Reaganomics essay

Today the Administration is proposing a national recovery plan to reverse the debilitating combination of sustained inflation and economic distress which continues to face the American economy. Were we to stay with existing policies, the results would be readily predictable: a rising government presence in the economy, more inflation, stagnating productivity, and higher unemployment. Indeed, there is reason to fear that if we remain on this course, our economy may suffer even more calamitously.

The program we have developed will break that cycle of negative expectations. It will revitalize economic growth, renew optimism and confidence, and rekindle the Nation's entrepreneurial instincts and creativity.

The benefits to the average American will be striking. Inflation—which is now at double digit rates—will be cut in half by 1986. The American economy will produce 13 million new jobs by 1986, nearly 3 million more than if the status quo in government policy were to prevail. The economy itself should break out of its anemic growth patterns to a much more robust growth trend of 4 to 5 percent a year. These positive results will be accomplished simultaneously with reducing tax burdens, increasing private saving, and raising the living standard of the American family.

The plan is based on sound expenditure, tax, regulatory, and monetary policies. It seeks properly functioning markets, free play of wages and prices, reduced government spending and borrowing, a stable and reliable monetary framework, and reduced government barriers to risk-taking and enterprise. This agenda for the future recognizes that sensible policies which are consistently applied can release the strength of the private sector, improve economic growth, and reduce inflation.

We have forgotten some important lessons in America. High taxes are not the remedy for inflation. Excessively rapid monetary growth cannot lower interest rates. Well-intentioned government regulations do not contribute to economic vitality. In fact, government spending has become so extensive that it contributes to the economic problems it was designed to cure. More government intervention in the economy cannot possibly be a solution to our economic problems.

We must remember a simple truth. The creativity and ambition of the American people are the vital forces of economic growth. The motivation and incentive of our people—to supply new goods and services and earn additional income for their families—are the most precious resources of our Nation's economy. The goal of this Administration is to nurture the strength and vitality of the American people by reducing the burdensome, intrusive role of the Federal Government; by lowering tax rates and cutting spending; and by providing incentives for individuals to work, to save, and to invest. It is our basic belief that only by reducing the growth of government can we increase the growth of the economy.

The U.S. economy faces no insurmountable barriers to sustained growth. It confronts no permanently disabling tradeoffs between inflation and unemployment, between high interest rates and high taxes, or between recession and hyperinflation. We can revive the incentives to work and save. We can restore the willingness to invest in the private capital required to achieve a steadily rising standard of living. Most important, we can regain our faith in the future.

The plan consists of four parts: (1) a substantial reduction in the growth of Federal expenditures; (2) a significant reduction in Federal tax rates; (3) prudent relief of Federal regulatory burdens; and (4) a monetary policy on the part of the independent Federal Reserve System which is consistent with those policies. These four complementary policies form an integrated and comprehensive program.

It should be clear from the most cursory examination of the economic program of this Administration that we have moved from merely talking about the economic difficulties facing the American people to taking the strong action necessary to turn the economy around.

The leading edge of our program is the comprehensive reduction in the rapid growth of Federal spending. As shown in detail below, our budget restraint is more than "cosmetic" changes in the estimates of Federal expenditures. But we have not adopted a simple-minded "meat ax" approach to budget reductions. Rather, a careful set of guidelines has been used to identify lower-priority programs in virtually every department and agency that can be eliminated, reduced, or postponed.

The second element of the program, which is equally important and urgent, is the reduction in Federal personal income tax rates by 10 percent a year for 3 years in a row. Closely related to this is an incentive to greater investment in production and job creation via faster tax write-offs of new factories and production equipment.

The third key element of our economic expansion program is an ambitious reform of regulations that will reduce the government-imposed barriers to investment, production, and employment. We have suspended for 2 months the unprecedented flood of last-minute rulemaking on the part of the previous Administration. We have eliminated the ineffective and counterproductive wage and price standards of the Council on Wage and Price Stability, and we have taken other steps to eliminate government interference in the marketplace.

