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Supply-Side Economics Isn’t The Answer For Today’s Problems

There is a time and a place for supply-side eco­nom­ics but this is nei­ther. Supply-side advo­cates seem to be fol­low­ing the eco­nomic “chicken soup the­ory”; tax cuts and less reg­u­la­tion are like chicken soup, talk­ing about chicken soup makes every­one feel bet­ter and if actu­ally pre­scribed prob­a­bly won’t make things worse either. But, the prob­lem with supply-side eco­nom­ics is that it is try­ing to solve a prob­lem that doesn’t exist. There is plenty of “sup­ply” in the econ­omy. The cur­rent eco­nomic slump is because of lack of demand and supply-side eco­nom­ics doesn’t do any­thing to stim­u­late demand. Eco­nomic pol­icy that tries to increase sup­ply when there is already too much sup­ply makes as much sense as treat­ing can­cer with chicken soup. Today’s “supply-siders” are los­ing cred­i­bil­ity and increas­ingly appear out of touch with real­ity as they ignore the under­ly­ing rea­sons for the cur­rent eco­nomic cri­sis and instead preach the dogma of a dif­fer­ent era.

Supply-side eco­nom­ics is an eco­nomic and polit­i­cal the­ory that argues the best eco­nomic and gov­ern­ment pol­icy is to increase the sup­ply of goods and ser­vices through tar­geted tax reduc­tions and lower reg­u­la­tion. On the other hand, Key­ne­sian eco­nomic the­o­rists believe that demand man­age­ment is the key to a sound econ­omy. Keynesian’s want to use fis­cal pol­icy to increase demand, espe­cially dur­ing a reces­sion, by mak­ing sure that there are con­sumers, busi­nesses and a gov­ern­ment ready to con­sume all of the goods and ser­vices pro­duced. Key­ne­sian eco­nom­ics is the “yin” to supply-side eco­nom­ics “yang”. Both the­o­ries have merit, just at dif­fer­ent times in the eco­nomic cycle. Right now the burn­ing eco­nomic issue is over capac­ity in the face of inad­e­quate and falling demand. Supply-side incen­tives fail to address demand and if enacted could actu­ally make things worse.

The cur­rent debate over tax pol­icy is an exam­ple of the ten­sion between supply-side and Key­ne­sian eco­nomic the­ory. Who should get tax relief — low income tax­pay­ers or high income tax­pay­ers and busi­nesses? Supply-side econ­o­mists say that tax relief for high income tax­pay­ers and busi­ness will stim­u­late the econ­omy by increas­ing sup­ply while Key­ne­sian econ­o­mists say that tax relief for low income tax­pay­ers will stim­u­late the econ­omy by increas­ing con­sumer demand.

Supply-siders argue that high income tax­pay­ers are the own­ers of stocks, bonds and small busi­nesses and if this group of tax­pay­ers pays less in taxes they will take the excess money and invest it in their busi­nesses as well as buy more stocks and bonds (which is another form of busi­ness invest­ment). And, if there is greater invest­ment in busi­ness, more jobs will be cre­ated, more goods pro­duced and the econ­omy will expand. Supply-siders believe that if there is excess pro­duc­tion, prices will fall and over­sup­ply will be absorbed through higher demand stim­u­lated by lower prices.

On the other hand, Key­ne­sian econ­o­mists say the gov­ern­ment should give tax relief to low income tax­pay­ers and should be pre­pared to go as far as pro­vid­ing trans­fer pay­ments (neg­a­tive tax pay­ments) to those at the low­est rung of the income lad­der. Keynesian’s believe that by increas­ing the dis­pos­able income of con­sumers most likely to spend, demand will be stim­u­lated and the econ­omy will oper­ate at a higher level. Key­ne­sians say that busi­ness pro­duc­tion will increase to meet demand and busi­nesses will rein­vest their prof­its to expand sup­ply so as to cap­ture the excess demand cre­ated by mid­dle and lower class income tax reduc­tion. And, if there is excess sup­ply, by stim­u­lat­ing demand, the excess sup­ply will get soaked up.

This tax debate is cur­rently tak­ing place in the U.S. Con­gress and in the media. Democ­rats, lead by Pres­i­dent Obama and Con­gres­sional lead­ers, are push­ing tax relief for mid­dle income and work­ing class tax­pay­ers. One pro­vi­sion of the stim­u­lus bill which went effec­tive a few days ago is a reduc­tion in with­hold­ing taxes so that most Amer­i­cans are going to see a mod­est increase in their take-home pay. The hope is that the result­ing increase in dis­pos­able income will be spent and demand will rise as a result. How­ever, Con­gres­sional Repub­li­cans argue that the best use of gov­ern­ment resources is to reduce taxes on high income Amer­i­cans and busi­nesses in the hope that lower taxes will spur busi­ness invest­ment and the econ­omy will expand as a result. When the Repub­li­cans con­trolled the White House and Con­gress, tax cuts for high income Amer­i­cans and busi­nesses were enacted reflect­ing this view.

Another prin­ci­pal objec­tive of supply-side eco­nom­ics is to lower the amount of gov­ern­ment reg­u­la­tion in the hope that lower reg­u­la­tion will lead to greater eco­nomic effi­ciency and a more com­pet­i­tive econ­omy. The yin and yang of gov­ern­ment reg­u­la­tion is on dis­play with the change from a Repub­li­can to a Demo­c­rat occu­py­ing the White House. The Bush Admin­is­tra­tion low­ered the amount of reg­u­la­tion and enforce­ment and the Obama Admin­is­tra­tion is mov­ing in the oppo­site direction.

Clearly there are times when pub­lic pol­icy designed to stim­u­late sup­ply is the best pub­lic pol­icy and there are other times when pub­lic pol­icy designed to stim­u­late demand is the best pub­lic pol­icy. But right now it is the demand side of the equa­tion that needs help and quickly. Supply-side econ­o­mists and politi­cians are turn­ing a deaf ear to the cur­rent eco­nomic reality.

What con­cerns me is that supply-side advo­cates appear to be so obliv­i­ous to cur­rent eco­nomic real­i­ties that they are fatally dam­ag­ing their cred­i­bil­ity and stand­ing as seri­ous pub­lic pol­icy experts. There will come a time in the near future when supply-side stim­u­lus is appro­pri­ate and if the supply-side advo­cates are thought of as crack pots they won’t be able to rally the cause.

Con­ser­v­a­tive econ­o­mists and politi­cians need to stop repeat­ing their tax cut and reg­u­la­tion mantra of the last 30 years and start fig­ur­ing out real solu­tions to the cur­rent eco­nomic cri­sis. What worked in the 1980’s isn’t the same mix of pub­lic pol­icy alter­na­tives that will work now. And, if the solu­tions pro­posed by con­ser­v­a­tive econ­o­mists and politi­cians don’t include stim­u­lat­ing demand, fix­ing the finan­cial sys­tem or help­ing pre­vent another melt­down, then they need to go back to the draw­ing board before talking.

Posted in: Bush Administration, Business Environment, economy, Finance, Fiscal Policy, Politics, Public Policy, REGULATION

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