Why China shouldn't adopt Reaganomics

By Liu Ge
0 Comment(s)Print E-mail China.org.cn, October 4, 2014
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When Reagan left office in 1988, he was hailed as one of the United States' most outstanding presidents ever. But history, like an oil painting, needs to be examined from some distance.

More and more people have begun to reflect on what exactly created the economic boom of the 1980s: Was it really achieved by the three measures at the core of Reagan's supply-side economics, or "Reaganomics"?

People tend to believe that Reagan did not practice what he preached, and that the boom in the 1980s was in fact largely due to another round of Keynesian policies that Reagan purportedly opposed. Unlike Roosevelt, the Reagan administration did not invest much in infrastructure and people's welfare, but rather in the military and the arms race. It was actually the federal government's large-scale budget deficit that contributed to economic development and created jobs.

The U.S. Congress passed a tax reform plan proposed by the Reagan administration in 1981, which reduced income tax three times over the span of three years, adding up to a 23 percent total decrease. Reagan also signed an amended tax law, the Tax Reform Act, in 1986, reducing taxes again. Thus, the disposable income of every American family increased by around US$600 to US$900 over the course of seven years. But in the views of Reagan's critics, tax reduction is like robbing the poor to feed the rich. It created a larger wealth gap and did not bring the large increase in tax revenue which supply-side economics predicted it would. Also, since Reagan did not cut any government spending and arms expenditures rapidly expanded during his tenure, the fiscal deficit grew tremendously in these years.

To address the deficit, the Reagan administration issued a large amount of national debt, which climbed from 26 percent of GDP in 1980 to 41 percent in 1989. The U.S. changed from the world's largest creditor to the world's largest borrower.

The loosening of government regulations is another pillar of Reaganomics. The 1960s and 1970s were the peak period of government regulation in the U.S. - the number of people working in regulating agencies grew from 28,000 in 1970 to 81,000 in 1979. When Reagan said in his 1981 inaugural speech that "Government is not the solution to our problem; government is the problem," he received a standing ovation. But according to the monograph "Cambridge Economic History of the United States: The Twentieth Century," the staff of U.S. federal regulating agencies increased to 107,000 during Reagan's second term, while the budget for these agencies increased by 18 percent.

Now let's turn to China. Reaganomics has won more supporters in China than in the U.S., and some economists have prescribed tax reduction as the medicine which can cure China's ills. But if these economists look into differences between the theory and the implementation of the Reaganomics, they may have second thoughts.

Due to major differences in the taxation system between China and the U.S., tax reduction means very different things in the two countries. The U.S. primarily practices the direct tax, so income tax contributes to a large part of total tax revenues. Therefore, tax reduction can stimulate middle class consumption and further drive the economy. In China, however, corporate taxes paid by enterprises contribute the major part of tax revenues. Thus China needs to cut down taxes on the real economy, especially on small and micro businesses, and more importantly, improve its taxation of the affluent class by replacing indirect tax with direct tax. It is imperative for China to undertake all-round taxation reform instead of a simple tax reduction.

When it comes to government regulation, the major regulatory mechanism in China is actually the pervasive examination and approval system, which is virtually non- existent in the U.S. The reason behind the failure of Reagan's deregulation rhetoric to produce results is that many laws in the U.S. focus on the regulation of the market. But in contemporary China, laws that can really regulate the market are desperately needed. In other words, China's top priority should be transitioning from an examination and approval-based system to a law-based system of market regulation.

In the meantime, we need to be aware that contemporary China is very different from the U.S. of the 1980s. If we look at China's level of urbanization, industrialization, and individual income, China might only pass for the U.S. in the 1930s. Thus, using Reaganomics to address the problems in the Chinese economy would be like using Viagra to tackle an upper respiratory infection, even if we don't acknowledge the fact that although Reagan prescribed an antihypertensive drug, he used a stimulant in the end.

The writer is a senior researcher with the Chongyang Institute for Financial Studies, Renmin University of China.

The article was translated by Zhang Lulu. Its original version was published in Chinese.

Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.

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