The fourth aspect of this comprehensive economic program is a monetary policy to provide the financial environment consistent with a steady return to sustained growth and price stability. During the first week of this Administration its commitment to the historic independence of the Federal Reserve System was underscored. It is clear, of course, that monetary and fiscal policy are closely interrelated. Success in one area can be made more difficult—or can be reinforced—by the other. Thus, a predictable and steady growth in the money supply at more modest levels than often experienced in the past will be a vital contribution to the achievement of the economic goals described in this Report. The planned reduction and subsequent elimination of Federal deficit financing will help the Federal Reserve System perform its important role in achieving economic growth and stability.

The ultimate importance of this program for sustained economic growth will arise not only from the positive effects of the individual components, important as they are. Rather, it will be the dramatic improvement in the underlying economic environment and outlook that will set a new and more positive direction to economic decisions throughout the economy. Protection against inflation and high tax burdens will no longer be an overriding motivation. Once again economic choices—involving working, saving, and investment—will be based primarily on the prospect for real rewards for those productive activities which improve the true economic well-being of our citizens.

II. The Twin Problems of High Inflation and Stagnant Growth

The policies this Administration is putting forward for urgent consideration by the Congress are based on the fact that this Nation now faces its most serious set of economic problems since the 1930s. Inflation has grown from 1 to 1 1/2 percent a year in the early 1960s to about 13 percent in the past 2 years; not since World War I have we had 2 years of back-to-back double digit inflation. At the same time, the rate of economic growth has been slowing and the unemployment rate creeping upward. Productivity growth—the most important single measure of our ability to improve our standard of living—has been declining steadily for more than a decade. In the past 3 years our productivity actually fell.

The most important cause of our economic problems has been the government itself. The Federal Government, through tax, spending, regulatory, and monetary policies, has sacrificed long-term growth and price stability for ephemeral short-term goals. In particular, excessive government spending and overly accommodative monetary policies have combined to give us a climate of continuing inflation. That inflation itself has helped to sap our prospects for growth. In addition, the growing weight of haphazard and inefficient regulation has weakened our productivity growth. High marginal tax rates on business and individuals discourage work, innovation, and the investment necessary to improve productivity and long-run growth. Finally, the resulting stagnant growth contributes further to inflation in a vicious cycle that can only be broken with a plan that attacks broadly on all fronts.

THE ROLE OF THE GOVERNMENT IN CAUSING INFLATION

Surges of inflation are not unusual in history; there were price explosions after both World Wars, as well as smaller outbursts in the 1920s and late 1930s. Therefore, in spite of the role played by food and energy prices in recent inflationary outbursts, it is misleading to concentrate on these transitory factors as fundamental causes of the inflationary bias in the American economy. Even when prices in these markets have been stable, inflation has continued with little relief.

What is unusual about our recent history is the persistence of inflation. Outbursts of high inflation in the last 15 years have not been followed by the customary price stability, but rather by long periods of continued high inflation. This persistence of inflation has crucially affected the way our economy works. People now believe inflation is "here to stay"; they plan accordingly, thereby giving further momentum to inflation. Since there are important long-term relationships between suppliers and customers and between workers and management, long-term contracts, sometimes unwritten, are often based on the view that inflation will persist. This robs the economy of flexibility which might otherwise contribute to reducing inflation.

The Federal Government has greatly contributed to the persistence of high inflation. Overly stimulative fiscal and monetary policies, on average, have financed excessive spending and thus pushed prices upward. Since government accommodation is widely expected to continue, inflation has become embedded in the economy.

When inflationary outbursts occur, policymakers all too often have made a quick turn toward restraint. Such turnabouts, however, have been short-lived and their temporary nature has increasingly been anticipated by savers, investors, and workers. Subsequent declines in employment and growth inevitably call forth stimulative policies before inflation can be brought under control. Such "stop-and-go" policies have only resulted in higher unemployment and lower real growth.

