Right-Leaning Policy Won a Nickname: Reaganomics

Through the prism of the right, Ronald Reagan's economic policies in the 1980s were a rainbow, a vision that was largely responsible for the nation's remarkable economy in the 1990s. Through the prism of the left, Reaganomics was a storm that devastated the poor and left huge budget deficits in its wake.

That debate may only be settled by historians not yet born, but this much is clear: Economic policymaking today must still contend with the rhetorical markers laid down by Ronald Wilson Reagan when he took office more than two decades ago.

Smaller government. Lower taxes. Less regulation. Low inflation.

Reagan's spending cuts barely nicked the fastest-growing parts of government, his tax cuts reduced revenue so much that later in his tenure taxes had to be raised repeatedly, his regulatory approach was criticized for leading to the savings and loan crisis and his unbalanced budgets to a near-tripling of the federal debt in eight years. Many economists give most of the credit for whipping inflation to former Federal Reserve Board chairman Paul A. Volcker.

But over time, some proponents of Reagan's economic policies argue, a more lasting legacy will become clearer: They argue that Reagan's huge defense buildup helped bankrupt the Soviet Union and ended the Cold War. If that is the case, they say, then Reagan should receive credit for the fact that in the Clinton years, the United States could dramatically reduce defense spending and balance the budget.

"That defense buildup [and the Fed's tight money policies] were primarily responsible for the deficit," said William A. Niskanen, president of the libertarian Cato Institute and a member of Reagan's Council of Economic Advisers. "The Cold War is over. Tight money has brought inflation down. Both of these policies looked risky at the time but look good in retrospect."

In assessing Reagan's economic legacy, "you have to distinguish between being a master at creating a mood and what he actually did in changing the structure or content of government programs," said Charles L. Schultze of the Brookings Institution, who was chairman of the Council of Economic Advisers in the Carter administration.

But Reagan's "mood" changed the terms of the debate, shifting the nation on a rightward economic course. He fired the air traffic controllers when they went on strike, forever altering union-management relations. He tolerated the high unemployment brought about in part by Volcker's tight money policies. And Reagan championed the free market and railed against government programs, making it more difficult for his successors to create new ones except in the guise of a tax credit.

Tax-Cut Cry Still Reverberates

Reagan's predecessor, Jimmy Carter, may have ushered in deregulation or set in motion a big defense buildup. But it was Reagan who took those policies to heart. Former president Bill Clinton may have declared "the era of big government is over" or finally balanced the budget. But it was Reagan who set those goals and inspired the Republican Congress that worked with Clinton.

Reagan also placed tax cuts firmly at the center of the Republican agenda. Before Reagan, Republicans disliked government and abhorred deficits. After Reagan, tax cuts became a crusade that one day would -- maybe, possibly -- lead toward smaller government and the end of deficits. Reagan preached that lower taxes would lead to greater economic growth, a theme that still echoes in the House and the Senate and whenever President Bush steps up to give an economic speech.

While Reagan only slowed the growth of nondefense spending, his deficits piled up and sent government interest costs soaring, thereby making it difficult for future Congresses and presidents to increase spending without making even bigger holes in the budget.

From 1980 to 1986, spending on annually funded domestic programs (besides defense), as a share of the overall economy, fell 29 percent, but in the same period defense spending rose 27 percent. Tax revenue plunged 17 percent while the interest on the national debt soared 61 percent. The net result: The budget deficit rose to 5 percent of the overall economy, an 86 percent increase.

When Reagan took office in 1981 after the inflation-ravaged years of Jimmy Carter, his advisers warned of a looming "economic Dunkirk." When he left the presidency eight years later, inflation and unemployment had fallen sharply and the country was in the midst of what was then the longest economic expansion in history.

That looks like success. But undergirding that expansion were stresses and fractures that quickly exposed themselves in the recession that doomed the George H.W. Bush's presidency. The boom was powered by the debt-financed defense spending, while savings and investment were poor, living standards had stagnated and the divide between rich and poor had widened.

Banks had lent money with abandon to finance real estate deals inspired by quirks in the tax code -- and soon found themselves in a financial crisis. The budget deficits, by eating away at overall national savings, helped keep interest rates from falling as much as expected, making it more expensive for businesses to borrow money to make long-term investments.

Were Voters Better Off?

