Supply side economics just plain works. An expanding economy more than makes up for the decreases in taxes that brought it about.

Now of course any fool knows that it is possible to blow the gains and then some – as we are doing now with the war and the 11,000 earmarks loaded into recent bills.

The trick is to keep taxes AND spending low so that the deficit drops as it did just before 2001

Essential to supply-side economics is the idea that supply creates demand, not the other way around (known as "demand-side, or keysian economics). It recommends giving taxes to entrepreneurs, who then presumably invest their savings in business capital (not stocks, derivatives (assets that "derive" their value from other assets, like stock options), currencies or commodities). Supply-side theory suggests that this investment will create more jobs, which will then pump demand.

A simple example can demonstrate why this doesn't work in practice. If one million people demand $15 orogomie ninjas, then we assume that, eventually, some enterprising young lad will set up an orogomie shop and capitalize on the dollars people will give for their precious orogomie ninjas. If, however, our lad makes orogomie ninjas without knowing the demand, we cannot assume that people will desire them enough to buy. In other words, whatever crazy demands people have, we can assume that some profit seeking person will benefit by creating a supply. But, just because a person makes a supply, doesn't mean there will automatically be a demand. Demand creates supply.

A more relevant example: a pizza shop during a recession. Consumer spending falls, and demand for pizza declines from 4 pizzas a day, to 3 pizzas a day. If a tax rebate was given to the pizza maker, why would they invest in their business, and increase production capacity for a decreased demand? If they already had enough equipment to produce three or four pizzas a day, it would make no sense to increase capacity to five or six pizzas. If, however, a tax rebate was given to customers, who then increase the amount of pizzas demanded to five or six, the owner would have an incentive to increase production capacity to meet the demand. Once again, its the demand that creates an incentive for producers to supply.

Let me say that I completely agree with you that an expanding economy is better than tax revenues, that our taxes now are probably too high, particularly on corporations that suffer from draconian 40% tax rates, and that the federal government should strive to keep its own spending low. None of these are supply-side ideas, however. Most conservative economist are not supply-siders. Conservatives should not feel compelled to defend supply-side, as no liberal must defend communism. Both ideas are totally bunk with no academic backing.

Um, did you read any of the links provided?

Because, if you did, you realize- no economic philisophy "just works"- especially when it is as large and complex as a global economy.

It's all mix and match baby.

So it is your contention that if the government lowers taxes by $1000 - "injects it back into the economy" by giving it back to the taxpayer - they will get back more that $1000 of tax revenues in return?

Entspeak found the best source to date that goes against that notion:


Now, we all agree that low taxes are good for the economy. But no way is there a full recapture of the taxes forfeited. You would have to cycle that money way too often in a year to come close.

This is from one economists blog. Supply side economics seemed to work at the end of the Clinton Administration after cutting taxes.

Scubatim, this isn't just any old economist, pulled off the web somewhere - this guy was in the belly of the beast. Andrew Samwick - Chief Economist on Bush's Council of Economic Advisers from 2003-2004. Check out the resume. Now, he's a professor at Dartmouth. He's from Bush's own team, not some partisan economist with an axe to grind. Listen to what he has to say - he makes a lot of sense. This is the kind of guy you can really learn from. Let go of your preconceived notions long enough to seriously consider what the other side has to say.

Also, try this exercise: follow $1000 of "stimulus money" on some invented journey through our economy (I did this many posts back, if you will remember, but you didn't like my example.) Use your own scenario, spend it however you wish, and just apply some realistic numbers to the sales and income taxes it could generate. See how much tax you can really earn with that $1000 in a year. It won't be close to $1000. That is what Samwick is talking about when he says "first order effect" of cutting taxes.

Now, about Clinton cutting taxes - I'm sorry I neglected to include the capital gains tax, but Entspeak is absolutely correct when he points out that CG taxes don't account for enough in the grand scheme of taxation to have accounted for the total jump in revenues. Besides, revenues increased even before those cuts.

And when supply-side economics was attempted during Reagan's administration what occurred? The national debt went up dramatically. The deficit dropped because of an increase in taxes during Clinton's administration. Yes, capital gains tax was cut and that provided incentives to move on the market, but surpluses existed before 2000. There was a surplus in 1998, there was a surplus in 1999. When you have a surplus, the increase in revenue from a capital gains tax cut will be noticed.

My error. More correctly the idea of TAX cuts to increase economic activity works but spending must still be controlled. It failed for Reagan because he pushed through defense sepeding and the Dems forced increased social spending = BIG deficits that overwhelmed the increased activity. And I agree taxes are too high now. But if you watched the SOTU address last night – republicans cheered maintaining the tax cuts while Dems sat and scowled.

