The passing of Ronald Reagan has transfixed the nation on the legacy of a great leader and reopened a debate on Reaganomics. Reagan came to office at a time when America faced the worst economic crisis since the Great Depression. Inflation and unemployment were at double-digits. Top federal tax rates were 70 percent, smothering incentives for risk-taking and private initiative. Galloping inflation meant unlegislated tax increases each year as households were shoved into higher tax brackets without a corresponding rise in real incomes.
To get a picture of just how bad the situation had become prior to Reagan, it is helpful to review a few statistics. Adjusted for the price of gold, wages sunk from $3.06 an hour in 1971 to just $0.36 an hour in 1980, a decline of 88 percent. Gold-adjusted household net worth dropped by 84 percent while the gold-adjusted Dow Jones Industrial average declined by 93 percent during the same period. In sum, high tax rates, high inflation, and high interest rates had clubbed the American economy and the standard of living to the ground. Communism seemed to offer a viable alternative to the “bastard” capitalism of loose money, high inflation, and high tax rates.
Reaganomics came to the rescue with large-scale tax-rate reductions that chopped the top marginal tax rate to 28 percent from 70 percent. At the same time, Federal Reserve chairman Paul Volcker and Alan Greenspan were given the green light to do whatever it took to break the back of inflation. As the value of the dollar stabilized, long-term interest rates decline by 50 percent. Gold-adjusted wages and the Dow Jones Industrial average indexed for gold rose fourfold during Reagan’s tenure.
The Reagan deficits continue to be viewed as a blemish on his economic record, but this is based on zero-sum analysis and single-entry accounting. The national debt increased by $2 trillion during the Reagan presidency. However, household net worth rose by $8.7 trillion. This means that for each dollar of national-debt increment, there was a parallel $4.35 increase in America’s balance sheet. Since federal revenues doubled during Reagan’s two terms, it is highly misguided to blame the deficits on Reagan’s tax cuts. Had top rates of taxation remained at 70 percent, the Reagan recovery would not have emerged and the deficits would have been worse.
A lasting tribute to Reaganomics is that pro-growth policies are spreading around the world — like wildfire. Sweeping reforms have taken place in India and China, ushering in rapid growth. A Chinese government official recently stated that plans for a new corporate tax overhaul would “look a lot like Reaganomics.” The Baltic states have adopted flat taxes and hard-currency regimes to boost growth and stabilize prices. East Asia has moved to lower tax rates and stable currency policies with predictably positive results. Ireland recently slashed income-tax rates while implementing a stunningly pro-growth 10 percent corporate tax rate. The road to these reforms was paved in the 1980s as Reagan slashed tax rates in the U.S. and British Prime Minister Margaret Thatcher cut them in Europe.
In the ultimate irony, Russia has become the most recent convert to Reaganomics. Russian President Vladimir Putin implemented a 13 percent flat income tax in 2001. Putin did one more for the Gipper by slashing corporate rates in 2002. These reforms have unleashed double-digit dollar growth rates of gross domestic product while tax revenues have shot up nearly 43 percent in dollar terms since 2001. Inflation and interest rates have dropped dramatically and a consumer and credit culture is beginning to emerge in Russia for the first time in 100 years. Low tax rates and stable money do the trick every time.
Ronald Reagan may be gone, but his economic legacy lives on.
– Michael T. Darda is chief economist and director of international investment strategy at MKM Partners, LLC, an equity execution firm located in Greenwich, Conn. He welcomes your comments here.