Reagnomics

The economic policy pursued by president Ronald Reagan was called "Reaganomics." This policy meant a radical shift from the Keynesian system where consumption was stimulated by massive government spending. Keynes put the emphasis of economic policy on the demand-side (consumption). Reagan, by contrast, put the accent on the supply-side (production). Keynes believed that demand would create supply, but Reaganomics started from the opposite idea, namely that supply would create demand. In this way of thinking, the supply side of the economy had to be stimulated in order to create wealth. The best way to do this was to cut the marginal tax rates on personal income. Such a tax cut would create a strong incentive to increase economic activity and would have dramatic effects on growth, investment and saving.

In the sixties and seventies, Keynes' economic theory was applied on a large scale. Keynes developed his ideas in the deep economic recession of the thirties, with its high unemployment. Keynes argued that governments should stimulate aggregate demand by massive spending and infrastructure works in order to invigorate the economy. Every dollar spent by the government would create a multiple in income. Unemployment would vanish, the tax base would broaden, and the budget deficit would disappear, Keynes argued. But during the oil crisis of the seventies, it became clear that Keynes theory did not work. Higher public spending did not resolve unemployment. On the contrary, unemployment increased in line with the increase of government spending. In fact, the economy experienced "stagflation", which meant that there was a combination of inflation, recession and unemployment. (Stone 1984).

According to Nissanen (1988), an increase in public spending, as advocated by Keynes, does not stimulate the economy. The main reason is that money that could otherwise be spent efficiently by the private sector, is instead made into a government program with little or no return. The fundamental flaw in Keynesian logic is that it taxes money away from productive people, thereby reducing their rewards, to spend it on unproductive goals.

Roberts (1984) writes of your young economists, Paul Craig Roberts, Robert Mundell, Norman Ture and Steve Entin, and a journalist, Jude Wanniski, who convinced Reagan to completely reverse the economic policy of that time. Their point of view was that high marginal tax rates were a disincentive to produce, to take risk, to invest and to save. In their opinion this "economy of discouragement" had to be transformed into an "economy of encouragement". The reasoning was as follows: people are producing because it pays to do so. Consumption alone will not result in increased production when the incentives to do so are not there. When tax rates are raised, people reduce their participation in taxed activities, such as working, risk taking, saving and investing. When tax rates fall, people increase their participation. Reagan, with a background in economics, understood this logic immediately. He followed the advice and took action.

The top marginal tax rate of 70% was lowered in two phases: to 50% with the Economic Recovery