August 15, 1996
SUPPLY SIDE ECONOMICS IS FOR REAL
We all know how it goes: "The eighties proved that supply side economics not only doesn't work, but is very dangerous. The deep Reagan taxcuts of 1981 tripled our national debt as annual deficits over $200 billion became routine. We simply cannot afford to go down that path again."
Supply side economics is not very new. It goes back at least to the eighteenth century and it is associated with such names as Adam Smith, James Mill and Jean Baptiste Say. Its central tenant is that the wealth of a nation depends on the quantity and quality of productive activity in it. Wealth is not pictures of George Washington. Rather, it consists of a pattern of production of real goods and services that meets the interests, wants and needs of the broad general public. All people -- entrepreneurs, skilled and unskilled workers, capitalists, and landowners -- undertake productive activity. Supply side economics focuses on ways to get people to choose to undertake more of it rather than less of it.
In other words, supply side economics is the economics of producing real good and services. Logically production must come first. Unless you are a thief, you cannot get what you want from another person unless you have something to supply to him in exchange. Whether it is labor services, capital goods, natural resources, or finished products we all must supply something before our demands can be effective. In sum, supply (production) is the source of demand.
One obvious way to encourage people to produce more is to allow them to keep more of what they produce so that they can use it for their own purposes. Cutting marginal income tax rates is an obvious way to do this. This is true whether or not the increased productive activity expands the tax base so much that more tax revenue is collected after the rate cut that before it. (Actually, experience during the 1920s, the 1960s and the 1980's indicates that from forty to fifty percent of the losses of tax revenue due to rate cuts are made up by increases in the tax base directly tied to the rate cuts). The main point of supply side economics is not to increase government revenues. It is to increase real productivity activity.
It is also to pursue social justice. While many enemies of supply side economics think that social justice is served if some wealth is taken from person A and transferred (minus substantial bureaucratic costs) to person B, most supply siders think that social justice is served by letting people who create the wealth decide for themselves how to use it. Note that the transfer theory of social justice implies that justice is served when a wallet of a rich person is stolen by a poor person.
But back to the eighties. It is true that deficits, and therefore the national debt skyrocketed during the decade. But that is because of (1) the large increases in defense spending that, in the end, were successful in defeating the Soviet empire, (2) a recalcitrant Democratic Congress that refused to cut non-defense spending and continued to invent new ways to spend other people's money, and (3) an increasing regulatory burden imposed on the economy.
Unlike Reagan's tax rate cuts, Bob Dole's fifteen percent across the board income tax rate cut will balance the budget. At least forty percent of tax revenue will be regained by a direct expansion of the tax base, and there is no longer any need to undertake a large military buildup. More importantly, if President Dole has a like-minded Congress to work with, real federal spending can be cut. For example, along with the departments of energy and commerce, the departments of education and housing and urban development can be terminated. Both the Cato Institute and the Heritage Foundation have extensive lists of useless government spending that ought to be eliminated.
Supply side economics is all about getting the producers of America -- the entrepreneurs, the workers, the savers and the investors -- to be more productive. One very important part of that endeavor is to lift the heavy burden of regulation from the economy. In my judgment, Bob Dole's promise to subject all existing and new regulation to serious cost-benefit analysis and to discard all regulations that don't past the test will breathe more life into the American economy than his fifteen percent tax rate cut. Federal regulations cost Americans at least $700 billion each year. That is almost $7000 per household per year. And most of the regulations cannot pass a realistic cost-benefit test. Consider OSHA controls on formaldehyde. They cost $119 billion per life saved. As Doug Bandow reports, "Pharmaceutical companies could develop 331 new drugs for the money necessary to save one person with the formaldehyde restriction." Lift this burden, along with the $132 billion per year excessive litigation tax, and the tax base will indeed grow enough to balance the federal budget by 2002.
Charles W. Baird, Director