Reagan owed his election to the economy. He won the presidency by asking a voters a simple but devastating question: Are you better off than you were four years ago?

In the waning days of the Carter administration, when high inflation and interest rates tormented Americans, the answer appeared to be no. And the former California governor appeared to have a plan: He would unleash the forces of the free market by reducing the size of government and cutting taxes. Reagan also demanded larger defense spending.

These goals appeared contradictory or, in the memorable phrase of 1980 presidential candidate George H.W. Bush, "voodoo economics." But Reagan insisted that reducing taxes would generate enough corporate activity to make up the difference in lost revenue. This was a theory espoused by "supply-side" economists, who focused on the impact of taxes on the total supply of output, in contrast to those who concentrated on how to stimulate demand.

The late Herbert Stein, who chaired Richard M. Nixon's Council of Economic Advisers, said during the Carter-Reagan fight there was general consensus to get inflation down by reducing monetary growth, balancing the budget and cutting government spending. But lowering inflation would raise unemployment, balancing the budget made tax cuts difficult and cutting government spending would eat into benefits enjoyed by middle-class Americans.

That posed a challenge for policymakers. In his book "Presidential Economics: The Making of Economic Policy From Roosevelt to Clinton," Stein offered this difference between Carterism and Reaganism:

Carterism: "Pursuing each element in the approach so tentatively and flexibly that no harm would be done to anymore, but no significant good either."

Reaganism: "Denying that the objectives being pursued had any costs."

In Stein's formulation, the Reagan campaign was "the economics of joy."

Then came reality.

Cooking Books With Gimmicks

The problem was how to cut taxes, increase defense spending and balance the budget in the midst of an increasingly grim economic situation. It was an impossible task, made possible by effectively cooking the books.

As recounted in the memoirs of budget director David A. Stockman and other former Reagan aides, the Reagan team was able to get its budget passed because of accounting gimmicks that came to be known by such terms as the "rosy scenario" and the "magic asterisk." The rosy scenario predicted the economy would do much better than expected, providing revenue that would never materialize. The magic asterisk was made of spending cuts that would be identified later -- but never were.

Congress did its part. The tax cut plan, which slashed taxes 25 percent over three years, was relatively easy to pass. So were defense spending increases.

But the same conservatives who eagerly denounced deficits fought cuts in agriculture programs, energy projects, highway funds or anything else with a vocal constituency. "Those were the mother's milk on which Republican politicians -- self-professed conservatives as well as moderates -- lived no less profitably than their Democratic colleagues," Stockman wrote in his book, "Triumph of Politics: Why the Reagan Revolution Failed."

Interest costs on the growing mountain of debt soared from 1.9 percent of GDP in 1981 to 3.1 percent when Reagan's successor took office in 1989. Those interest payments consumed about $69 billion in 1981 and $169 billion by 1989, a percentage increase almost as large as the boost in defense spending. While Reagan managed to kill few programs outright, those interest costs helped squeeze money out of domestic programs, many of which barely kept pace with inflation or shrank.

"In economic terms one of his biggest legacies was these very large deficits," Isabell V. Sawhill, a former Clinton budget official and Brookings scholar, said. She noted that during the Reagan era, the United States went from being the largest net creditor to the largest net debtor nation.

As the economy deteriorated early in Reagan's presidency, just months after the "rosy scenario" had predicted a balanced budget by 1984, the scope of the deficit problem quickly became clear. Within a year, lawmakers had convinced Reagan that he needed to raise taxes to help close the gap, though the president convinced himself he was only closing loopholes.

In 1986, Reagan made one more attack on the tax system, signing into a law a significant overhaul of the tax code that simplified the rate structure and shut down many tax shelters.

As the deficits mounted and some social programs were cut back, Volcker kept a tight grip on the money supply to cure the inflation problem. The result was the most severe recession in modern times.

Sawhill said one of the most positive aspects of Reagan's economic legacy was getting inflation under control. "He was willing to tolerate a deep recession to accomplish that," she said.

Still, Sawhill said, it could be argued that a better mix -- a smaller tax cut, lower deficits, less stringent monetary policy -- would have been a wiser economic course. The Fed, she said, would not have had to step so hard on the economic brakes if the administration, with its tax cuts and defense buildup, weren't at the same time stepping on the accelerator.

Staff writer John M. Berry contributed to this report.