“When the government cuts taxes, you see, consumers are left with more disposable income. They will then go and buy more stuff. This increased spending will encourage businesses to hire more workers and produce more goods. The economy will thus grow faster.”
“And that, folks,” he concluded triumphantly, “is how supply-side economics works.”
There was a slight problem with the talk-show host’s explanation. What he had described was not supply-side economics.
Supply-side economics came into vogue during the Reagan years. Reaganomics in fact came to be associated with tax cuts. However, the tax cuts of the 1980s were accompanied by growing income inequality and rising budget deficits, and the philosophy acquired an unpleasant patina.
During the Clinton years, supply-siders largely disappeared into the woodwork as Clinton turned to economic advisors advocating a more activist government policy. When Clinton raised taxes early in his presidency — on the rich, no less! — conservatives were apoplectic.
The Wall Street Journal issued fiery editorials warning of imminent economic doom. Of course, no such thing happened. As the 1990s in fact served witness to a protracted economic boom, they promptly forgot their dire predictions, and claimed, with a cleverness that took one’s breath away, that the robust economic performance was the result of Reagan’s tax cuts in the ’80s!
The arrival of President Bush, and his dogged determination to cut marginal income tax rates, has been accompanied by the re-emergence of the supply-siders from the Stygian gloom of the Clinton era. Right-wing think tanks are busily disgorging policy papers purportedly showing the salubrious effects of tax cuts (they are always salubrious) while the editors of conservative newspapers and rabidly partisan radio hosts work in cahoots with Bush officials to spread the gospel of tax cuts.
But, in their haste to convince the public of the desirability of cutting tax rates for the affluent, the messengers occasionally confuse supply-side economics with demand-side fiscal policy. The argument that cutting taxes will augment household disposable income and thus spur spending is vintage Keynesian economics (after John Maynard Keynes, a British economist who shot to prominence during the Great Depression with his stance on activist government policy as a means to resuscitate economies mired in recession).
No supply-sider worth his salt will wish to be called a Keynesian. The WSJ editors practically consider Keynes a four-letter word, trotting him out on occasion only to fulminate against some hapless Democrat (Dick Gephardt, for instance) who has the temerity to suggest that the economy may actually be helped by a dose of government spending.
“Discredited Keynesian policy!” they thunder, and the poor Democrat shudders in shame and retreats.
So what exactly is the supply-side logic? And what does cutting marginal tax rates have to do with it?
The supply-side argument is as follows: When the government cuts income tax rates, consumers get to keep a larger portion of their earnings. This encourages them to earn even more, possibly by spending longer hours at the office. This burst of productive fervor permits businesses to produce more output, leading, in the aggregate, to strengthened economic activity.
This argument (and its more elaborate variants) are susceptible to criticism. First, the supply-side effects of tax cuts may be quite small, since consumers may not respond to cuts in taxes by working harder.
Second, cutting taxes will result in larger budget deficits which, in turn, may lead to higher interest rates and reduced investment by the private sector.
And finally, there is the question of fairness. Conservatives will decry this as “class warfare,” but the question remains: Should the government provide large tax cuts to the wealthy, especially when the cuts are unlikely to have any significant effects on output in the short run?
Such issues are unlikely to trouble radio talk-show hosts seeking to “educate” their audience on supply-side policies. Cutting taxes, they spout confidently, will provide a strong boost to the economy. Noting that “it is our money, not the government’s,” they will add righteously, “it is the right thing for the government to do.”
If he wasn’t preoccupied with personal matters, Bill Bennett would approve of this appeal to government probity.
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Sanjay Paul is associate professor of economics at Elizabethtown College.
He lives in Hershey, Pa. E-mail him at columns@greenbaypressgazette.com.