Figure 1. Ronald Reagan outlines his plan for tax reduction legislation in July 1981. Data suggest that the supply-side policies of the 1980s actually produced less investment, slightly slower growth, and a greater decline in wages than the non–supply side policies of the 1990s.

The New Right in Power

In his first inaugural address Reagan proclaimed that “government is not the solution to the problem, government is the problem.”^[1] In reality, Reagan focused less on eliminating government than on redirecting government to serve new ends.

Reaganomics and Supply-side Economics

His economic policies, called Reaganomics by the press, were based on a theory called supply-side economics which had recently gained popularity among the New Right. It’s important to note that many economists were skeptical about supply-side economics.

Figure 2. This shows a Laffer Curve with a distribution skewed to the right, where 70% would be the ideal tax rate. Under this model, there is supposedly some sort of ideal point where the government can maximize revenue by getting more people to buy in. For example, if the tax rate were 100%, the government would get no revenue because people would stop working.  During Reagan’s presidency, the government cut income tax rates for the wealthiest earners from 70% to 50% and eventually to 28%.

What was different about supply-side economics? While Keynesian economics, heavily embraced in postwar America, had focused on stimulating consumer demand in part by providing more buying power to the consumer, supply-side economics claimed that lower personal and corporate tax rates would encourage greater private investment and production. Supply-side advocates promised that the resulting wealth would reach—or “trickle down” to, in the words of critics—lower-income groups through job creation and higher wages. In other words, when Reagan cut income taxes for those at the top of the economic ladder, the stated intention was to motivate the rich to invest in businesses, factories, and the stock market in anticipation of high returns. It was believed that this economic policy would also create more jobs further down the socioeconomic ladder.

The Laffer Curve

A basis of supply-side economics is the Laffer curve, a mathematical relationship between tax revenues and tax rates, which was popularized by economist Arthur B. Laffer in 1974. The Laffer curve suggests that when the tax level is too high, lower tax rates will boost government revenue through higher economic growth. (You can watch Dr. Laffer explain the curve in this video.) Reagan used this theory to argue for lower taxes.

In addition to all of the previously mentioned benefits of supply-side economics, conservative economist Arthur Laffer predicted that lower tax rates would generate so much economic activity that federal tax revenues would actually increase. The administration touted the so-called Laffer Curve as justification for the tax cut plan that served as the cornerstone of Reagan’s first year in office. Republican congressman Jack Kemp, an early supply-side advocate and co-sponsor of Reagan’s tax bill, promised that it would unleash the “creative genius that has always invigorated America.”^[2]

Supply-side economics is a macroeconomic theory that states economic growth can be achieved by lowering taxes for all Americans, decreasing corporate and business regulation, and allowing free trade. In theory, these benefits to the top of the economic ladder will “trickle down” and help working-class Americans through increased employment opportunities and a greater supplies of goods and services at lower prices.

Pushing Reaganomics Forward

The tax cut faced early skepticism from Democrats and even some Republicans. Vice president George H. W. Bush had belittled supply-side theory as “voodoo economics” during the 1980 Republican primaries.^[3] But a combination of skill and serendipity pushed the bill over the top. Reagan aggressively and effectively lobbied individual members of Congress for support on the measure. Then on March 30, 1981, Reagan survived an assassination attempt by a mentally unstable young man named John Hinckley. Public support swelled for the hospitalized president. Congress ultimately approved a $675 billion tax cut in July 1981 with significant Democratic support. The bill reduced overall federal taxes by more than one quarter and lowered the top marginal rate from 70 percent to 50 percent, with the bottom rate dropping from 14 percent to 11 percent. It also slashed the rate on capital gains from 28 percent to 20 percent.

The next month, Reagan scored another political triumph in response to a strike called by the Professional Air Traffic Controllers Organization (PATCO). During the 1980 campaign, Reagan had wooed organized labor, describing himself as “an old union man” (he had led the Screen Actors Guild from 1947 to 1952) who still held Franklin Roosevelt in high regard. PATCO had been one of the few labor unions to endorse Reagan. Nevertheless, the president ordered the union’s striking air traffic controllers back to work and fired more than eleven thousand who refused. Reagan’s actions crippled PATCO and left the American labor movement reeling. For the rest of the 1980s the economic terrain of the United States—already unfavorable to union organizing—shifted decisively in favor of employers. The unionized portion of the private-sector workforce fell from 20 percent in 1980 to 12 percent in 1990. Reagan’s tax bill and the defeat of PATCO not only enhanced the economic power of corporations and high-income households, they confirmed that a new conservative age had dawned in American life. In addition to this, banks and savings and loan associations were deregulated. Pollution control was enforced less strictly by the Environmental Protection Agency, and restrictions on logging and drilling for oil on public lands were relaxed.