NEWS ANALYSIS : History May Judge Reaganomics Very Harshly : Economy: Lower taxes and deregulation were expected to raise government revenues. Debt soared instead.

Reaganomics, the dominant political philosophy of American government for the past 12 years, is history.

It may come back--its true believers still remain powerful voices in the Republican Party. Jack Kemp, President Bush’s housing secretary and a founding father of Reaganomics, is one of the very early favorites for the Republican presidential nomination in 1996.

But with the GOP’s defeat in the 1992 presidential election and the shelving of Republican policies, Reaganomics can now be judged like a medical theory that has completed a lengthy clinical trial.

Ultimately, Reaganomics was a failure. It produced big political dividends for the Republicans, and it may have contributed to rapid economic growth during the 1980s. But it was, at its core, a governing philosophy based on a deeply flawed economic notion: that tax cuts, especially large tax cuts for the rich, would not worsen the government’s budget deficit.

Ironically, it was the illogic of that theory that helped bring down President George Bush--even though it seems clear that Bush never fully believed in the theory himself.

Reaganomics simply didn’t do what Ronald Reagan promised when he swept into power in 1981. And in the end, both Reagan and Bush were repeatedly forced to ratchet Reaganomics back in the face of its frightening effects on the nation’s level of indebtedness.

Yes, Reaganomics helped stimulate growth. Despite the economic downturn, roughly 17 million more Americans are working today than were in 1981. “The record of very rapid economic expansion in the 1980s is important to emphasize,” said John Taylor, a Stanford professor and former White House economist under Bush.

But the job growth was largely due to deep-seated demographic shifts, most notably because more women entered the work force. Meanwhile, the overall economy shined brightly only for a few years, and only because of an ephemeral burst of consumption brought on by heavy deficit spending--the exact opposite economic effect that Reaganomics called for. Tax cuts did not generate higher government revenues, and so did not help balance the federal budget.

Over the decade of the 1980s, that lesson was learned at a heavy price--lower rates of saving, investment and long-term productivity.

In the end, what will be remembered most about Reaganomics is the debt that it brought America--towering mountains of it. Deficits “as far as the eye could see,” in the prescient words of Reagan budget director David Stockman, have been bequeathed to the nation’s children and grandchildren by Ronald Reagan and George Bush.

“The lasting legacy will be the deficits,” argued Alan Auerbach, an economist for the Joint Committee on Taxation in Congress.

“Reagan will go down as having done a great deal for the current generation, but as having done great damage to future generations,” added Barry Bosworth, an economist at the Brookings Institution.

The statistics are staggering: Since Ronald Reagan first took office, the budget deficit has more than tripled, from $79 billion in 1981 to $290 billion today, while total government debt held by the public has soared from less than $800 billion to more than $3 trillion.

The nation has been mortgaged. In 1981, government debt equaled 25% of gross domestic product, the nation’s total output of goods and services; today it is more than half. Now, 3.5% of GDP, roughly $200 billion, goes just to pay the annual interest on the federal debt.

The bottom line is that the most profligate government spending of all time came during an extended period of conservative Republican rule.

“We will have to live with the deficits built up during the Reagan era for the rest of our lives,” warned Robert McIntyre, director of Citizens for Tax Justice, a Washington research firm.

By the end of the Republicans’ 12-year run, the deficits caught up with them. The Republicans had made a Faustian bargain in the early 1980s--grow now, pay later. And George Bush was there when it was time to collect.

Faced with crushing debt burdens, the federal government was unable to respond with any kind of fiscal stimulus when an inevitable business cycle slowdown arrived in 1990. Senior Bush Administration officials began to openly complain about the mess they had been handed by their political mentor, Ronald Reagan.

“Reaganomics as an ideology began to be winnowed away in 1989” when Bush came into office, argued Norman Ture, a former Reagan Administration policy maker.

So Bill Clinton rode to the White House on a platform of economic change, campaigning as much against the “trickle-down” policies of Ronald Reagan as against those of George Bush.

But back in 1981, Reaganomics seemed to be fresh and new, a radically conservative notion brought to Washington by Ronald Reagan and his new breed of Republicans.

