SUPPLY
SIDE ECONOMICS: IS IT FOR REAL?
By
Edward Lawrence, Citizens for Responsible Government
Supply side economics is the theory that certain types of tax cuts cause economic growth. Tax cuts benefiting businesses and the wealthy, the theory goes, allow entrepreneurs to invest their tax savings, which creates higher productivity, jobs, and profits. This growth, say the supply-siders, allows the entrepreneur and the new workers to pay more taxes, even at lower rates.
Supply-siders point to two items to prove the validity of this theory: the claim that it worked in the Reagan Administration, and the fact that Harvard University Professor Martin Feldstein says it is true.
It was the theory of supply side economics that encouraged George W. Bush to propose a $1.4 trillion tax cut in 2001 and a $695 billion tax cut in 2003 (subsequently cut to $350 billion by the Senate). And this in spite of a $6.4 trillion national debt, an unfunded war, and deficits “as for as the eye can see.”
What is astounding is that Congress passed the tax cuts, and many people in business and the media endorsed them, in spite of the fact that there is no evidence of validity to the supply site theories.
Those who claim the Reagan tax cuts caused an increase in economic growth generally measure the economy from the depths of the recession in 1982 through to the next business cycle peak in 1989, concluding that the economy grew at an average annual rate of 3.8 percent. Showing that the economy recovered from the recession (as it does in every swing of the business cycle) says nothing about whether the 1981 income tax cuts caused the underlying growth rate to be greater than it would otherwise have been.
Looking at the business cycles from one peak to the next, rather than from the trough to the peak, reveals that growth rates were unaffected by the Reagan supply side tax cuts. As one writer put it: Reagan didn’t create a “supply-side boom”; he sat in the Oval Office during a “business-cycle boom.”
Two other factors contributed to the 1982 to 1989 economic growth: the 400% increase in oil prices in the early seventies, followed by a 125% increase in 1978-81. Oil prices happened to come down to normal about the time of the tax cuts; the reduction in oil prices helped the economy a lot. The cut in taxes may have temporarily helped only a little.
The other factor with fortuitous timing for the Reagan Administration was the decision of Federal Reserve Chairman Paul Volcker to reduce interest rates, which had been kept high in order to fight inflation. In 1982 Mr. Volcker started to reduce the interest rates, not because of the tax cuts but because he felt inflation had been tamed. The falling interest rates impacted the economy quickly, bringing about the investment and jobs that supply-siders attribute to the tax cuts. In reality, tax cuts take at least a year to begin to show some impact.
Even if tax cuts could bring some temporary economic stimulus, the long term negative impact more than offsets any short term gain. We are still paying interest ($332 billion per year) on the national debt that almost tripled during the Reagan years.
The other feeble argument of supply-siders is that the tax-cut resulted in increased revenues. What increased revenues was the major increase in payroll taxes in the Social Security Reform Act of 1983.
Supply-siders conveniently forget that that when Bill Clinton restored some of the tax cuts granted to the highest income individuals by Ronald Reagan, we achieved a balanced budget for the first time since the Nixon Administration. Since George W. Bush took over that surplus has turned into deficits.
The guru of
supply side economics, Prof. Martin
Feldstein, acknowledged that the 2001 tax cuts would not pay for themselves, and
would in fact lead to increasing deficits.
In testimony to the Senate Budget Committee on
Great. Instead of a deficit of $1.6 trillion, the tax cut would generate a deficit of “only” $1.2 trillion over ten years, and more beyond. This is money that our children and grandchildren will be paying interest on, probably forever. Prof. Feldstein said this $1.2 trillion deficit was o.k. however, because it was “…still less than half of the non-Social Security surplus.” Many objective observers in February of 2001 knew that the projected surpluses were a fantasy, but Prof. Feldstein did not want to admit it.
So if the primary example purporting to demonstrate the truth of supply side economics is invalid, and if the guru of supply side economics admits that tax cuts will result in a deficit (but not as big a deficit as some would predict), why would anyone hang on to a theory that George Bush Sr. called “voodoo economics”? Wishful thinking, and grasping at whatever straw they can find to support their desire for cutting income taxes, capital gains taxes, estate taxes, and taxes on dividends.
Opposing the supply side theories are almost every economist and policy analyst not on the payroll of a right-wing think tank. Among those who acknowledge that the current wave of Bush tax cuts will result in massive deficits are Robert Reischauer, former Congressional Budget Office director and now president of the Urban Institute; Federal Reserve Chairman Alan Greenspan; economists with the Center on Budget and Policy Priorities, the Congressional Budget Office, the Tax Policy Center, the Brookings Institution, the Economic Policy Institute and many other think tanks; plus 450 economists including ten Nobel prize winners.
In addition to all the evidence, economists, and policy research organizations opposing the supply side dogma, common sense requires one to oppose it as well. The supply side theory says that if we cut taxes on the wealthy that they will invest in new plant and equipment and thereby create jobs and generate more tax revenues than are lost by the tax cuts. But there is currently over-capacity in our economy, and the wealthy have plenty of money to invest in new plant and equipment if they want to. It is unlikely that much, if any, of the windfall tax gains would be invested in new plant and equipment.
The problem is not that the wealthy do not have enough to invest; the problem is that the middle and lower income families do not have enough discretionary income to purchase all the goods that our economy is already capable of producing.
Supply side, or “trickle-down” economics, is nothing but a ploy to reduce the tax burden on the very wealthy, and thereby increase the tax burden on everyone else – especially future generations who will have to pay interest on the money borrowed to fund these tax cuts.
Read the article: Our Increasing Economic Vulnerability, about supply side tax cuts, deficits, and the unfunded social security obligations.