President Ronald Reagan began the implementation of Republican supply-side economic policies after he was elected in the fall of 1980. It was a major turning point in the history of the U.S. economy because the strategy he promoted wasn’t based upon economic science, but upon the goals of a political ideology. It was widely criticized by professional economists and dubbed “voodoo economics” by his opponent in the Republican primary elections.
Nicknamed Reaganomics, his economic policies called for reducing taxes, especially for the wealthy, and deregulating businesses with the idea that this would stimulate investment in the economy and the increased wealth would “trickle down” to the middle and lower income classes.
To this day Republicans continue to claim that Reagan’s scheme worked because the U.S. economy did, in fact, improve during his administration. But that was mostly due to the Keynesian economic stimulus created by his large increases in defense spending.
The heart of Republican supply-side economic theory is the belief that reducing taxes will inevitably increase business investments which will create more wealth that will be shared throughout the economy. In other words, every dollar of income that’s used to pay a tax is a dollar that’s “removed” from the economy.
Reagan’s economic policies began to go into effect with passage of the 1981 Kemp-Roth Tax Cut, which cut income tax rates for everyone, but especially for the rich, with the tax rate for the very wealthy falling from 70% to 50%. Then his Tax Reform Act of 1986 lowered income taxes for the wealthy even further, to 28%, while simultaneously increasing taxes for the lowest income bracket by 36%.
According to supply-side theory, these income tax cuts for the wealthy should have increased investment in the economy, resulting in better growth. But according to the President’s Council of Economic Advisers, the rate of U.S. gross domestic product (GDP) growth has steadily declined since the two Reagan tax cuts went into effect. GDP growth was 31% in the 1980s, almost unchanged at 32% in the 1990s, just 22% in the 2000s, and only 19% so far in the 2010s. In comparison, it was 40% in the 1950s, 44% in the 1960s, and 32% in the 1970s. This disparity is even more troubling when you consider that the income tax rate for the wealthy was 91% in the 1950s, averaged about 80% in the 1960s, and was 70% in the 1970s.
The chart below shows that investment in the economy has actually trended downward since the implementation of Reaganomics, even though corporate taxes were decreased too.
The reality is that lowering taxes for the wealthy and corporations didn’t lead to more business investment and economic growth. This might seem counterintuitive because Republican claims that all tax reductions stimulate growth may sound like common sense. But the truth has been that most wealthy people have simply kept the extra money they’ve gotten from lower taxes. Why would you risk your fortune on a risky new business venture when you already have all the money you need?
Consider, for example, where much of the tax money that was kept by high income people was spent. Some of it, of course, was reinvested by responsible business managers. But a lot of it was spent on luxury cars and clothes, mansions, plastic surgery, mistresses, divorces, second and third homes, international vacations, personal jets, yachts, lobbyists, political bribes, conservative think tanks, lawsuits, and campaign contributions.
These types of purchases create economic activity, but not the type that benefits the entire economy. If this money, for example, had been collected as taxes, it could have been spent on transportation infrastructure, education, or mental health initiatives – expenditures that would have benefited all Americans and recirculated the money throughout the economy. In other words, the Reagan tax cuts actually “removed” money from the broader economy.
All Taxes Aren’t the Same
The problem with the supply-side theory that lower taxes will inevitably lead to economic growth is that all taxes aren’t the same. As we’ve seen, lowering income taxes for the wealthy doesn’t necessarily increase business investments. The Congressional Research Service (CRS), a public policy research arm of the U.S. Congress, issued a report in 2012 that confirmed this. They concluded that:
There is not conclusive evidence, however, to substantiate a clear relationship between the 65-year steady reduction in the top tax rates and economic growth. Analysis of such data suggests the reduction in the top tax rates have had little association with saving, investment, or productivity growth. However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution.
Lowering income taxes for the middle and lower income classes, however, will stimulate growth because they are the primary consumers of the economy’s products. Lowering taxes for the top 1% of income earners doesn’t significantly stimulate consumer spending.
Regressive taxes, which uniformly take the same percentage from lower income people as from higher income groups, also reduce economic consumption because poor people must spend a higher percentage of their money on necessities. A sales tax is the best example of a regressive tax. Social Security and Medicare (FICA) payroll taxes are also regressive taxes because high income earners don’t pay them above a certain annual income – called the Social Security Wage Base. Reagan’s Social Security Amendments of 1983 raised the FICA payroll tax and also the full retirement age for Social Security benefits.
Free Markets Aren’t Fair Markets
Another pilar of supply-side economic theory is that government deregulation will allow for a “free market” or “laissez-faire” economy that will undoubtedly be more efficient, and thus produce greater wealth than an economy with regulated markets. This philosophy, however, was already thoroughly disproven before Reagan was elected. The problems caused by unregulated markets, for example, were the impetus for passage of anti-trust and regulatory laws during the Progressive Era such as the Sherman Antitrust Act of 1890, the Pure Food and Drug Act of 1906, and the Federal Trade Commission Act and Clayton Antitrust Act of 1914. And the failure of the government to effectively intervene in the economy was a primary cause of the Great Depression. Moreover, the enormous GDP growth that the U.S. experienced during WWII proved that government involvement in the economy isn’t inherently bad.
