REAGANOPMCS

Rejecting Keynes

When Ronald Reagan ran for president in 1980 he rejected the prevailing economic theory that had dominated American economic policy since World War II. Reagan affirmed his belief in free markets and rejected the idea that the federal government should influence the business cycles with its fiscal policies. Indeed, one of the favored targets for Reagan's wrath was the deficit spending that Keynesian economists called for, and the ensuing debt. Upon election, Reagan inherited, as he put it, a runaway deficit of nearly $80 billion in 1981, leading Reagan to proclaim that the federal budget was out of control. Reagan promised to balance the budget and to bring a new type of economics to Washington.

Supply-Side Economics

Reagan desired to change the nation's economic path. During the 1980 presidential primaries Republican presidential hopeful George Bush labeled Reagan's plan as "voodoo economics/' although after the election Bush upheld Reagan's economic policies both as his vice president and after his own election to the presidency in 1988. At the heart of supply-side economics was Reagan's belief in incentives. Proclaiming that government was the problem, not the solution, Reagan argued that across-the-board cuts in the personal tax rates would provide enough economic stimulation so that lower tax rates would deliver higher tax revenues. Reagan believed that lower tax rates, with lower government spending, would in fact balance the federal budget, not increase deficit spending. Reagan and his budget director, David Stockman, spoke of reducing federal spending by $67 billion. However, Reagan had also promised to restore America's military might after a losing effort in the Vietnam War and a failed attempt to rescue hostages held by Iran. Fulfilling this promise resulted in the largest increase in peacetime military spending in the history of the United States. Reagan found it politically difficult to counter Democratic opposition to cutting popular nondefense programs. In 1981 Congress overwhemingly passed the Kemp-Roth tax cuts to put Reagan theory into practice. Congress cut the projected federal spending by $35.1 billion, as opposed to the $67 billion that Reagan first proposed, in 1982 and approved a three-year, 25 percent reduction in personal and business income taxes. Following the 1978 capital gains tax cut and the new 1981 tax rates, the combined federal income taxes paid by the top 1 percent of the population on earned income dropped from 50 percent in 1981 to 37.5 percent in 1983. The tax cuts were combined with Democrat-forced modest cuts in nondefense spending and a massive increase in military spending. Americans enjoyed both continued government spending and lower tax rates. According to Reagan's original plan, such policies would produce a balanced budget by 1984.

Debt

Deficit spending was a key issue in presidential politics in the late 1970s. While campaigning for the presidency, Reagan promised to balance the budget by 1983. Deficit spending is the gap between what the federal government takes in as income (mostly but not exclusively from taxes) and what it spends. To make up the difference between expenditures and income, the federal government borrows money from the private sector or from other governments, sometimes in the form of bonds. Therefore, every year that the government runs a deficit it adds to the national debt. Some economists believe that deficit spending can be good in that it will stimulate the economy, as was the case when spending on World War II ended the Great Depression, but others believe that long-term deficit spending makes it harder for people in the private sector to borrow money. When those people borrow money to buy a house or start a business, they end up competing with the government for the available capital. From 1981 to 1987 the federal deficit ranged from a low of $128 billion in 1982 to a high of $221 billion in 1986. The accumulated debt of the six years of deficit spending was more than $1.1 trillion. When Reagan left office in 1988 the national debt was $2.6 trillion, compared with the $914 billion debt he inherited from Carter. In 1986 the United States became a debtor nation, the largest in the world.

INFLATION RATES UNDER REAGANOMICS

Sources:

Lou Cannon, President Reagan: The Role of a Lifetime (New York: Simon & Schuster, 1991);

Benjamin M. Friedman, Day of Reckoning: The Consequences of American Economic Policy Under Reagan and After (New York: Random House, 1988);

Kevin Phillips, The Politics of Rich and Poor: Wealth and the American Electorate in the Reagan Aftermath (New York: Harper & Row Perennial Library, 1990).