Finally, but equally important, government policies have increased inflation by reducing the potential of our economy to grow—directly through the increasing burdens of taxes and regulations, and indirectly through inflation itself. The result is a vicious circle. Its force can be measured by the statistics of our productivity slowdown, but it is seen more dramatically in the anxiety and concern of our people.

GOVERNMENT CONTRIBUTES TO THE PRODUCTIVITY SLOWDOWN

Productivity, popularly measured as output per worker-hour, is an indicator of the efficiency of the economy and consequently of our ability to maintain the rate of improvement in our standard of living. Over the past 15 years, the rate of productivity improvement has slowed, and now virtually halted.

Government policies have been a major contributor to the slowdown but they can be an even more important contributor to the cure. The weight of regulation and the discouragement that results from high marginal tax burdens are key factors, but inflation itself also plays an important role. Reduced capital formation is the most important and visible, but not the only, channel by which this occurs.

By increasing uncertainty about the future, inflation discourages investors from undertaking projects that they would have considered profitable but which, with today's inflationary environment, they consider too risky. Inflation also diverts funds from productive investments into hedging and speculation.

Although recent statistics show that the share of our economy's production devoted to investment is high by historic standards, the magnitude is illusory—an illusion fostered by inflation. Accelerating prices, and the high interest rates and shifting economic policy associated with them, have contributed to an unwillingness to make long-lived investments. As a result, our stock of productive plant and equipment depreciates faster, so that more investment is needed simply to stand still.

The regulatory requirements imposed by the government have likewise served to discourage investment by causing uncertainty in business decision-making. In addition, investments to meet regulatory requirements have diverted capital from expanding productive capacity. Some estimates have put regulation-related investment at more than 10 percent of the total level of business investment in recent years. The expanding intrusiveness of the government into the private sector also inhibits innovation and limits the ability of entrepreneurs to produce in the most efficient way.

INFLATION, GROWTH, AND THE TAX SYSTEM

The role of the tax system in reducing our past growth, and its potential for improving the prospects for future growth, deserve special attention. By reducing the incentives for investment and innovation, both by individuals and by businesses, the tax system has been a key cause of our stagnation. Restoring the proper incentives will make a major contribution to the long-run vitality of our economy.

The progressivity of the personal income tax system levies rising tax rates on additions to income that merely keep pace with inflation. Households therefore find that even if their gross incomes rise with inflation, their after-tax real income declines. Some households respond to these higher marginal tax burdens by reducing their work effort. "Bracket creep" also encourages taxpayers to seek out "tax shelters," sources of income that offer higher after-tax returns but not necessarily higher before tax returns than more productive sources, again contributing to economic inefficiency. In the last two decades the Congress has reduced personal income taxes seven times. Nevertheless, average effective tax rates are now about 30 percent higher than their mid-1960's low. Marginal tax rates have climbed in tandem with average rates.

Due to inflation, the rate of return on corporate assets, after tax, and the level of corporate earnings have been seriously eroded over the past decade and a half. That was a major factor stunting capital spending from what it otherwise would have been. The tax treatment of depreciation has been an important contributor to this lowering of returns. We now allow write-offs at the cost of purchase, rather than at more realistic prices. This creates phantom profits upon which taxes are paid.

Finally, unless the Congress takes frequent actions to offset the revenue-generating effect of inflation on the progressive personal tax system, the Congress has available for spending unlegislated increases in funds. Inflation in tandem with the tax system thereby impairs the fiscal discipline of the budget process and facilitates higher levels of government spending than would result if the Congress were forced to vote on each tax increase. This offers further encouragement to inflation.

