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| Supply side economics is, as its name suggests, concerned with policies affecting the aggregate supply curve. You will recall that in the classical model the level of aggregate supply is determined by the supply of, and demand for, labor, and the amount of capital in the economy. Supply-side economics is concerned with the impact of economic policy on these variables. |
| Despite all the vicious rhetoric you may have heard about supply side economics, and the vicious rhetoric you will see in the readings below, there is nothing dramatic about supply side economics. All economists understand that incentives matter: taxes on investment lower the amount of capital in an economy, and that makes it harder to turn labor into goods and services; taxes on wages reduce the incentive to work; welfare payments reduce the incentive to look for a job; social security contributions, minimum wage legislation, and corporate profits reduce the incentive for firms to hire workers. |
| But at the same time, the government has services to provide. It needs to tax, to raise revenue, to support the provision of these services. Non-distortionary taxes, such as the poll tax proposed by Prime Minister Thatcher in the late 1980s, have been rejected as politically unacceptable. Similarly, Forbes' flat-tax proposal also made little headway. So we are going to have distortionary taxes, and the provision of government services is going to have incentive effects. |
| Supply-side economics is concerned with the simple question of how big these incentive effects are. How costly, in terms of foregone output it it to raise a dollar of tax revenue? |
| This mundane empirical question has become the center of a major political storm that has gone on largely unchecked for over 20 years. Beginning in the mid-1970s, some economists (particularly Arthur Laffer and, to a lesser extent Robert Mundell) and economic journalists (particularly Jude Wanniski, then associate editor of the Wall Street Journal) made the argument that the incentive effects of taxes were so large that one could raise tax revenue by lowering tax rates. Although the majority of academic economists rejected the proposition, the so-called supply-siders won the ear of the Reagan presidential camp. So the empirical debate becomes central to fiscal policy and, before you know it, it becomes central to one's attitude to government in general, the role of the nuclear family, and the meaning of life. |
| The readings below collect a couple of pro-supply side arguments, both by Jude Wanniski, and rather more from the 'conventional' camp. One reading in the latter group -- by Steve Kangas - presents some data that might help you make up your own mind. Kangas has strong opinions about the debate, which you may or may not agree with, but his numbers are copied correctly from official sources. Other readings in the 'conventional' camp are by Nouriel Roubini, who maintains a very good web site at the Stern School of Business at NYU, and by Paul Krugman. Many of you will be familiar with Krugman: a brilliantly original academic economist, a witty writer with an entertainingly bad temperament, and an unfortunate predilection for immature personal attacks. |
| Politics is important in this debate. But so, unfortunately, is a rather trivial set of personal snipes. In attacking Mundell's association with the supply-siders (but not his receiving the Nobel prize for unrelated work in 1999) Krugman notes in one essay that at one point Mundell had long hair, and somehow this was relevant to his reliability as a mainstream economist. Jude Wanniski writes, in an open letter to (former labor secretary) Robert Reich, "I would embarrass [Reich] . . and he would no longer be considered the new guru on the block." |
| All this makes for entertaining reading. But remember, no matter the political importance of the answer, the debate is about a mundane empirical issue that really should be the domain of some dull and reliable econometricians. |
| Perhaps I should make an apology for the extra weight given to the 'conventional camp'. But I won't. I belong there, although I can't say I lose much sleep over divergent estimates of the elasticity of the tax revenue with respect to changes in the tax rate. It also turns out to be quite difficult to find reliable writing that takes the position espoused by Wanniski. In fact, Wanniski writes himself that his internet site "really is the only place in the world where individuals can learn supply-side political economics." |