Lesson Plan - Get It!
When the economy is doing well, more people get jobs. Unemployment goes down, and people are paid more.
In a healthy economy, inflation begins to rise as a result of this growth.
Conversely, when the economy is doing poorly, fewer people have jobs. Unemployment goes up, and people are paid less.
In an unhealthy economy, inflation nearly comes to a halt as a result of this lack of growth.
- This sounds nice and simple, right?
Well, in the 1970s, this economic relationship between inflation and unemployment was proven wrong. When Ronald Reagan arrived at the White House in 1981, he brought with him an all-new economic program.
During the 1970s, the U.S. economy had to deal with slowing consumerism, an immense debt from the Vietnam War, and a global oil embargo that led to a skyrocketing in the price of goods.
These events caused unemployment and inflation to rise dramatically at the same time. For 40 years, the country had been operating under the assumption that those two factors could never occur together.
Americans would need a new idea to regain faith in their government, and they found this with Ronald Reagan's new approach to economics.
Election of 1980
Image [cropped] by Department of the Navy, via Wikimedia Commons, is in the public domain.
During the 1980 presidential election, Jimmy Carter came under fire for the way he was handling stagflation.
Carter was attempting to use the previously accepted tools of unemployment and inflation to control the economy. While this was slowly working, the unemployment numbers had just gone up again.
Watch a clip from the video below to hear how Ronald Reagan framed his new economic plan.
1980 Presidential Candidate Debate: Governor Ronald Reagan and President Jimmy Carter - 10/28/80 from Reagan Foundation:
His solution to the high rate of unemployment and inflation was to increase productivity and decrease government spending.
Image, via Wikimedia Commons, is in the public domain.
The new economic theory Reagan was referencing is called supply-side economics, but it came to be called Reaganomics during his presidency. While Reagan did not come up with the idea, he was the candidate that made the policy a reality.
The idea behind the theory is that, instead of getting revenue directly from taxing people and businesses, the government can make money on the supply-side of the economy.
Especially during this economic downturn, cutting taxes on businesses made managing a business easier. It was thought that, eventually, these businesses would take the money they weren't spending on government taxes and invest it in goods and services that would then be taxed by the federal government.
With lowered taxes, businesses could also afford to hire more workers who, in turn, would pay income tax. With more individuals working, more tax could be collected from their income instead of from businesses.
Remember, the government needs the revenue it earns from taxes. If it wants to lower the taxes anywhere, it must find that money somewhere else. The hope was that by removing much of the tax burden from companies, unemployment would rapidly decrease.
Coupled with the reduction in government spending Reagan called for in the debate, this economic theory was refreshing to those who feared the reality of the established economic system.
You may have heard of this theory by its other name, trickle-down economics. George H.W. Bush even referred to it in 1980 as voodoo economics.
- From where does this idea that money will trickle down to the lower classes come?
While supply-side economics encourages companies to hire more workers, this solution was only meaningful to stagflation in the short-term.
However, the principle of reducing taxes on the rich has pervaded American economic theory as far back as the 1920s. Watch a prolific economist explain this idea in Thomas Sowell - Tax Cuts For The Rich, from LibertyPen:
When the United States had tax rates between 70-90% for the top income brackets, many of the rich went to extreme lengths to protect their money from taxation. However, when Ronald Reagan lowered the top tax rate to under 28%, it no longer made sense for the rich to go through the trouble of avoiding paying taxes.
Although not generally advertised by supply-side economic proponents, this phenomenon is more important than the principle of reducing taxes on businesses.
When you are ready, head over to the Got It? section to review the principles of supply-side economics.