If they get the WH and hold Congress look for taxes to go UP and not just “on the rich” which is the classis dodge used. Note how painful it was for Congress (both parties) to save 20 million from the ATM this year. They really didn’t want to and only postponed it for another year. Next year if a Dem is president look for at least a good number of the 20 million to feel the bite of this stupid tax passed in 1962 with no index for inflation.

I was going to take you to task for this statement, Ted; but it appears this statement is not yours - another reason to make use of quote tags.

So, BH, what kind of comparison is this?

Supply-side economics can work in theory if, and only if it isn't combined with deficit spending - something both Reagan and Bush have done.



Well, what level of taxation is acceptable? None? We obviously can't pay for what we're spending now... who's to pay?



I understand that the AMT (for a second there, I thought Congress had a special ATM all there own ) needs to be reformed. There are some problems with it, but I don't think it necessarily needs to be repealed. Oh, and the tax passed in 1969 - effective 1970.

TEd- you keep talking about riegning in spending- but there is a 1.6 trillion dollar elephant in the room. The most logical and easiest cut to make is to make cuts to areas that don't help a single American, so that would be to cut all non-domestic spending by 100%. Then you can pay for tax cuts.

If you are going to have a decrease in revenue- you need a decrease in spending. And it is not moral, ethical or realistic to cut domestic spending without first cutting the 1.6 trillion dollar fiasco we are now in, and all other foriegn expenditures.

Read my critique of supply-side above.

I think your suggesting that tax cuts can lead to increased tax revenue if its not combined with deficit spending. As CR pointed out, thats true only on a specific side of the "Laffer curve." If taxes are cut from 2% to 1%, economic growth will have to double just to break even with the 2% tax rate.

Supply side economics, and the idea that demand is derived from supply, doesn't even work in theory. I demonstrate this above.

While I agree that supply-side economics *is* a naive economic model, I disagree with that it cannot work in theory. First, even Dubya didn't cut taxes in half, he cut taxes by ~1/5 (~1/6 for income & 1/4 for long-term capital gains). That means the economy would have to grow by ~20% to make up the difference. Second, economic growth is calculated incrementally. Thus, you would see the following for 5% economic growth rate:

Base = 1000
+ 1 year = 1000 + 1000 * 0.05 = 1050
+ 2 year = 1050 + 1050 * 0.05 = 1102.50
+ 3 year = 1102.50 + 1102.50 * 0.05 = 1157.63
+ 4 year = 1157.63 + 1157.63 * 0.05 = 1215.51

So, after 4 years of a constant 5% economic growth rate, you would achieve greater than 20%; you would need another year to make up the loss in revenue over the first 3 years. Note that this calculation assumes that money is not being borrowed to make up the loss in tax revenue.

Of course, *all* this is premised on the notion that tax cuts cause economic growth: an entirely unproven hypothesis.

Right. What needs to be done is INDEX the dollar amount for the start of the ATM bite. Obviously the difference from 38 years ago is substantial. And we know this TAX has been biting more people every year and so does Congress.
Obviously it should have been indexed from day one.

I think we need to better clarify what I mean by supply-side theory: the notion that demand is derived from supply doesn't work in theory. I explained my reasoning two posts ago.

My 2% to 1% wasn't suppose to be a sterling reconstruction bushes tax cuts. I merely wanted to demonstrate that, there comes a point on one side of the Laffer curve where the amount of growth needed to compensate for a tax cut becomes practically impossible to attain. Thus, the theory that taxs cuts will always generate more revenue from growth is unlikely.

This doesn't demonstrate anything except that, assuming the economy grows at 5% per quarter, the growth will eventually return the tax back to its 100% value four years before. It doesn't show that a decrease in taxes will lead to an extra amount of growth which will lead to more tax revenue than at the rate originally taxed. In order to do that, you would have use two different tax rates, and solve for the amount of extra growth. I will be back

Yes, you wrote the following:
I agree with the gist of this reasoning, however you are leaving out a component of the supply-side theory. Specifically, investing in greater production capacity reduces the cost of the pizzas overall and this can be passed on to the consumer. Lower costs will encourage more pizza purchases.


I understand the Laffer curve model (and agree with it). But, while your example demonstrates the problem with tax cuts, it is not realistic: no one would cut taxes in half (particularly from 2% to 1%). I was trying to add some realism to demonstration. Also, we are in complete agreement that tax cuts = more revenue from growth is unproven.

