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Supply-Side and Deficit Reduction

July 27, 2010

There’s been a meme going around recently arguing that supply-side economics was an abject failure, to use the popular colloquialism of today’s current affairs pundits.  These claims of failure, however, aren’t based in any suggestions that supply-side economics depressed employment, decreased GDP, or killed our trade-surplus, but rather that it exasperated peacetime deficits by allowing Republicans to basically ignore them.  Martin Wolf has a post up on his FT blog that’s been getting a lot of attention for exposing the political opportunism allegedly inherent in the support of supply-side economics:

To understand modern Republican thinking on fiscal policy, we need to go back to perhaps the most politically brilliant (albeit economically unconvincing) idea in the history of fiscal policy: “supply-side economics”. Supply-side economics liberated conservatives from any need to insist on fiscal rectitude and balanced budgets. Supply-side economics said that one could cut taxes and balance budgets, because incentive effects would generate new activity and so higher revenue.

The political genius of this idea is evident. Supply-side economics transformed Republicans from a minority party into a majority party. It allowed them to promise lower taxes, lower deficits and, in effect, unchanged spending. Why should people not like this combination? Who does not like a free lunch?

He then outlines what he believes the step-by-step (political process) was for politically expedient policy-makers:

How did supply-side economics bring these benefits? First, it allowed conservatives to ignore deficits. They could argue that, whatever the impact of the tax cuts in the short run, they would bring the budget back into balance, in the longer run. Second, the theory gave an economic justification – the argument from incentives – for lowering taxes on politically important supporters. Finally, if deficits did not, in fact, disappear, conservatives could fall back on the “starve the beast” theory: deficits would create a fiscal crisis that would force the government to cut spending and even destroy the hated welfare state.

Fair enough, but I have a beef with this line of reasoning.  Just because you lost a bunch of games 10-9 after you adopted sabermetric analysis on the offensive side of your baseball strategy doesn’t mean that sabermetrics is wrong.  It just means you forgot about/were unwilling to do anything about your pitching.

Sure, contemporary conservatives (at least nominal conservatives) have been schooled in this tradition.  Jon Kyl and Mitch McConnell may buy into this hooey — or, more cynically, are still scheming as those Republicans of the early 80s did, attempting to resurrect the free-lunch theory for political gain.  But Wolf gives no evidence that the original theories of supply-side economics were designed to be implemented in the absence of spending cuts.  I’m no Homer, and I wasn’t a politically sentient organism in the 80s, but I think it’s very likely that the “tax cuts pay for themselves” belief arose from the fact that tax receipts increased in the 80s where they had been lagging in the 70s.

Of course, that’s because the economy picked up the 80s — people were making more money and more people were employed, therefore tax receipts were higher.  What Wolf and others are seeing as a vast conspiracy I’m seeing as a simple correlation-v-causation error.  I don’t see that supply-side theory necessarily exists in the absence of spending cuts, nor am I aware of any evidence that it was sold that way during its early stages.  Do supply-side theories about the level of taxation on businesses and individuals mandate that levels of spending elsewhere in government remain unchanged?  Are those aspects of supply-side economics invalidated because of the deficits we’ve seen during the past thirty years?

Again, what Wolf sees as a failure of supply-side I see as a failure by Republican and Democratic leadership alike to reduce spending, especially in the entitlement area.  Sure, “starve the beast” is a farce, and Republicans did nothing about spending when they had the chance — save their effort to privatize Social Security — but if you subtract the “tax cuts pay for themselves” element from the rest of supply-side theory, are you left with nothing?  Or are you left with the idea that low taxes on businesses and individuals foster economic growth without producing mass inflation?  I don’t see that those ideas are dependent on one another, and I don’t see how the deficits of the Bush and Reagan years are evidence of the abject failure of supply-side economics.

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