Supply-side economics

["David Shemano" <dshemano@xxxxxxxxxx>]

>Supply-side is very much alive -- Robert Mundell recently won the Nobel
>prize, for goodness sake!    George Gilder is the guru of the internet.
>Lawrence Lindsey, Bush's top economic advisor, is a supply-sider.
>Personally, I am a big-fan of supply-side theory, and if I don't get a big
>tax cut from Bush, I'm voting for Nader next time.

It would be interesting to see your defense of supply-side economics,
David. What is the logic behind it? How do supply-siders deal with the
conflict between income and substitution effects that occur with both labor
supply and saving behavior? What evidence is there for the supply-side
view, besides taking credit for Keynesian demand-side stimulation?

--------------------------------

I am not a professional economist, so let me preface this by saying that if
you are really interested in supply-side theory, by all means check out Jude
Wanniski's website -- http://www.polyconomics.com/ -- as often as possible.
It is an excellent website.  Wanniski is a quirky guy and many of you may
find yourself in agreement with certain of his points -- he is quite
respectful of Marx, for instance, and thinks the IMF screws up whatever it
touches.  He also thinks US foreign policy in Serbia and Iraq is wrong, but
that is off-point.

Jim asks a very fair question, one that is typical of the criticisms of
supply-side theory.  Supply-side theory assumes that if you cut tax rates,
that will incentivize people to increase labor, production, savings (or
whatever is being taxed).  However, if tax rates are cut, which means that
after tax income goes up and individuals reach a targeted income level with
less labor, won't the individuals substitute leisure (or consumption, if the
tax on savings is reduced) once the targeted income level is reached, rather
than increasing labor, savings, etc.?

I don't doubt that there are examples of conduct that support Jim's view.
But we are talking at the macro-aggregate level, and supply-side theory
assumes that at that level if you tax something, you get less of it, and if
you subsidize something, you get more of it.  This is both a theoretical
assumption, and a testable hypothesis.  A key component of the theory and
hypothesis is where the marginal rate is.  At very low levels of marginal
taxation, Jim's argument probably is correct, because at low enough levels
taxes are not a measurable wedge to economic activity.  However, as the
marginal rate increases, supply-side theory assumes human behavior changes.
At a certain point, a worker will say the hell with it and go to the beach.
At a different point, a worker will say the hell with it and take his wages
off the books.  Conversely, the opposite is true.  If marginal rates start
too high and then are reduced, likewise behavior will change.  The worker
will agree to work extra hours or to assume added responsibilities for added
pay.  Individuals engaged in tax avoidance will change strategy and engage
in taxable activity.

Supply-side, as a theory, does not claim to know whether any specific tax
rate is optimum.  All that it claims is that marginal tax rates, and changes
in marginal tax rates, affect human behavior as described above.

Like all economic theories, supply-side is hard to test because there are so
many economic variables.  Probably the best test case for supply-side was
the individual tax rate cuts in the early 1980s.  Supply-siders were the
only ones I am aware of that accurately predicted: (1) growth would
increase, (2) tax revenues would not be reduced, and (3) inflation would not
increase.  The Keynesians certainly thought that the tax cuts would be
inflationary.  Unlike Keynesians and other demand-side economists,
supply-siders think the Phillips Curve is a hoax and  accurately predicted
that a decrease in unemployment would not cause an increase in inflation.
Supply-siders disagree with Alan Greenspan and do not believe that growth
causes inflation. In general, inflation is viewed strictly as a monetary
phenomena.

I hope this partially answers your questions.

David Shemano