But Reagan, a former movie actor who earned the moniker The Great Communicator, succeeded in drawing upon the fears and frustrations of many voters to convince them their own government was an enemy. He was so successful that he is largely responsible the anti-government sentiment that is so prevalent today. One of his most famous statements, for instance, was “Government does not solve problems.” This destructive narrative was protected in 1987 when his appointments to the Federal Communications Commission revoked the Fairness Doctrine, which required broadcasters to present controversial issues in an honest, equitable, and balanced manner.
The Modern Robber Barons
Reagan’s tax policies, along with his anti-regulatory agenda, promoted long-term trends that have seriously damaged the U.S. economy. Reagan’s tax cuts for the wealthy, for instance, made it easier for corporate executives to pocket more profits. This is shown in the chart below by the enormous growth in corporate chief executive officer (CEO) pay since the 1980s.
Profit Stealing not Profit Sharing
The ability of CEO’s to siphon off more money from their companies also meant there was less available for employee wage increases. As you can see from the chart below, employee wages have been flat despite enormous increases in worker productivity.
Furthermore, U.S. worker wages have steadily declined as a percentage of the nation’s GDP, and in dollar amounts too.
In a properly regulated economy these new robber barons wouldn’t have been able to get away with stealing profits. But the modern U.S. economy is characterized by industries dominated by oligopolies, wherein a handful of producers can manipulate prices and wages. The two agencies that are supposed to enforce the antitrust laws, the Department of Justice’s Antitrust Division and the Federal Trade Commission, are run by political appointees. Furthermore, they depend upon Congress for their funding and taking legal action against large corporations is difficult and expensive. American consumers know firsthand by the odd behavior of prices for things like drugs and gasoline that price-fixing by oligopolies is a daily reality in today’s economy.
Reagan cannot be given all of the blame for the U.S. economy’s trend toward industries controlled by a handful of large corporations, as it’s been going on for a long time. But he can be blamed for popularizing the demonization of government regulators. His myopic ideology made him blind to the fact that government regulation is essential for many reasons, like prohibiting price manipulations, stopping the exploitation of workers, protecting public health, and preventing pollution. It’s also necessary for maintaining competitive-capitalism, especially in an economy dominated by oligopolies. It isn’t a coincidence that an alarming increase in the number of corporate merges and acquisitions started when Reagan began to implement his anti-regulatory agenda in 1981, as shown in the cart below.
Standard economic theory says that combining two competing companies can reduce unnecessary duplication and create a new company that’s more efficient and profitable, thereby benefiting the entire economy. This is certainly the result of some mergers and acquisitions. But many of the recent ones have been the product of vulture capitalists, also known as corporate raiders. They buy distressed companies, ostensibly to save them. The companies they acquire are then unnecessarily dismembered to ruthlessly extract as much value as possible and the remnants are merged with others they already own. The resultant “cost-cutting” results in the suppression of wage increases and layoffs. The insufficient enforcement of U.S. antitrust laws has often failed to ensure competitive capitalism, and allowed these mergers to proceed with insufficient scrutiny.
Fair Trade Isn’t Free Trade
But the ability of large U.S. corporations to effect the suppression of wages can’t be solely attributed to the trend towards industries dominated by oligopolies. It’s also a product of the U.S. government’s flawed foreign trade policies. Free trade is supposed to generate increased wealth for both trading partners because it maximizes their comparative advantages – letting each country’s economy focus on the things it does best. The economic advantages of free trade, however, depend upon it being fair trade. Too often U.S. trade agreements haven’t ensured a level playing field. How can an American company compete, for example, with a foreign company that requires its workers to work long hours and pays them very little and then uses violence against them if they complain? Or a foreign company that isn’t required to provide its workers with a safe workplace, or can pollute the local environment without any consequences? Or a company that receives direct government subsidies? Or a company in a country, like China, where the government manipulates the value of its currency in order to make the prices of its export products more attractive? The most immediate effect of these unfair trade agreements has been to create a race to the bottom of the wage scale in the U.S.
Common sense says that many foreign products sold in the U.S. would be more expensive if there were a level playing field, as their prices must include the costs of international transportation. Instead, however, unfair U.S. trade policies have resulted in the layoffs of millions of U.S. workers, and the cost of this unemployment has often outweighed the benefits of the lower prices for the imported products. How can U.S. workers, for example, enjoy lower import prices if they don’t have a job and have to live off unemployment? The anti-regulatory climate that Reagan created made it easier for corporations to convince U.S. politicians to leave effective fair trade provisions out of trade agreements.
