Supply-side economics

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Supply-side economics is recognition that demand is not completely independent of supply: demand for a good or service often increases if its affordable supply increases. For example, construction of a free highway will result in its increasing use over time.

In macroeconomics, the implications of this insight are that cutting tax rates can increase the supply of goods and services, and increase the demand for them, with an overall result of increasing tax revenues. Conversely, high marginal tax rates stifle economic growth by reducing the potential supply of goods and services, and decreasing tax revenues. Simply put, increasing taxes often decreases government revenue.

Contents

History

John F. Kennedy's fiscal policy stance made it clear that he believed in pro-growth, supply-side tax measures.[1]

These ideas were taken up as a popular political movement during the 1980 election campaign, with Ronald Reagan proposing a modified policy of supply-side economics (although liberals disparagingly used the term "trickle-down" economics)--a term they have used against conservatives since William Jennings Bryan in 1896.[2] The decreased regulation begun in the late 1970s, together with lower marginal tax rates would provide enough savings and investment to pool new capital and drive economic growth. Manufacturers for example, would hire more people, produce more, and create more demand and economic activity. The idea gained wide popular support, and became known as "Reaganomics".

During the presidential campaign of 1980, Ronald Reagan argued that high marginal tax rates were hurting economic output, but contrary to what many people think, neither Reagan nor his economic advisers believed that cuts in marginal tax rates would increase tax revenue.[3]

One key aspect of Reagan's program in 1982 was tax cuts for Research and Development (R&D) in high technology firms intended to make United States more competitive with Japanese electronics manufacturers which had dominated the industry since the late 1960s. Liberals were critical of the idea, claiming "tax cuts for business" only benefited "the rich"; however, the "trickle down effect" became a flood of prosperity in high tech industries starting in the 1980s and continuing on ever since.

Murray Rothbard wrote:

Specifically, Reagan called for a massive cut in government spending, an even more drastic cut in taxation (particularly the income tax), a balanced budget by 1984 (that wild-spender, Jimmy Carter you see, had raised the budget deficit to $74 billion a year, and this had to be eliminated), and a return to the gold standard, where money is supplied by the market rather than by government. In addition to a call for free markets domestically, Reagan affirmed his deep commitment to free­dom of international trade.[4]

The idea that all tax cuts raise revenue is an oversimplification, sometimes used by politicians with a poor grasp of mathematics or the Laffer curve.

Some people have falsely claimed that Karl Marx was the earliest advocate of supply-side economics[5] in an attempt to discredit the theory.

Criticism

Critics of supply-side economics generally support demand-side economics, usually considered to be part of the Keynesian school of thought. These critics believe that the capacity for supply is not enough, and that there needs to be demand for goods and services in order to drive the need for supply and create economic growth. They also believe that money in the hands of the middle and lower classes is more effective at creating this demand because their money has more "velocity" (i.e. it gets re-spent more often). Essentially, proponents of supply-side economics believe supply creates its own demand, whereas supporters of demand-side economics believe demand is required before supply can create economic growth. Critics of supply-side economics point towards the increasing income gap in the U.S. since Reagan's election[6] as evidence of the failure of supply-side policies.

Most criticism comes from the Left, but some on the Right have been skeptical as well. George H.W. Bush during a campaign debate famously referred to it as "voodoo economics", due to the discarding of Keynesian orthodoxy. On the Left, it was seen as threat to the welfare state with the (feared) loss of federal revenues in tax cuts that had funded the failed War on Poverty programs for more than a decade. However, Reagan did not significantly cut back on the welfare state (that happened in 1996).

References

  1. http://www.heritage.org/research/reports/2004/06/the-laffer-curve-past-present-and-future
  2. Understanding Supply-Side Economics, David Harper
  3. Supply-Side Economics - James D. Gwartney, The Concise Encyclopedia of Economics
  4. http://www.mises.org/story/1544
  5. Brin, David. "A Primer on Supply-Side vs Demand Side Economics." February 20, 2010. Institute for Ethics and Emerging Technologies. http://ieet.org/index.php/IEET/more/brin20100220
  6. "Winners Take All." February 14, 2011. The Economist - Free exchange (blog). http://www.economist.com/blogs/freeexchange/2011/02/income_inequality

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