At its core was the idea that deep cuts in federal tax rates would create new incentives for Americans to work harder and longer, and would especially give the wealthy new motivation to invest more of their money in productive enterprises. All of that would generate new wealth and new jobs. This economic growth would provide enough new taxable income to offset the deep reductions in the rates of taxation.

It was called the “supply-side” effect, and above all it offered a powerful new political weapon to Republicans. It meant that the GOP was no longer the party of grim and unpopular nay-sayers, constantly telling the Democrats that the nation couldn’t afford their new spending programs. Now, Republicans had goodies of their own to hand out to voters--lower taxes, which, the Republicans said, would pay for themselves.

“The Republicans promised the American people that for $1 dollar in taxes, you could still get $1.25 in government services,” noted Alan Blinder, a Princeton economist and an adviser to President-elect Bill Clinton.

It marked a revolutionary transformation of Republican ideology. Suddenly, young, fire-breathing conservatives had the most energy and the newest ideas in Washington. They espoused a new gospel of cutting taxes, deregulating industry and shrinking the size of domestic government programs while building up the Pentagon to compete with the Soviet Union. And, to top it off, they would balance the federal budget.

The Republican Party of Ronald Reagan had effectively reversed roles with the Democrats. Liberals found themselves on the defensive, protecting the status quo and arguing that the country could not afford the Reagan Revolution.

“It was powerful stuff for Republicans,” observed Bosworth. “They had shifted the terms of political discussion in the country. Republicans expropriated the tax issue from the Democrats. And throughout the Reagan period, the Democrats never really recovered.”

Reaganomics had its most dramatic burst of success immediately in 1981, when the Reagan Administration quickly pushed its revolutionary legislative agenda through a shell-shocked Congress eager to respond to the grass-roots tax revolt that had propelled Reagan into the White House. The biggest tax cut in American history--which slashed marginal tax rates for individuals by 25% over three years and dramatically accelerated tax write-offs for businesses--quickly sailed through.

That huge tax cut benefited all taxpayers, but it gave the wealthiest Americans the most. The effective federal tax rate for the richest 1% of Americans fell from 31.7% in 1980 to 24.9% in 1985, the greatest reduction for any income group during the period, according to the Congressional Budget Office.

While the tax cut was being pushed through in 1981, defense spending took off and domestic spending was sliced, as Reagan used his election mandate to cut a wide array of once-sacred programs, including food stamps and welfare. The budgetary trends were massive and stunning to those accustomed to only gradual change in government policies. In the first five years of the Reagan era, domestic programs (excluding mandatory spending like Social Security) fell from 4.9% of GDP to 3.7%, while defense spending rose from 5.1% of GDP to 6.4%.

“Throughout the early and mid-1980s, domestic programs, especially those for low-income people, were never allowed to grow again after the big cuts of 1981,” said Gary Bass, executive director of OMB Watch, a Washington budget research group.

But while Reagan harnessed the growth in domestic spending, he never got enough cuts in that area from Congress to offset both his tax reductions and defense increases.

What was worse, the supply-side revenue effects of the 1981 tax cut were simply not showing up in federal coffers.

As Stockman, Reagan’s budget director, later admitted, independent presidential candidate John Anderson had asked Reagan the right question during the 1980 campaign: How was it possible to raise defense spending, cut income taxes and balance the budget, all at the same time?

It wasn’t, and that became clear almost immediately. Beginning in 1982--and in almost every year after--Reagan was forced to raise taxes to try to close the ever-widening budget deficit. The result: By 1992, most Americans were paying almost the same tax rates they faced before Reagan took office.

The top 20% of American taxpayers saw their effective tax rate drop only from 27.5% in 1980 to 26.6% today; the middle class--the middle 20% of taxpayers--saw its effective tax rate go from 19.8% in 1980 to 19.5% today. In 1983, payroll tax increases to finance Social Security and Medicare began to swamp the effects of the 1981 income tax rate reductions for the middle class.

By 1991, individual income taxes, as a share of the nation’s output of goods and services, were virtually identical to the level posted in 1977, according to the CBO. “There was very little change in the level of taxation by the end of the 12-year period,” noted one senior congressional tax analyst.

