Reagan’s first domestic objective was a massive tax cut. To justify tax cuts in the face of a large budget deficit, Reagan relied on a new theory called supply-side economics, which held that cutting taxes would actually increase revenue by enabling businesses to expand, encouraging individuals to work harder because they could keep more of their earnings (especially the wealthy who enjoyed the greatest tax savings), and increasing the production of goods and services — the supply — which in turn would boost demand. Reagan promised that the economy would grow so much that the government would recoup the lost taxes, but instead it incurred a galloping deficit.

In the summer of 1981, Congress passed the Economic Recovery Tax Act, the largest tax reduction in U.S. history. Rates were cut from 14 percent to 11 percent for the lowest-income individuals and from 70 percent to 50 percent for the wealthiest, who also benefited from reduced levies on corporations, capital gains, gifts, and inheritances. A second measure, the Tax Reform Act of 1986, cut taxes still further. Although the 1986 law narrowed loopholes used primarily by the wealthy, affluent Americans saved far more on their tax bills than did average taxpayers, and the distribution of wealth tipped further in favor of the rich. Carter had confined deregulation to particular industries, such as air transportation and banking, while increasing health, safety, and environmental regulations. The Reagan administration, by contrast, pursued across-the-board deregulation. It declined to enforce the Sherman Antitrust Act (see "Railroads, Trusts, and the Federal Government" in chapter 18), which limited monopolies, against an unprecedented number of business mergers and takeovers. Reagan also loosened regulations protecting employee health and safety, and he weakened labor unions. When members of the Professional Air Traffic Controllers Organization — one of the few unions to support him in 1980 — struck in 1981, Reagan fired them, destroying the union and intimidating organized labor.

Reagan blamed environmental laws for the nation’s sluggish economic growth and targeted them for deregulation. His first secretary of the interior, James Watt, declared, “We will mine more, drill more, cut more timber,” and released federal lands to private exploitation. Meanwhile, the head of the Environmental Protection Agency relaxed enforcement of air and water pollution standards. Of environmentalists, Reagan wisecracked, “I don’t think they’ll be happy until the White House looks like a bird’s nest,” but their numbers grew in opposition to his policies. Popular support for environmental protection forced several officials to resign and blocked full realization of Reagan’s deregulatory goals.

Deregulation of the banking industry, begun under Carter with bipartisan support, created a crisis in the savings and loan industry. Some of the newly deregulated savings and loan institutions (S&Ls) extended enormous loans to real estate developers and invested in other high-yield but risky ventures. S&L owners reaped lavish profits, and their depositors enjoyed high interest rates. When real estate values began to plunge, hundreds of S&Ls went bankrupt. After Congress voted to bail out the S&L industry in 1989, American taxpayers bore the burden of the largest financial scandal in U.S. history, estimated at more than $100 billion.

The S&L crisis deepened the federal deficit. Reagan cut funds for food stamps, job training, student aid, and other social welfare programs, and hundreds of thousands of people lost benefits. Yet increases in defense spending far exceeded the budget cuts, the deficit soared, and the nation’s debt tripled to $2.3 trillion, consuming one-seventh of all federal expenditures. Despite Reagan’s antigovernment rhetoric, the number of federal employees increased from 2.9 million to 3.1 million during his presidency.

It took the severest recession since the 1930s to squeeze inflation out of the U.S. economy. Unemployment approached 11 percent late in 1982, and record numbers of banks and businesses closed. The threat of unemployment further undermined organized labor, forcing unions to make concessions that management insisted were necessary for industry’s survival. In 1983, the economy recovered and entered a period of unprecedented growth.

That economic upswing and Reagan’s own popularity posed a formidable challenge to the Democrats in the 1984 election. They nominated Carter’s vice president, Walter F. Mondale, to head the ticket, but even his precedent-breaking move in choosing a woman as his running mate — New York representative Geraldine A. Ferraro — did not save the Democrats from a humiliating defeat. Reagan charged his opponents with concentrating on America’s failures, while he emphasized success and possibility. Democrats, he claimed, “see an America where every day is April 15th [the deadline for income tax returns] … we see an America where every day is the Fourth of July.” Reagan was reelected in a landslide victory, winning 59 percent of the popular vote and every state but Mondale’s Minnesota.