by James K. Glassman
(published in The Rising Tide, Fall 97)
Americans are still living in an economic golden age. For the first time
in our history, 15 years have passed with only a single shallow recession.
The gross domestic product, that grand measure of all our goods and
services, is clipping along at 3 percent annually. Unemployment is 4.9 percent
Inflation is 2.2 percent -- and probably closer to 1 percent if a more accurate
gauge were used than the Consumer Price Index.
While these figures are impressive, even more remarkable is the stability that
has descended on the economy. Growth, inflation, interest rates have reached
a kind of stasis -- a glorious plateau. The lack of volatility has encouraged
investors to commit more of their money to long-term investments in the stock
of U.S. corporations, and partly as a result, since the recession of 1982, the
Dow Jones industrial average has risen from 777 to over 8000 -- an unprecedented
advance. At the same time, the total number of Americans employed has increased
by 30 million, or one-third.
Who gets credit for this golden age?
First and foremost, individual Americans and the companies they create and work for.
In the past 15 years, we've made things (and provided services) better, cheaper, and
faster -- through risk taking, talent, better education and training, hard work and
But what about government? Is there something government has done to encourage
the private sector to boom? And, if so, whose government?
The answer, it seems to me, couldn't be clearer. The golden age began under Ronald
Reagan, and policies set during his administration have sustained it. George Bush
and Bill Clinton deserve credit mainly for not tampering excessively with the changes
Reagan wrought. And then there's the GOP Congress. But for the GOP victory in 1994,
Clinton almost certainly would have ended the game prematurely. (In this assessment
of the role of Republican majorities on Capitol Hill, the market seems to concur. For the
first two years of the Clinton Administration, with a Democratic Congress, the market
rose 21 percent, or about 10 percent annually. Since November 1994, the market is up
98 percent, or about 30 percent every 12 months).
Tax Cuts, Inflation, Spending and Regulation
The causes of economic growth remain a mystery, but the barriers to growth are clear:
high tax rates, high inflation, high government spending and excess regulation. Reagan's
goals, at the start of his administration in 1981, were to reduce all four, writes William
Niskanen, a member of the Council of Economic Advisors.
The reasons that these conditions thwart growth is that they put heavy burdens on
businesses and prospective entrepreneurs, restricting their flexibility and their ability
to raise capital, hire good workers and plan for the future. The four conditions do
something else. They deter experimentation, which is the wellspring of growth
--an issue I'll get to a little later.
Reagan was successful on taxes and (with the help of Paul Volcker, who was appointed
chairman of the Federal Reserve Board by President Carter in 1979) on inflation. He
reallocated government spending to defense, but didn't reduce it overall. In 1980,
spending on the military and on domestic discretionary programs was roughly equal.
By 1990, spending on the military was 50 percent greater. Today, domestic spending
But, to the disappointment of those who wanted to see a smaller government, total
federal outlays as a percentage of GDP rose from 22.3 percent in 1980 to a post-
World War II record of 24.4 percent in 1983 before settling back to 22.1 percent
in the last year of Reagan's term.
The regulatory record was mixed, and perhaps the single most important accomplishment
in this area was the work of a judge: the break-up of AT&T, which led to at least a
partial lifting of the restrictions on what communications companies can do. In the July
issue of Wired magazine, Peter Schwartz and Peter Leyden argue that what they call
"The Long Boom" began with two events that occurred at roughly the time Reagan
took office. "One is the introduction of personal computers. The other is the break-up
of the Bell System." Both led to wider, cheaper dispersion of information, which, in turn,
has meant that individuals and businesses can work more efficiently.
On both spending restraint and regulation, the new Republican Congress has picked up
the ball for Reagan. Federal outlays have fallen to 20.8 percent of GDP; subsidies are,
at last, being phased out in farming; and free-market competition is the norm in
transportation and telecommunications -- with gas and electric utilities next on the agenda.
Meanwhile, another of Reagan's economic victories was the firing of striking air-traffic
controllers just seven months into his presidency -- a watershed in the history of organized
labor. Subsequently, the percentage of union members in the work force fell by one-fourth,
from 20 percent to 15 percent.
Finally, in a surprising failure that was remedied in great measure by Bush and Clinton,
Reagan "added more trade barriers than any administration since Hoover," as Niskanen
puts it. Still, Reagan's successful defense policy, which led to the demise of the Soviet
empire and the spread of democracy and capitalism throughout Latin America, helped
create vast new markets for American goods. His tax policies were mimicked by Britain,
Canada, New Zealand, Japan and much of the rest of Europe and Asia. It's an amazing
record, considering that throughout his term the Democrats held majorities of from 51
to 101 seats in the House, where revenue and spending bills originate.
