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Thatcher and Reagan: The radical economics at the heart of their relationship

    Centre for Policy Studies intern Tom Waters writes on the economic foundations of the Thatcher-Reagan relationship.

    Aside from their excellent personal relationship, Thatcher and Reagan are commonly renowned for their revolutionary economic policies. They faced similar difficulties upon their first electoral victories, in 1979 and 1980; inflation was 18% in Britain, and 10% in America, economic growth had been faltering for a decade, and taxes were at a record high. Both Thatcher and Reagan were ultimately successful in reversing these trends. When they left office, in 1990 and 1989, inflation had been brought under control, they had overseen consistent growth for almost all their time in power, and taxation rates had been substantially reduced. The steps the two leaders took in achieving these feats were broadly similar, and were based in a belief in free markets and a responsible monetary policy.

    Reagan and Thatcher adopted a similar strategy to reduce income tax rates. Inspired by the economic theory of Arthur Laffer, Reagan reduced the top rate of income tax from 70% to 50% in his first year; whilst excluding up to $3,000 of income from tax for married couples. Thatcher, likewise, had also seen the damaging effects that high marginal rates had on incentives in the UK. In her first budget, she dropped the top rate of income tax and increased the threshold for the basic tax rate, as well as lowering that rate by 3%. Later tax cuts went even further, cutting the basic rate of income tax to 25%, and the top rate to 40%.

    But reform to the income tax system was not just about the changing the rates – Thatcher and Reagan recognised Adam Smith’s view that a good tax system was a simple one. Prior to Thatcher, there had been 11 bands of income tax. She reduced this to 7 in her first year, and by 1989 had got it down to just 2. The year before Reagan entered office there had incredibly been no less than 17 income tax brackets for single people. By 1988 there were also 2. Whereas before middle and high earners had faced damaging marginal taxes, the Reagan-Thatcher tax cut and simplification measures helped spur on an increase in productivity and innovation.

    And these tax cuts didn’t mean that government spending had to fall either. On the contrary, Reagan upped federal spending in real terms from $1299bn in 1981 to $1645bn in 1989 (2005 $s) – an increase of almost 27%. But he did this without making government spending burdensome on the economy – across his Presidency, federal spending as a percentage of GDP stayed almost the same, falling just slightly from 21.7% to 20.9%. Likewise, although Thatcher has developed a reputation for savagely cutting, she in fact, like Reagan, increased spending – by 7% in real terms. But she too managed to do this without the state becoming an excessively large part of the economy, by decreasing public spending as a share of GDP from 42.8% to 36.5%.

    Inflation had been a major issue in the late 1970s in both countries, and in the fiscal year in which Thatcher entered office inflation soared to almost 18%. In Reagan’s first year, inflation stood at over 10%. Both of them used high interest rates to curb the inflation which was damaging savings and capital investment. They recognised that the short-term pain of high rates was to produce a more certain environment for investment, wages and growth - to get the economy out of its stuttering trend of the 70s and move towards a steady, sustainable growth path.

    And, indeed, growth was enjoyed in both countries. After inflation had been bought under control, America saw its longest ever period of sustained growth in peacetime – a full 92 months without recession. Similarly with Thatcher, after two years of recession caused by having to reign in the profligate monetary policy of previous governments, the British economy enjoyed continued growth for almost her entire premiership – from 1981 until 1990. And this wasn’t an artificial, debt fuelled growth like the one of the noughties – public debt as a percentage of GDP fell from 42% to 25% under Thatcher.

    The starkest difference in their economics surrounds Thatcher’s privatisation agenda. For all his rhetoric, Reagan’s only major privatisation was of Conrail, a freight railroad system. Thatcher’s included huge state assets: British Airways, British Telecom and BP were sold off. She encouraged the public to buy shares in the industries being privatised, resulting in the number of individual shareholders across the country tripling. Other privatised companies included British Aerospace, the National Freight Company, and Jaguar. In 1979, 35% of people lived in state owned houses which were costly to the taxpayer; but under Thatcher, millions of people were able to buy their houses.

    The similarities, both in approach and results, far outweigh the differences. The tough decisions taken by the President and Prime Minister gave economic hope to two nations in deep-rooted economic problems. By reducing and simplifying income taxes, privatising wasteful publicly owned industries, and reducing inflationary pressure, Reagan and Thatcher were both able to engender a long period of prosperous growth. It was that growth that enabled them to – despite the fall in tax rates – increase public spending, without making the state a burden on the economy.

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