Budget Deficit

The phrase, "budget deficit," is normally applied to situations where, at the end of a calendar or fiscal year, a public entity turns out to have spent more money than it has been able to collect in taxes, fees, and other impositions. Individuals, businesses, not-for-profit entities, and public bodies all operate under budgets too, of course. But when a business has a "budget deficit" the phrase means that it has experienced a "loss." Individuals "overspend." When contractors spend more than their contracts provide, they have "overruns."

Public sector deficits are of substantial interest to the public, not least to the commercial sector. Deficits are invariably covered by borrowing. When governments borrow money they compete for available national savings with the commercial institutions that also wish to borrow money to finance their operations. The Federal Government, particularly, enjoys an advantage because its treasury bills are of the highest quality and are preferred to any other kinds of bonds. A shortage of available money hampers economic activity.

THE U.S. BUDGET DEFICIT

Based on the estimates of the Congressional Budget Office, the FY 2005 budget deficit was $331 billion, down from $412 billion in FY 2004. In the 40-year span from FY 1965 to FY 2005, the Federal Government has had a budget surplus only five times, in FY 1969 and in the period FY 1998–2001 inclusive. In all other years, the government ran in the red. The FY 2004 deficit was the highest ever in U.S. history.

INDIVIDUALS AND HOUSEHOLDS

According to the Bureau of Economic Analysis (BEA), an element of the U.S. Department of Commerce, the personal savings rate in FY 2004 stood at 1.8 percent (savings as a percent of disposable income); this rate stood at 7.7 percent in FY 1992 and has been on a steady decline in the intervening years. Household data indicate a slightly lower rate, 1.6 percent in FY 2004 and 7.5 percent in FY 1992. In FY 2005, according to the BEA, the savings rate had turned negative (−0.2 percent in November, but it had been as low as −3.4 percent in August), suggesting that individuals were experiencing a "budget deficit" too.

BIBLIOGRAPHY

Congressional Budget Office. "Historical Budget Data." The Budget and Economic Outlook: Fiscal Years 2006 to 2015. 25 January 2005.

Hornyak, Steve. "Budgeting Made Easy." Management Accounting. October 1998.

Reason, Tim. "Building Better Budgets." CFO. December 2000.

U.S. Department of Commerce. "Personal Income and Outlays: November 2005." Bureau of Economic Analysis. 22 December 2005.

                                Hillstrom, Northern Lights

                                 updated by Magee, ECDI

BUDGET DEFICIT

A budget is an estimate of expected income and expenses for a specific period of time. Governments, private businesses, and individuals use the budget-making process to establish financial goals. The completed budget is then used as a blueprint to monitor the progress toward those goals. If income or expenses are equal, a budget is in balance. But, depending on financial objectives, a budget might have a surplus or deficit. A surplus is created when an individual or organization has more income than expenses for a given time period and decides to set some of this money aside. For instance, an individual might make monthly payments into a college-savings plan that will be used in the future. A deficit is just the opposite and occurs when expenses are greater than income. As a consequence, money is borrowed from an outside source. For example, an individual who wants to buy a car may lack the necessary cash and so takes out a loan to cover the cost. If a deficit continues over a long period of time, it is called a chronic deficit.

During much of the 1970s, '80s, and '90s, the U.S. federal government had annual budget deficits that often exceeded $100 billion. In 1992, the federal government had an annual budget deficit of $290 billion. The result of these years of deficit spending was that by 1999, the United States had a national debt of approximately $5.5 trillion and paid $240 billion annually in interest to finance the debt. The purpose of the federal budget is to collect and spend the funds needed to carry out social, military, and economic policies. According to the Employment Act of 1946, the federal government has the responsibility to promote maximum employment, fight inflation, and encourage economic stability and growth. To achieve these aims, the federal government might spend more money than it receives in order to stimulate the economy. This type of fiscal policy creates a budget deficit. The federal government reversed this budget deficit spending in the late 1990s and began passing surplus budgets. By 2008, the federal government's annual budget is expected to reach a surplus of $251 billion. However, unless these annual surpluses are used to pay off the accumulated debt, the country will have an estimated federal debt of $6.3 trillion in 2003.

See also: Inflation