Re: Supply-side economics

[Michael Perelman <michael@xxxxxxxxxxxxxxxxx>]

David, most of us here are familar with supply side economics.  The evidence to
support is is very thin.  Some people support it because they like the politics,
but I have not seen any economist try to defend it to the general population of
economists.

David Shemano wrote:

> >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

--

Michael Perelman
Economics Department
California State University
Chico, CA 95929

Tel. 530-898-5321
E-Mail michael@xxxxxxxxxxxxxxxxx