I suppose we're in agreement so much that this is becoming a vain technical point. I just think your model does not demonstrate the supply-side theory. The "tax cuts create more tax revenue" is a growth claim. The reasoning is that cutting taxes will increase growth so much that revenue receipts are larger than they were at the higher tax rate ((100)(0.15) is more than (50)(.20)). Its not making the claim that, given constant growth, a cut in taxes will eventually return to its previous gross level. That claim is valid for all tax cuts, even my 2% to 1% would eventually recover its gross receipt value, given constant growth. Using your numbers:

2000 = 1000(1.05)^X
2 = (1.05)^X
log(2)/log(1.05) = 14.207 years

Or, in 14 years at a 5% growth rate, the economy will hit 2000, at which point, the (.02)(1000) will equal the (.01)(2000) and will surpass it in value as the economy grows at its constant rate.

But supply-siders are making the claim that tax cuts lead to increased growth, so that the value of the tax receipt, even at a lower tax rate, is greater than the value of tax receipts at higher tax rates. In order to show this, let me slowly alter your model. Lets use your decrease of taxes by one-fifth, but, for simplicity, we will give numbers, from 10% to 8%.

Assuming constant growth of 5%, the 10% must obviously give more tax receipts than the 8%.

Year..........Growth..........Total Amount...............8%..........................10%
0...................-...................1000.......................80...........................100
1................1.05.................1050.......................84.............
..............105
2................1.05.................1102.5....................88.2............
.............110.25

And so on and so forth. As we can see, the 8% tax rate, for any given year, will never equal the 10% rate. The supply-sider would claim, however, that the 8% tax cut actually increases growth beyond 5%. In fact, they claim that it will increase growth by so much, that the lower 8% tax rate will actually give more gross tax revenue in any given year. How much more growth? Well, in order to just reach the same gross receipts as the 10% bracket in year 1, the economy would have to grow by about 31%:

105 = (1000)(.08)(X)
X = 1.3125

I suppose due to the magic of compounding, if a tax cut increased the growth rate consistently, year after year, the tax revenues would eventually match, but that would be some pretty amazing growth! While I do believe tax cuts stimulate growth, I don't think that they generate so much growth as to offset the reduction in the tax rate.

OK, now factor in the effects of the deficit spending used to offset the loss of tax revenue.....
--------------------------------------

BH, that was a great post. I'm glad someone was smart enough to do the math, because I'm too far removed from those classes to remember much of anything.

It is that aggravating claim - that lowering taxes will increase tax revenue - that drives me crazy about Reaganomics and its backers. When politicians trot out that promise, voters find the prospect irresistible, even if it means deficit spending to do it.

I suspect that a modest increase in taxes would have a surprisingly small negative impact on the economy. Who's up for that calculation?

The way I see it is: the economy would have to grow by 20% or (1 - 0.08/0.10) to compensate for the difference in tax revenue. Of course, the supply-sider would argue that the 10% rate has a 2% depressive (i.e. negative) effect on the potential economic growth rate. Either way, you are essentially correct, BecomingHuman.

That said, if the tax rate were at 50% and dropped to 45%, you would need (1 - 0.45/0.50) = 10% growth rate to compensate.

It's not a bad idea in principle, but I'm sorry $300-600 for most people is not going to stimulate the economy. With the threat of a recession (if we're not in one already), a smart citizen will save that money and not go out and buy an HDTV (which you probably couldn't do with $600 anyway). So this stimulus is based on a good idea but largely useless.

The key is to reduce taxes on the middle class, since if you put more money in peoples' pockets, they'll spend it, keep more money in circulation, which grows the economy. But the government is ignoring the problem that people aren't finding as good jobs as they used to. Hundreds of thousands of good jobs have been lost or shipped overseas (which in turn de-values the jobs left behind) , we're getting threats from illegal immigrants taking jobs, and the corporate friendly policies which cause a greater gap between the rich and poor. If more Americans had a chance to earn a good living, and you could lower taxes on the middle class while making the rich and corporations pay their fair share, that would go ten times farther than just giving a token $600 to people.

I'm not a diehard supply-sider but tax cuts can stimulate enough economic growth to pay for themselves if taxes are already so high (anything over a third is my best guess) that workers and companies cannot get ahead fast enough through work. The best illustration of this actually happening was with Ireland in the late 1980's. Reagan's cuts are another example, and this may not be enough to 'prove' it outright to you logo, but it's a great case study in favor of it.

Ireland basically went from being the 'beggars of Europe' to Celtic Tiger from 1985-2000. During the 1990's Ireland's GDP grew at over twice what the US's rate is. Their GDP per person is equal to the US's now and is higher than any other in Western Europe. Ireland's unemployment rate went from 19.6% to 4.5% in 13 years. They've attracted 1000 international company headquarters. Impressive stuff, and they've done it all while importing oil, electricity, and other other natural resources.