THE ECONOMY AS A WHOLE HAS SUFFERED

Because past policies have not reduced unemployment, even as they have encouraged rising inflation—the economy as a whole has suffered. Over the past two decades, we have seen the "misery index"—the sum of the inflation and unemployment rates—more than double, rising from 7.3 in 1960 to 17.2 in 1980. While unemployment rates have fluctuated over the business cycle, there has been no long-run tradeoff between unemployment and inflation. The upward movements in inflation have not brought us falling unemployment rates, nor has high unemployment brought lower inflation.

Thus trends of the past are clearly disturbing in that they have sapped our Nation's economic vitality. Of greater significance, however, is the danger we face if the policies of the 1970s are continued.

For the first time in American history financial markets reflect the belief that inflation will not retreat significantly from current high levels. The Nation's economy and financial system are on a dangerous course—one which, if not reversed, would lead to a prolonged stagnation of economic growth and employment, ever higher inflation and interest rates, and potentially a financial crisis. The solution to this growing economic threat calls for bold actions designed to reduce—dramatically and sharply-inflationary expectations. These policies must restore fiscal integrity; increase incentives for saving, investment, and production; attain monetary and financial stability; and enhance the role of the marketplace as the principal force in the allocation of resources.

III. Slowing the Growth of Government Spending

The uncontrolled growth of government spending has been a primary cause of the sustained high rate of inflation experienced by the American economy. Perhaps of greater importance, the continued and apparently inexorable expansion of government has contributed to the widespread expectation of persisting—and possibly higher—rates of inflation in the future.

Thus, a central goal of the economic program is to reduce the rate at which government spending increases. In view of the seriousness of the inflationary pressures facing us, the proposed reductions in the Federal budget for the coming fiscal year are the largest ever proposed.

Despite the tendency to refer to "cutting" the budget, it is clear that an expanding population, a growing economy, and a difficult international environment all lead to the need for year-to-year rises in the level of government spending. Thus, the badly. needed effort to "cut" the budget really refers to reductions in the amount of increase in spending requested from one year to the next.

The magnitude of the fiscal problem facing the United States can be seen when we realize that, despite the $49.1 billion of savings including $5.7 billion in off-budget outlays that is being recommended for fiscal 1982, the total amount of Federal outlays for the year is likely to be $41 billion higher than the current year. (A separate document is being issued by the Office of Management and Budget that outlines the major spending reductions in considerable detail.)

It is essential to stress the fundamental principles that guided the development of that program.

First, and most importantly, all members of our society except the truly needy will be asked to contribute to the program for spending control.

Second, we will strengthen our national defense.

Finally, these fundamental principles led to nine specific guidelines that were applied in reducing the budget: • Preserve "the social safety net." • Revise entitlements to eliminate unintended benefits. • Reduce subsidies to middle- and upper-income groups. • Impose fiscal restraint on other national interest programs. • Recover costs that can be clearly allocated to users. • Stretch-out and retarget public sector capital investment programs. • Reduce overhead and personnel costs of the Federal Government. • Apply sound economic criteria to subsidy programs. • Consolidate categorical grant programs into block grants.

The application of these guidelines has required great care, judgment, and sensitivity. However, we are putting forward over 80 proposals that will carry out these guidelines and affect virtually every segment of our economy except the truly needy. The Administration's insistence on this fundamental principle has meant that programs benefiting millions of truly needy beneficiaries have not been affected by the spending control effort. These programs include social insurance benefits for the elderly, basic unemployment benefits, cash benefits for the chronically poor, and society's obligations to veterans.

The selection of specific reductions has been a difficult task involving the entire Administration as well as much consultation with representatives of business, labor, agriculture, minority groups, and State and local governments.

The spending reduction plan will shift Federal budget priorities so that Federal resources are spent for purposes that are truly the responsibility of the national government. As the table below indicates, our budget plans reflect the increased importance attached to national defense, maintain the Federal Government's support for the truly needy, and fulfill our responsibilities for interest payments on the national debt. The spending reductions will restrain Federal involvement in areas that are properly left to State and local governments or to the private sector.