Supply-side Economics Have Increased the National Debt
Perhaps the biggest problem created by Reagan’s implementation of supply-side economics is the enormous increase in the federal debt that began with his administration. As we have seen, his income tax policies encouraged corporate executives to keep profits for themselves, instead of reinvesting them in their businesses or using them for employee wage increases. His anti-regulatory rhetoric and political appointments encouraged corporations to prey upon their competitors and outsource jobs overseas. The primary net effect was to decrease the size and prosperity of the middle class – the primary consumers of the goods and services produced by the U.S. economy. This lowered demand, and coupled with increased productivity from technological advancements, created an over-productivity in the economy that had be dealt with in order to avoid an accelerating downward economic spiral with high unemployment.
The easiest tool our politicians had to deal with this problem was to stimulate economic demand by increasing government spending. In other words, stimulating the economy through government spending replaced doing it with increased employment and higher wages. The dramatic increase in the national debt caused by supply-side economics has had the effect of shifting government spending from providing services for all citizens to increasing the wealth of the upper income classes, and accelerating wealth disparity.
Why do Politicians Continue to Promote Supply-side Economics?
The bottom line is the facts show that supply-side economic policies don’t work. They’ve shrunk the middle class and generated unemployment, while dramatically increasing income inequality and the national debt. They haven’t created economic growth that’s pulled everybody up, just a rising tide that’s only helped the rich.
These policies are even more destructive when they are implemented by state governments because the states don’t have the federal government’s ability to incur debt to reduce unemployment by increasing spending. The race by Republican governors to lower state taxes at any cost has already created economic disasters in Kansas and Louisana.
The truth is that jobs are created by prosperous consumers generating demand for goods and services. In other words, the economy grows from the inside out, not the top down. The obvious solution to America’s economic problems is demand-side economics, wherein policies that grow the middle class by increasing wages, eliminating regressive taxation, and requiring that fair trade agreements are implemented.
The national discussion about how to identify and implement effective demand-side economic policies won’t make good progress, however, until supply-side theories have become so discredited that Republican politicians are forced to abandon them. You might imagine that would be an easy thing, since supply-side policies have been such a dismal failure. But a good example of the magnitude of the task is shown by the fact that Larry Kudlow and Arthur Laffer, two of the primary architects of Reaganomics, are still selling this snake oil today and people are still buying it.
Large Corporations Have Been Given Personhood
The biggest reason so many Republicans are still promoting supply-side economics is because they are being paid to do it. The U.S. Supreme Court’s 2010 Citizens United v. FECC decision decreed that nonprofit 501(c)(6) corporations could raise and spend unlimited amounts of money for political campaign advertising while concealing the identities of their donors. Additionally, very wealthy “conservative” businessmen, like the Koch brothers, have created a network of generously-funded think tanks that constantly spew cleverly worded, but disingenuous, political talking points. The result is that Republican political candidates know the easiest way to win an election is to mindlessly regurgitate the policies that are being promoted by these deep-pocketed donors and their organizations.
Democratic politicians, of course, aren’t immune to the powerful influences of large corporations. The enforcement of antitrust laws by Democratic administrations has been spotty. And Democrats were complicit in the 1999 passage of the Gramm–Leach–Bliley Act (GLBA), which repealed the Glass-Steagull consumer protection provisions of the Banking Act of 1933. They also haven’t pushed very hard for the full implementation of the 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act.
The problem is that the self interests of the wealthy are increasingly dictating government policy. Discrediting supply-side economics, and other bad public policies, will continue to be a difficult job unless there are significant political campaign financing reforms.
What Are the Real Objectives Supply-Side Proponents?
The wealthy supporters of supply-side economics claim they are in favor of a free market economy that will create greater prosperity. But an economy dominated by oligopolies isn’t a free, competitive market. And the destruction of the middle class and the outsourcing of jobs overseas isn’t generating widespread wealth in the U.S. So, what are they really trying to accomplish?
One of their primary objectives is to lower taxes for upper income earners. They know supply-side economics don’t really work but can be an effective political smokescreen to justify tax cuts for the rich. It would be too politically difficult to simply argue that wealthy people shouldn’t have to pay higher taxes.
Some want to create a libertarian utopia wherein the government is practically dismantled so all problems can be magically solved by a free market. This isn’t true conservatism, but a radical ideology that’s never been successful in the real world. The result would not be a utopia, but a dystopia wherein things like worker exploitation, unfair business competition, and industrial pollution would be rampant. The absurdity of this vision is illustrated by the fact that growth inevitably creates a need for more government.
More importantly, if economic freedom is made paramount, political and social freedom suffers because elections become relatively meaningless when most of the important decisions are being made in corporate board rooms. The result is a society whose values are almost solely commercial, ruled by an mega-wealthy oligarchy of corporate executives. Some would say we’re already there.
But whatever it is that motivates the supporters of supply-side economic theory, it is an ideological strategy looking for real world validation that will never come. It’s supporters are helping to perpetuate a con game being run on the American public, and we can blame Ronald Reagan for initiating it.
In March 2018 President Trump appointed supply-side economics proponent Larry Kudlow to be Director of the National Economic Council.