So how did they do it? They cut the corporate tax rate to 12.5% vs 30% or more from the rest of Europe and the US. They also cut government spending as % of GDP by cutting needless government entities like the "Health Education Bureau" and "National Social Services Board". The deregulated a lot of industry. Speaking English helped. Open immigration policies helped. Lots of factors, but most agree that without the tax incentives to draw businesses like Dell and Intel, and to encourage more work, then it wouldn't have happened. Something to consider.

Well I for one would rather have the money to spend as I choose rather than give it to government.

Below on the theory.


“Many early proponents argued that the size of the economic growth would be significant enough that the increased government revenue from a faster growing economy would be sufficient to completely compensate for the short-term costs of a tax cut, and that tax cuts could, in fact, cause overall revenue to increase.[2] Some assert this was borne out during the 1980s, when many supply-siders claim tax cuts ultimately led to an overall increase in governmental revenue due to stronger economic growth, although other economists doubt this claim.[3][4] In a 1992 article for the Harvard International Review James Tobin wrote, "[The] idea that tax cuts would actually increase revenues turned out to deserve the ridicule..."[5] But while few modern economists claim that tax cuts will completely pay for themselves, some empirical and theoretical research suggests that tax cuts do help to pay for themselves through increased economic growth. In 2006, for example, Trabandt and Uhlig find that "for the US model, 19% of a labor tax cut and 47% of a capital tax cut are self-financing."[6] Trabandt and Uhlig note that "a tax cut may not deliver a free lunch. But it often delivers a cheap lunch." Many other economists agree that the mechanism proposed by supply side economists does exist, although nowhere near as significant as early proponents had claimed.[7][8] Though such policies are associated with the Reagan Administration, the first implementation came under John F. Kennedy”

http://en.wikipedia.org/wiki/Supply-side_economics



And lets remember that, as we have all seen, the more of our money the Congress HAS the more they SPEND. So I contend that lower tax rates stimulate some growth and “help pay for themselves” AND keep our money out of the hands of people who are only too willing to spend it.

All true. But since tax cuts do not completely pay for themselves, tax cuts without spending cuts = more deficit spending. So don't forget that most of that money that is going back into your pocket is coming straight from the Big Credit Card.

Yes- that would be the crux of the GW and Reagan economic "plan" - it is really quite a bit worse than "tax and spend"-because with tax and spend, bad though it is - it isn't borrowing the money from a future generation to spend now- so the "reaganomics" would more acurately be called "borrow and spend"- since no president that "cut taxes" (though, really, Reagan just shifted the tax burden down- payroll taxes, whateverone on this board except those that are rich and own thier own companies - your taxes went up)- and each of those administrations, with exception of Clinton, cut taxes and INCREASED spending overall- With Reagan and GW spending the most of all, of any presidents, ever.

So the entire "Reaganomics" thing is just one of those ideological myths that some cling too, but have no basis in reality.

CR, this isn't exactly true. Go here to see National Debt vs. GDP for the past 60 years. As you can see, it was under FDR (not shown) when we incurred the most national debt. FDR (a Democrat) gave us a huge debt in part because of WWII and in part because of the New Deal. Truman, Eisenhower, Kennedy, LBJ and Nixon all paid down that debt. Ford gave us slightly more debt which Carter then paid down. Reagan and Bush the First gave us a huge debt bringing us back to Truman levels. Clinton paid down the debt back to Eisenhower levels. Dubya then brought our debt back to Eisenhower levels.

As I see it, for the past 70 years, these POTUSi gave us debt:

Debtor Presidents (in order of debt increase)
FDR (D.)
Reagan (R.)
Dubya (R.)
Bush I (R.)
Ford (R.)

Fiscal Conservatives (in order of debt decrease)
Truman (R.)
Eisenhower (R.)
Clinton (D.)
Kennedy (D.)
LBJ (D.)
Nixon (R.)
Carter (D.)

In terms of fiscal responsibility, Democrats for the win.

Hmmm, probably should have qualified it with "peacetime presidents- not of a fake, "wag the dog" type war either -

But the domestic spending bills were higher- IIRC under Reagan even, than under FDR- once you removed the WW2 costs IIRC- but I could be wrong- has been some time since I researched it last.

I agree that the best way to stimulate the economy is through tax cuts, which increases consumer spending. The problem with the Reagan plan (and Bush today) was that the plan was to give tax breaks to the corporations hoping it would "trickle down" by them creating new jobs. Problem was, they hoarded the money and used it to gain more power, which is one of the reasons between the gap between rich & poor today. The better idea is "trickle up" economics. People HAVE to spend money to survive, but businesses will only hoard it.