Monday, September 10, 2012

Failed Supply-Side Economics?



(Written September, 2012)
 In the last couple of weeks, I’ve read several political commentaries that mention, just in passing, how supply-side economics were a dismal failure.  Typical of those were Joe Klein’s TIME magazine piece of September 3rd, where he wrote:  “In a way, neoconservatism is the Republican foreign policy equivalent of supply-side economics. It has been tried and failed.”  Similarly, President Obama, who I like overall and plan to vote for in November, said that supply-side economics was a theory that “has never worked “  (http://cnsnews.com/blog/david-james/obama-supply-side-economics-theory-has-never-worked)  I say that comments like these are made “just in passing”, because the failure of supply-side economics is so widely accepted as true these days that the claim often doesn’t even merit explanation.

But that’s a big problem, because it’s not true.  Here are three reasons why:

Robert Lucas wrote the following in 1995, 14 years after Ronald Reagan initiated the age of supply-side policies in America: “The supply side economists, if that is the right term for those whose research we have been discussing, have delivered the largest free lunch that I have seen in 25 years of this business, and I believe we would be a better society if we followed their advice.  The attraction of (supply-side economics) is not that it is pretty – though it can be – but that, given half a chance, it works.” (The Wall Street Journal, October 13, 1995)  Lucas explains his comments in more detail of course, but his message is pretty clear: supply-side economics, in fact, worked quite well.  Lucas, by the way, has been called the most influential economist of the final 3 decades of the 20th century, and received the Nobel Prize in Economics the same year he made those comments.  (http://chronicle.uchicago.edu/951012/lucas.shtml)  Wouldn’t you think that Nobel Prize-winning Lucas knows more about the topic than politicians running for office and pundits like Klein?   I would.

I’m not sure why the conventional wisdom (supply-side failed) ignores Lucas’ comments, but he is, after all, just one guy with an opinion.  So maybe he is wrong, or maybe the Journal misrepresented his views on the subject.  But here’s thing #2.  The main reason people say supply-side economics failed is the huge federal deficits caused by supply-side tax cuts during the Reagan years.  There were indeed large deficits during those years, but it’s not at all clear that they were caused by supply-side tax cuts. 

First of all, it’s not clear that lower tax rates were responsible for lower revenues to the Treasury in the 1980s and ‘90s.   Higher tax rates actually lowered tax revenues after the rate on capital gains was increased from 20% to 28% in 1986.  The politically-neutral Congressional Budget Office (CBO) “overestimated capital gains realizations by $527 billion between 1989 and 1992.”  A few years later, Congress’s Joint Committee on Taxation (JCT - also politically-neutral) projected that cutting the capital gains rate back to 20% from 28% in 1997 would reduce revenues by $21 billion.  Instead, the lower tax rate increased revenues by $38 billion.  (San Diego Union Tribune, May 12, 2006)   So while raising tax rates might increase federal revenues, and lowering tax rates might lower federal revenues, there do seem to be cases where the opposite occurred, in line with supply-side theory.

Secondly, the evidence indicates that the main source of budget deficits in the 1980s was the uninterrupted increases in government spending, not a decline in tax revenues.  The following chart shows that while tax receipts dropped for a couple of years in the early-80s (a natural result of the country being in a recession), the larger problem was that federal spending never did slow down.  In fact, the chart shows that by the mid-80s tax revenues were back to rising at a healthy rate, even with the supply-side cuts.  According to Bob Packwood, chairman of the Senate Finance Committee in the 1980s: “In 1982, when we were in the recession and we knew we had to narrow the deficit, Congress made a promise to Reagan: accept $1 in tax increases and we’ll give you $3 in spending decreases.  He signed the tax bill.  He never got the spending cuts (that Congress promised).” (Barron’s, April 24, 1995)   Rather clearly, excessive government spending was the main cause of the Reagan-era deficits, not supply-side tax cuts. 

Yet Reagan himself deserves blame for some of that big spending, as he ratcheted up money going to national defense in line his commitment to win the Cold War.  One can argue whether that spending was wise or effective, but one cannot claim that it was part of supply-side economics.  It quite simply was not; supply-side policies have nothing at all to do with increasing defense spending.