Some critics, including Niskanen, cite large deficits as another failure of Reagan's, but I
disagree. As Reagan told Stockman, his budget director, in 1981: "I did not come here
to balance the budget -- not at the expense of my tax-cutting program and defense
program. If we can't do it in 1984, we'll have to do it later."
Reagan took a courageous position, pushing tax cuts and national security while ignoring
deficits in the short term -- and his prediction about the budget will turn out to be right.
We'll end fiscal year 1997 with a deficit of only $34 billion, the lowest since 1974, and,
next year, I'll lay even money that we'll have a surplus. The zero deficit, some 17 years
after Reagan took office, is his legacy as well. Let me explain . . .
The Myth of the Reagan Deficits
The Reagan deficits have been widely misunderstood. They were created not by a shortfall
in revenues, but by a surfeit of spending. Roughly half the spending increase came from
defense, which rose from 5.1 percent of GDP in 1980 to a peak of 6.3 percent in 1987.
In my opinion, that was money well spent.
But revisionists have attacked Reagan mainly on the revenue side, and they're dead-wrong.
Reagan and his supporters in Congress didn't cut tax revenues in 1981 and 1986. He cut
tax rates. The view of his advisers was that rate cuts would generate more economic
activity because, at the margin, Americans would have more incentive to work and invest.
And what's just what happened.
It's not a difficult concept. Before Reagan took office, the top rate on 'unearned' (that is,
investment) income was 70percent; the top rate on earned income was 50 per cent;
on capital gains, 35 per cent. All of these rates fell to 28 per cent in the 1980s.
In addition, Reagan took the important step of indexing tax brackets so that Americans
no longer encountered higher rates simply because of inflation.
Consider a woman, pre-Reagan, who is offered the chance to work longer hours and earn
an extra $10,000. That sounds tempting -- until she realizes that the U.S. Treasury will take
$5000 of that additional income in taxes. She decides the extra work is not worth the
$5000 she'll keep, so she chooses leisure.
But under Reagan, the bite at the margin drops to 28 per cent, so she'll keep $7200.
The differences in marginal rates are even more dramatic for interest and dividend income.
Instead of keeping just $3000 out of every additional $10000 in 'unearned income, '
an investor in the top bracket keeps the same $7200.
By cutting marginal tax rates in this way, Reagan and his advisers believed they could boost
economic growth, and they were right. Between 1981 and 1989, GDP advanced at a 3.1
per cent annual clip -- including the recession year of 1982 --and 18 million new jobs were
created as new businesses were launched. The 1980's became "the great heydey of venture
capital industry," wrote Robert Bartley, editorial page editor of the Wall Street Journal
in his book on the Reagan boom, Seven Fat Years. After the 1982 recession -- the result
of action by Volcker, with Reagan's encouragement, to stop virulent inflation created in the
Carter years -- the recovery would last nearly eight years, second in the modern era only
to the1961-1969 boom during the Vietnam War (which lasted an extra year). But net
fixed investment --a good measure of how much new capital was pouring into the economy
-- grew at a record 3.5 per cent annually.
It's Tax Cuts, Stupid
But back to the tax cuts. Alan Reynolds, who was present at the creation and now directs
economic research at the Hudson Institute, makes the point that, "since revenues are
constant at 19 % of GDP, the only way for an administration to raise more money is to
increase GDP." Why are revenues constant -- or roughly so -- at 19 per cent? "That's
all you can collect," he says. "The American public won't put up with anything higher."
Indeed, between 1958 and 1980 tax revenues averaged 18.5 percent of GDP annually,
ranging from a low of 17.4 per cent to a high of 20.2 per cent. During the Reagan years
(1981-89), revenues averaged 18.9 per cent of GDP -- actually, higher than in the
preceding three decades -- with a low of 18.0 and a high of 20.2 percent. They've
stayed in that range since.
So the key was constructing a tax system (and making other policy changes) that would
make government less obtrusive and encourage growth. That policy worked, without
a doubt. The proof is in the tax revenues that were generated. In 1980, Jimmy Carter's
last year as president, the Treasury raised $517 billion; in 1989, at the end of Reagan's
term, it raised $991 billion. That's a 92 percent increase during a period when consumer
prices rose just 46 percent.
It's true that most of the tax rate cuts accrued to higher income Americans -- but, because
those cuts encouraged them to work, and invest more, these higher earners became the
source of much of the tax revenue growth. "In effect," wrote James D. Gwartney of Florida
State University in the Fortune Encyclopedia of Economics, "lower rates soaked the rich."
