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Burying Supply-Side Once and for All

By Neera Tanden
from Summer 2013, No. 29 – 11 MIN READ
Tagged Middle Class

https://democracyjournal.org/magazine/29/burying-supply-side-once-and-for-all/

it’s time for conservatives to go back to the drawing board and come up with a reality-based economic agenda.

Amazing the consistency, the breadth in how non-reality grips conservatives on economics, science, history, during Sarah Sanders' press briefings and anytime Kellyanne Conway's lips are moving.

If you are going to base all your efforts to win political power on a single economic theory, as conservatism has over the last 30 years, you might want to make sure it works. But that’s what’s so surprising about supply-side economics: Despite the fact that its central claim has been belied by decades of economic experience, it persists.

Supply-side economics assumes that lower tax rates boost economic growth by giving people incentives to work, save, and invest more. A critical tenet of this theory is that giving tax cuts to high-income people produces greater economic benefits than giving tax cuts to lower-income folks. Essentially, the more money the rich are able to keep, the more the whole economy will grow.

But the evidence reveals two fundamental problems with this story. First, its primary prediction is wrong—giving tax cuts to the rich does not increase economic output or create new jobs. Instead, tax cuts for middle- and low-income taxpayers are much more effective at boosting macroeconomic activity.

Second, supply-side theory misunderstands the actual mechanism by which tax rates influence macroeconomic activity. While supply-siders maintain that lower rates at the top incentivize people to earn more money, the evidence shows that tax cuts boost output mostly by putting money in people’s pockets and thereby stimulating demand.

These empirical findings carry an important lesson for our tax policy: Rather than increasing inequality by throwing away revenue on tax cuts for the rich, we should ensure that middle- and lower-income Americans have enough after-tax income to maintain strong consumption levels, especially during economic downturns.

Moreover, by perpetually fetishizing tax cuts for the top rates, conservatives have disregarded other policies that are more effective at spurring economic growth. Given the mounting evidence against supply-side economics, it’s time for conservatives to go back to the drawing board and come up with a reality-based economic agenda.

Beyond Supply-Side

All this empirical work carries at least three important lessons for policy-makers.

First, giving new tax cuts to rich people is a very bad idea unless your goal is simply to make rich people richer. Unfortunately, supply-siders’ decades-long fixation on cutting top tax rates has done just that, thereby exacerbating economic inequality. We know that America’s hyperinequality is deeply unfair and that it is reducing upward economic mobility, corroding our democracy, and eroding social cohesion. But as the other contributors to this symposium make clear, widening inequality also poses a serious threat to America’s future economic growth.

Second, we could raise top marginal tax rates quite a bit without reducing future growth or job creation. Such a policy would have the dual benefits of raising badly needed revenue while also mitigating inequality.

Third, targeted tax cuts for lower-income Americans, especially refundable tax credits like the earned-income tax credit, can be a powerful way to boost the overall economy. This is especially true during recessions when aggregate demand falls and people are unemployed for extended periods of time. Under these circumstances, as Larry Summers and Brad DeLong have recently argued, fiscal stimulus can significantly improve long-term growth by getting the economy moving again and thus preventing lasting damage to the productivity of workers and physical capital.

But in addition to distorting American tax policy, perhaps the most troubling legacy of supply-side theory is that it has led generations of conservative politicians and policy-makers to obsessively focus on tax cuts as the tool to promote growth, to the exclusion of many others.

This myopia has been especially harmful because tax cuts have significant opportunity costs. For instance, by reducing government revenue, they can crowd out high-return public investments in areas like education, scientific research, and infrastructure. These investments are critical to America’s long-term growth and we shortchange them at our peril.

Supply-side theory also fails to address the most pressing challenge the American economy has faced since 2008: namely, insufficient demand to foster economic growth. In a world where people don’t have enough money to buy things and thereby create more demand for goods, a policy that focuses attention on tax cuts for people who are not going to spend them is ineffective at best.

While progressives may not have all the answers to achieve equitable growth, conservatives have the wrong answers. If conservatives are serious about promoting economic growth and prosperity, they need to stop fetishizing tax cuts and start proposing policy ideas that are based on actual facts. Indeed, history would tell us that investing in the middle class and those who want to rise into it is the best long-term economic growth strategy.