| 'Supply-side'
is not a dirty term
by
Lawrence Kudlow |
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| |
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from NewsLink, Vol. 2, No. 4, Summer 1998
Despite its success in overturning the old Keynesian order, supply-side economics is still a dirty term among the pundits who drive the policy agenda.
In fact, deriding supply-siders has become a blood sport, a pageant of sound and fury that supporters say bears little understanding of the theory.
“...Popular crank doctrines like supply-side economics – seemed to have crowded Keynes off the stage,” writes the irrepressible economist and popularizer Paul Krugman in Fortune., a publication where he was rather kind compared to other critiques.
Back in 1981, the old school of Keynesians decreed that President Reagan's tax cuts would invite inflation. But as the most dedicated supply-sider will recall, the 1981 cuts were part of a tax and regulatory shift that ultimately caused inflation to subside. The “inflation tax cuts” of the 1980s ushered in a new era where rapid growth can coexist with declining, rather than accelerating, inflation. Thus did the supply-siders declare victory.
The Keynesians refuse to believe that inflation is caused by too much money chasing too few (a scarcity of) goods, instead they fret over the perils of excessively rapid growth. To supply-siders, this view is wrongheaded. Critics from the Keynesian school also claimed that interest rates would spiral upward as a result of the Reagan deficits. The claim is baseless, respond Reagan's defenders.
Aside from a reluctance to admit they were wrong, what is it exactly about supply-side economics that the critics fail to grasp? For one thing, the idea of cutting taxes among other things, currently reigns supreme across the world. And the idea of raising them is sure folly in a competitive global market. Note that very few economists today call for tax increases to absorb “excess demand.” Even in the ivy-covered towers of the Eastern establishment, the old models are dying.
As economist Lawrence Kudlow notes in his new book American Abundance: The Economic and Moral Prosperity, there is still another reason why supply-side economics has rubbed practitioners the wrong way. “Tax cut policies remove both the resources and raison d'etre of government spending, fine-tuning, targeting, engineering and controlling, all the policy levers of modern Keynesian government management.” For some this is hard to accept.
Kudlow who worked as an economist at the Office of Management and Budget during the Reagan administration has compiled a readable, spirited defense of supply-side economics. To be sure there are other more thorough explanations of the controversial school: Robert Bartley's The Seven Fat Years, and Lawrence Lindsey's The Growth Experiment. But Kudlow's is far more accessible.
The author of New Jersey Governor Christine Whitman's famous 1993 state income tax cuts, Kudlow writes from the vantage point of seeing policy translated into action. (BHI showed that those added 25,000 new jobs and resulted in more than $2.1 billion in additional capital spending in New Jersey.) While Whitman has lately strayed from the faith, Kudlow continues to spread the gospel.
Optimistic, generous in spirit, and willing to find allies wherever he may find them, Kudlow gives some credit where it's due: Despite its penchant for targeted tax cuts and class warfare, the Clinton administration is committed to free trade and NAFTA and its approval of last year's tax bill that reduced the rate on capital gains and is swelling the nation's coffers. Kudlow sees a bit of Reagan in Clinton proving that there's a bit of Reagan in the author: like the Gipper, Kudlow doesn't care who gets the credit.
Overall, the forty essays and columns presented in this slim volume serve as a counterpoint to all the hue and cry that results at the mere mention of the term supply-side economics.
Kudlow reminds us that supply-side economics is little more than a restatement of neoclassical economics. If business raises prices, fewer sales result. If business lower prices, more people are able to buy the product, and business sells more. Taxes are no different than prices, says Kudlow. “When you tax something you get less of it. When you tax something less, you get more of it.” The goal is to expand the base of taxpayers who will see tax cuts as an incentive to work , save and invest.
The Kemp-Roth tax cuts promoted by Ronald Reagan in 1981, (the supply-siders' crowning achievement) and the tax reform act of 1986, have been blamed for most of the ills besetting the republic: budget and trade deficits, income inequality, and trade deficits to name a few. Thus we heard from Vice President Al Gore in the 1996 campaign that candidate Robert Dole's proposed across-the-board tax cuts would “blow a hole in the deficit,” that they would be skewed toward the wealthy and that people would spend their tax cut savings, if they were lucky, rather than save or invest it. These are akin to the arguments against supplyside economics; Kudlow confronts them head on.
Did Reagan create deficits that were as long as the eye can see? Kudlow notes that Reagan “left the budget deficit at 2.9% of GDP in fiscal year 1989, almost exactly where he inherited it at 2.7% in 1981.” That differential was well worth the cost: a Cold War victory and the defeat of inflation. “Debt finance underwrote the sharp reduction of inflation, which was an absolute, necessary starting point for any economic recovery or stabilization. Moving the inflation rate from roughly 15 percent in 1980 down to 2 percent in 1986, had a tremendous positive impact on the economy, in effect, a huge tax cut which re-stabilized monetary value.”
Over time the Reagan tax cuts proved to be successful because they made both political and economic sense: “By 1987, with the top income tax rate chopped down to 28 percent from a staggering 70 percent in 1981, the stock market increased by 260%, creating a surge in US wealth that cynics thought was impossible. “
In addition, entrepreneurs became folk heroes, inaugurating American dominance in high technology and telecommunications. New financial markets were created, opening the closed Wall Street society to virtually every working American. Today roughly 125 million people, virtually the entire workforce, own a piece of the economy through IRAs, mutual funds, Keoghs, 401K plans. These workers know how to spend their money much better than Uncle Sam, reasons Kudlow.
Part of the reason for the vociferous reaction against supply-side economics, can be attributed to its being a victim of its own success. The current prosperity, built on the fundamentals of 1980s tax policy, and interrupted by an mild recession, vanquished the memory of 1970s style stagflation, 20% prime interest rates, rising taxes and easy money. The setting at the time was ripe for a new solution to what ailed both the American economy and economic spirit. Recall that in the 1970s, easy money drove up inflation and rising taxes put a brake on growth.
Moreover, it is difficult to see how Intel, Microsoft, MCI, Dell, Gateway and thousands of other new companies could have prospered in an inhospitable 70s style environment.
“I have to believe that it was no coincidence that lower inflation, lower taxation, less onerous interest rates, and so forth, combined to bring these things to commercial success.” Kudlow writes.
Relying on the work of his “favorite dead economist,” Joseph A. Schumpeter, Kudlow maintains that the gales of creative destruction so congenial to tax cuts and entrepreneurship are mostly responsible for the creation of 36 million new jobs since 1981 and the creation of $17 trillion in new household worth.
Kudlow is well aware of the next challenge: the growing obsession with the national debt. In the new age surplus, the specious argument that tax cuts “cost too much” haunts the Republicans both on Capitol Hill and in State Houses across the nation.
Tax cuts have taken a back seat to “Saving Social Security First.” “This means that in the first skirmish of the budget surplus era, the victory goes to the government class,” writes the Wall Street Journal's Paul Gigot despairingly. “For years Congress couldn't cut taxes because of deficits. Now it can't cut taxes because of surpluses.”
Kudlow thinks that the emphasis on debt, the cornerstone of austerity politics, is misplaced. After all the shouting is done, debt finance is neutral he tells us. Debt finance does not affect growth nor does it cause interest rates to rise. Policymakers should focus instead on increasing capital formation, output and employment. If that is done, the nation, reawakened with human potential, can then solve more serious political and social problems.
NewsLink is the quarterly newsletter of the Beacon Hill Institute for Public Policy Research at Suffolk University.
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