There were, however, deficits. Big Ones. But, despite dire warnings, those deficits did not
cause inflation to accelerate, nor did they boost interest rates. Doomsayers like Lester
Thurow -- who in 1985 wrote, "Americans were enjoying the thrill of a cyclical recovery
in 1984, but ahead lie more sickening bouts with inflation and unemployment" -- were
While consumer prices doubled in the 1970's, they rose by less than half in the 1980's.
Rates on 30 year Treasury bonds were 12 percent when Reagan took office and less than
9 percent when he left. One big reason that inflation and rates were relatively low was that
the supply-side revolution actually did increase supply. Inflation is too much money chasing
too few goods; Volcker (and later Alan Greenspan) took care of the money part, and the
tax cuts and deregulation encouraged the production of goods.
The Reagan Legacy
The Reagan Boom continues today. In July, Investor's Business Daily commissioned
a survey of 200 CEOs and chief financial officers form the nation's largest publicly
traded corporations. They were asked, "What triggered recent economic growth?"
Leading the list was productivity, followed by Federal Reserve monetary policies,
information technology, restructuring and globalization. Following these, in sixth place,
came "Reagan policies" (which, I'd argue, ignited four of the preceding factors as well).
They were credited by 26 percent of the executives. Further down the list, at 14 percent,
were "Bush policies," and nearly at the bottom, at 8 percent, "Clinton policies."
At a press conference on August 6 touting what he considered his own economic
achievements, Clinton could not resist taking a swipe at Reagan. "In 1993," he said,
"we abandoned supply-side trickle-down economics."
In fact, while Clinton (and, alas, Bush) chipped away at Reagan's economic edifice,
it still stands. It's performed as advertised.
Tax rates are higher now than they were under Reagan, and that's a shame -- but they
are still far below the levels that existed before he took office. The top rate on ordinary
income is 39.6 percent instead of 70 percent (and 50 percent for earned income). The
capital gains rate held steady at 28 percent, and, thanks to the Republican Congress, well
be lowered next year to 20 percent.
Just as important, the principle that government usually does more harm than good to the
economy is well entrenched. While spending has not fallen, it's risen at a relatively moderate
pace. The result, as Reagan predicted, is an imminently balanced budget.
People, things and recipes
It's a mistake, however, to give too much credit to any politician. Economic growth is
strictly a private-sector phenomenon. Government can hurt a lot but help not much.
In a famous formulation, Paul M. Romer, a Stanford economist (whose father, by the way,
is Democratic National Committee General Chairman and Colorado Governor Roy
Romer), wrote, "Economic growth occurs whenever people take resources and rearrange
them in ways that are more valuable." He says that three things show up in every economy:
people, things and recipes (or arrangements). For example, "we need to use iron oxide to
make cave paintings, and now we put it on floppy disks. The point here is, the raw
material we have to work with has been the same for all of human history. . . So when you
think about growth, the only place it can come from is finding better recipes for
rearranging the amount of stuff we have."
The function of government in this growth equation is to help these rearrangement occur
more quickly and more often by liberating people to pursue their imaginations. One way
to do that is by keeping tax rates low -- that is, minimizing the penalties applied to the
rewards of finding better recipes. As Romer puts it, "If the government confiscated
most of the oil from major discoveries and gave it to consumers, oil companies would do
Some Americans worry that, if we let government stand aside and let the market operate,
unknown things will happen. That's true, and, as far as I'm concerned an unknown future,
as long as it's created by the intelligence and imagination of free people, is the good part
of the economic story. A certain faith is required, and Ronald Reagan had it.
Lawrence Kudlow, a former Reagan budget official who is now chief economist for
American Skandia, the insurance firm, noted last April that the Dow Jones industrial
average was 777 in 1982, and, at the time, "not a living soul would have believed it
would be 6500 in 1997." (Later, of course, the Dow would pass 8000). [and is now
Not a living soul would have believed that a high technology revolution would account
for 40 percent of the annual increase in GDP or that a company called Intel, started by
a Hungarian immigrant, would have a market value of $156 billion -- 20 percent more than
General Motors, Ford, Chrysler and U.S.Steel combined. Or that a place called Silicon
Valley (along with its outposts in Washington state and Oregon) would be more vital
to the economy than Detroit or New York.
And more vital, for that matter, than Washington, D. C. -- which may be the most
important development of the Reagan Boom. the declining relevance of government
to our lives is something for which Reagan devoutly wished -- and brilliantly
James K. Glassman is the DeWitt Wallace-Reader's Digest Fellow at the American
Enterprise Institute. He writes two weekly columns for the The Washington Post on
finance, economics and politics. He also hosts Capitol Gang Sunday on CNN and
TechnoPolitics on PBS.
Return to beginning of ejps