Today, only the very richest and the very poorest are still benefiting from tax cuts enacted during the Reagan-Bush years. The richest 1% have tax rates that are 19% lower than they were in 1977, because the effects of the 1981 tax bill on the wealthy were so powerful that they could not be fully offset by a 15.7% rise in effective tax rates for that elite group between 1985 and 1992. Meanwhile, the poorest 20% of Americans enjoyed a 9.9% cut in their tax rates, thanks largely to the tax bills passed in 1986 and 1990, which restored progressive features of the tax code that had been lost in earlier legislation.

But the damage done to the budget by tax cuts, the defense buildup, and the uncontrolled growth in Medicare and other entitlements could not be undone by later tax hikes. So the deficit ballooned, stimulating the economy. Fortunately for Reagan, that stimulus came just as tight money policies at the Federal Reserve Board were finally beginning to wring inflation out of the economy.

That lucky combination of tax and monetary policies meant that the government was spurring demand and consumption in a new era of stable prices. That was a formula for rapid economic growth. But it was also conventional economics--and had nothing to do with supply-side theory.

“The great irony is that the tax cuts expanded consumption in the 1980s,” and apparently did little to motivate people to work harder or invest more, argued Paul Krugman, an economist at the Massachusetts Institute of Technology.

“Reaganomics was falsely labeled,” added Jeff Faux, an economist at the Economic Policy Institute in Washington. “They attributed the growth in the 1980s to the supply-side, but what they were really doing was a huge, bastardized Keynesian experiment in fiscal stimulus.”

Meanwhile, Reagan-era deregulation of financial institutions gave momentum to a debt-induced speculative bubble that had a ripple effect throughout the private sector. The emergence of junk bonds and highly leveraged corporate buyouts left many companies heavily in debt, while poorly supervised savings and loans poured money into an overheated commercial real estate market. Corporate America borrowed roughly $1 trillion during the 1980s, and little of that went into productive investments.

The consequences became clear as soon as the great economic expansion of the 1980s ran out of steam and the economy inevitably turned down in the early 1990s. Corporations, financial institutions, and individuals were unable to keep up with their payments, and the vast American credit machine ground to a halt. A mild recession turned into a crisis the likes of which America had not experienced since World War II. Paralyzed by its own public deficits, Washington was unable to do much to help America get out from under the credit crunch in the private sector.

“You had an incredible orgy of borrowing, and you ended up with a private debt overhang and very little to show for it,” observed Faux.

Yet Reaganomics can’t be held responsible for all of the ills of the 1980s, either. Most economists now believe, for instance, that government policies in the Reagan-Bush era were not the driving force behind the widening gap between rich and poor that became so obvious over the past decade. The trend toward greater income inequality was in place even before Reagan took office, and the growth in that trend has been far larger than could be explained by changes in federal taxes or government regulations. Indeed, most of the growth in inequality has shown up in pretax income--which means that something besides tax policy has been at work.

The inflation-adjusted incomes of the top 1% of Americans grew 75.5% between 1980 and 1990, while the poorest 20% suffered a 3.7% decline. The failure of federal spending on poverty programs to keep up with inflation clearly depressed incomes at the bottom. At the top, tax breaks for the wealthy, surging defense spending for a handful of large corporations, as well as regulatory relief that benefited businesses and their affluent investors, may have all played a role.

Yet most economists now believe income inequality has expanded largely because of a deeper trend dating back to the early 1970s: increasing economic globalization and its long-term effects on unskilled American workers. Forced to compete head-to-head with low-wage workers in the Third World, unskilled American factory workers have suffered devastating losses in jobs and income.

By contrast, highly educated professionals have enjoyed much greater insulation from import competition. As a result, the relationship between income and education is greater than ever before.

So while Reagan’s policies magnified the underlying trends, they were not the root cause.

“When you look at the worsening income disparity, you cannot honestly blame it on Reagan tax cuts,” said Blinder.

Which leads finally to an intriguing, and obviously controversial question: Was Reaganomics a political response to growing income inequality that was already building in the American economy, rather than the cause of it? Was the tax revolt of the late 1970s, which set the stage for Reagan’s rise to power, brought on by growing discontent over government policies among the beneficiaries of rising income inequality?

“Perhaps it was income disparity that was driving Reagan, rather than the other way around,” observed Krugman. “Clearly something deep and pervasive was going on.”