The Problem With Supply-Side Economics
While supply side economics is not new, per legend, it was re-born out of a graph drawn on a cocktail napkin in the ’70s. Dr. Arthur Laffer developed the Laffer Curve based on a simple premise: at 100% taxation any incentive for work or investment ceases, eliminating the ability to collect taxes. At 0% taxation, productivity soars, but the politicians can’t collect any revenues to carry out basic government activities. Somewhere between these extremes, tax revenues get maximized.
The genesis of the supply side revolution was high taxes and an inflation driven decade of stagnation in the Seventies. Following Philips Curve logic (I know, I know that’s an oxymoron) inflation was deliberately unleashed to stimulate consumption. Keynesians in both parties tried to offset unemployment by debasing the currency. Nixon even declared, “We’re all Keynesians now.”
When these temporary inflationary boosts subsided, recessions returned with a vengeance and the cycle was repeated. The Carter years expanded our economic lexicon with the concepts of Stagflation and the Misery Index. Inflation in lieu of growth. By 1982, when the economy was finally left free to begin the corrective re-structuring that recessions require, both sides of the unemployment/inflation curve were devastatingly painful.
Ronald Reagan strengthened the dollar and implemented long overdue tax cuts, thus launching what Laffer et al pronounce triumphantly as the greatest period of wealth creation in world history. The notion that tax cuts increase tax receipts circled the globe, and was ultimately tried in such previously unimaginable locales as Euroland, Russia, India and China.
Here, Reagan lowered the top marginal rate from 70% down to 28%. Tax revenues doubled by decade’s end. This phenomenon has proved true at every try including JFK’s posthumous tax cuts and more recently under George W. Bush. It remains one of the few economically sound policies Bush authored. Despite his reputation as a tax cutter, lower rates worked so well Bush became the heaviest tax collecting president in U.S. history.
Given the consistency of tax receipts as a percentage of GDP, growth obviously supersedes marginal rates as the driver of tax revenue. Tax collections have hovered between 16% and 21% of GDP since WWII, even as the top individual rate has been as high as 91% and as low as 28%. Washington employs numerous devices beyond personal income taxes, but this consistency is telling.
Recently this ratio artificially slid below 15% as Washington concealed additional welfare spending inside the tax code. The stimulus bills didn’t lower marginal rates, which has proven a reliable means to growth, but instead redistributed wealth as aggregate demand maintenance, i.e. demand side economics.
These “credits” went to low earners regardless of whether the recipients even paid taxes, but were disallowed for our best producers. Thus tax receipts slipped as stimulus spending was netted out.
Supply side economics invokes the most basic element of human nature: self-interest. We all seek to improve our material circumstances. The tinier the tax man’s bite, the greater is our incentive to produce. As tax burdens lighten, motivation heightens, sparking a robust economy. Allowing producers to enjoy their hard earned gains is both just and effective.
Contrasted with demand side economics it’s a no-brainer. It is neither just nor effective to funnel public money to political favorites hoping they will spend lavishly and thus stimulate production. Paying people not to produce inspires little effort. Depriving producers of needed capital so it can instead be transferred according to political whim ridicules the very pretense of stimulus.
Even calling political waste “investments” merely makes the semantics more palatable to gullible voters. Rather than paying people to consume others’ wealth hoping this will rejuvenate production, it obviously works far better to let producers enjoy their gains. We will always direct our own resources better than will politicians or their bureaucratic henchman. It’s not rocket science. Tax cuts incent production; profligate spending enables sloth and encourages corruption.
Other than the false credence this assigns to the pseudo science known as macro-economics, supply side principles seem irrefutable: lower tax rates motivate production which spurs economic growth thus expanding tax revenues. Let’s dissect this into its component parts:
Lower Tax Rates – Both fair and essential to liberty. Check
Motivates Production – Obviously better to incent work than free-loading. Check
Spurs Growth – We all benefit from the rising living standards. Check
More Tax Revenue – Yeesh, now why would we give the federal government more money to waste?
It’s not like Washington has a remotely positive spending record. According to George Gilder, “Under capitalism, when it is working, the rich have the anti-Midas touch . . . turning gold into goods and jobs and art.” Not so with government. They turn our gold into lead. Woeful tales of government fraud and abuse are legion. More taxes fuels more damage. For instance:
The welfare state ruined low-income communities by subsidizing illegitimacy thus spawning new levels of human pathology. Their intrusions into retirement and healthcare have replaced families, churches and communities as the wellsprings of charity.
The entire social spending infrastructure diminishes personal responsibility and the cohesiveness of communities. Who needs family or neighbors when the state eagerly offers assistance? The nanny state doesn’t prevent irresponsibility; it promotes recklessness because others bear the burden.
Our foreign policy bolsters dictators around the world, invariably fostering resentment. Why, when millions can remember the atrocities committed by Germans, Russians and Japanese during World War II, are those nations more popular than America? Part obviously reflects jealousy, but our meddling doesn’t help.
Washington’s intrusions into energy, healthcare, education, labor, housing and a host of other areas merely drive up costs. Much of what Washington does is counterproductive or unnecessary. Most legitimate governance is best left to the states or local bodies. We should find that point on the Laffer Curve which generates the highest tax revenue and then cut taxes further by several magnitudes.
Maybe then the federal government’s meddling will cease and it will stick to those precise few roles enumerated in the Constitution. Thus focused, the federal government’s effectiveness might be improved.