If Today's Problems Are the Question, Supply-Side Economics Isn't the Answer

by: Mark Sunshine

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.