This leads us to important problem #3; most people don’t really understand what “supply-side economics” means.  Supply-side economics is an attempt to increase the supply of goods and services in an economy, using a variety of specific policies, or "levers".  Cutting marginal taxes and capital gains rates, while the most publicized of those, is only one possible lever.  Other supply-side levers include: reducing government regulation on businesses, privatizing public enterprises, increasing education and job-training, reducing discrimination, limiting the powers of labor unions, providing subsidies for key industries, improving infrastructure, and promoting free trade.

Again - the goal of policies like these is to increase the amount of stuff being produced in a country, which tends to create more jobs and lower inflation rates.  Hence, few if any people argue that increasing aggregate supply is a bad thing.  Some have a problem with the negative side-effects of certain supply-side levers, and it’s not clear that all of those levers worked during the Reagan/Bush years.  But overall, they seem to have done the trick, as Lucas argued and this chart shows.  Both inflation and unemployment rates started dropping dramatically after a couple of years of supply-side policies.  By the late-80s, unemployment was averaging about 6%, vs. 7.5% earlier; meanwhile, inflation dropped even more dramatically – from about 8% to around 3%.  This was truly a win/win for the nation.  And there’s good reason to believe that the much-vaunted successes of the Clinton years that followed were mainly the afterglow, ongoing effects, of these earlier policies.  But to repeat - tax cuts were only one part of this success story.

So look: Dismissive claims of the failure of supply-side economics are unfair and inaccurate.  They seem to be based on a selective and sometimes-flawed reading of history, supplemented by a misunderstanding of the actual nature of supply-side policies.  These days, economists are dubious about the ability of lower tax rates to increase tax revenues further, and few argue that rates are currently too high.  So tax cuts (and other supply-side policies) may not be the answer to today’s economic problems.  But it was a different world and a different economy 30 years ago, and back then they seemed to be just the ticket.  They worked; that’s what the evidence shows, in contrast to what Klein, Obama, and others snarkily aver today.  
 

8 comments:

Natalie Fleming said...

Great blogs and ideas
very open minded
I don't like it
I love it ;D

Dylan Lee said...

The only reason why supply side economics doesn’t work in theory and reality is because people who use the public like puppets say so; this includes the media and politicians.

Will Krueger said...

I was one of those people who dismissed supply-side economics without really understanding it, but your article and the ideas we learned in class about it made me think twice. It makes perfect economic sense, but there are other obligations that a society has.

Zachary Zisser said...

I agree that not much Regan did during his time to build the deficit wasn’t based on the supply side policies because they where government departments being changed. Not anything with the government reaching into companies and making them change policies and creating for regulations for the market. Not much of this ever happened so we see that the idea of the deficit being created by Supply side policies is completely false and just is another way the government sounds like they don’t want to take any of the blame.

James Howell said...

In “Failed Supply-Side Policies,” an essay by Mr. Strebler, the achievements and misconceptions surrounding Supply-Side policies during the Reagan Era are analyzed well. Those who oppose Supply-Side policies often do not understand the nature of Supply-Side policies, are confused by the deficits made in the Reagan era, or don't agree with the political and social economic impacts of Supply-Side policies. I agree with everything in this essay, however Mr. Strebler demonstrates confusion to why a lot of politicians and people dismiss Supply-Side policies, even though they worked brilliantly in the Reagan era. The answer is simple, they won't accept the fact that helping the rich can benefit the whole nation.

adam wright said...

Supply-side economics is something I have been taught ever since middle school as a system that actually does work. However, after reading about the inaccurately stated "failed" Reagan years I began to doubt the system. After learning about the policy both in your article and other places I was again reassured that supply-side economics does work, ceteris paribus.

Alex Tam said...

Initially, I always thought that Reaganomics was a terrible concept; it didn't help the economy because of the increasing supply and tax cuts. But it's just one view from today: the supply-side actually worked 30 years ago and the economy was consistent. Sure, war spending was a huge issue, but there is not enough proof that supply side economics is related to that war effort. It may be better to look back on history and do the correct options so the future would not be ruined

Raley Slaymaker said...

I realize now from this article and stuff we learned in class, that supply side economics really isn't bad. During the reagan era, it really helped the economy, even though there was some mistakes. What people don't want to realize, but need to realize is that helping the rich, helps the nation. That is just fact.