reagan was more flexible than his rhetoric, repeatedly raising taxes through “revenue enhancers” as the deficit ballooned).

Moreover, Reagan’s uber-libertarian economic philosophy has created a caricature of market economics. To say “Government is not the solution; government is the problem” as Reagan so often did sounds great, but all too often sets up markets as some mythical good that can do no wrong. Thus concepts like market failure, externalities, and public goods, all important players in classical economics, are given short shrift in today’s pop economics debates.

Recently in Business Week, conservative economist Gary Becker made the case for higher gas taxes to finance basic research in alternative fuels, an effort to lessen our dependence on foreign oil. The irony is that eminently sensible policies like this are regarded as left-wing. Among too many conservatives, markets are worshipped, rather than respected. Reagan’s rhetoric, parroted by countless talk show hosts and politicians, went a long way to setting up this simplistic approach to policy.

Thus, Reagan’s economic legacy is decidedly mixed. It is undeniable that he changed the terms of the economic policy debate, which since FDR’s election had assumed that government growth was inevitable, even desirable. And he took a country that didn’t believe in itself anymore and convinced it that its best days were not behind it. Thus, just as FDR was, he was the right man at a critical time in U.S. history.

That two men with such differing economic philosophies could both be the right men for their times should be a sobering lesson, however. Economic policy ultimately needs to react to the problems of the time, whether those problems are economic depression, economic malaise or exploding structural budget deficits. History will ultimately reward leadership that addresses today’s economic problems with solutions, not unbending political dogma parading as economics.

Reprinted with permission from The Dismal Scientist, a service of Economy.com, Inc. 

Links:
Robert Samuelson Unsung Triumph Washington Post (June 9, 2004)

Centrists.Org Where Will the Deficit Go From Here?  New Long-Term Budget Projections
06.03.2004 ||  Under realistic assumptions, the annual federal deficit is poised to hover around $400 billion through 2007, between 3 and 4 percent of GDP.  After that, the deficits will grow as the first waves of baby boomers leave the workforce and join the entitlement rolls.