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Thursday, September 22, 2005

Take a walk on the supply side

Take a walk on the supply side

She says, hey babe, take a walk on the supply side
Said, hey babe, take a walk on the supply side
And the entrepreneurs go

Op, op, op, op-portunity, ty, ty opportunity….

More than thirty years ago while still in high school I had a fascination with stock and futures markets. One thing which became clear to me was that the ideas and logic presented in the financial press had little to no correspondence with what actually happened. As I delved deeper into both economics and markets it seemed even worse than this - even after the fact explanations being offered were essentially garbage.

I was never a Leftist, but was too much of a liberal to ever vote for Ronald Reagan. However, by the end of his second term it was clear to me that Reagan had the better of it in the economic arguments with his critics. It was another few years until the breadth of my reading brought me to the works of authors propounding the supply-side ideas championed by Reagan.

Excerpts below are from this article by Bruce Bartlett.

An era ended on August 30 when Jude Wanniski, who did more than anyone else to popularize supply-side economics, died at age 69.

Jude’s real achievement was to recognize the importance of, and political potential for, the ideas that underlay supply-side economics. The originator of those ideas — at least in the modern sense — was economist Robert Mundell, later a winner of the Nobel Prize in economics, who first articulated them in 1971.

At the time, stagflation was the world’s biggest problem. Most economists said that the most important way to fix this scourge of inflation and slow growth was to reduce the budget deficit — by raising taxes if necessary. Mundell said this was nonsense. Inflation has nothing to do with budget deficits, he said; it is solely the result of an easy money policy by the Federal Reserve. And slow growth is primarily caused by excessive tax rates. So raising taxes to balance the budget is worse than doing nothing. It would make the problem worse.

Typically, Jude was not content simply to report a new idea. He proselytized for it. He was responsible for bringing supply-side economics to the attention of Bob Bartley, then editorial page editor of the Wall Street Journal; Irving Kristol, a New York University professor affiliated with AEI; and Kemp, who was then a congressman from Buffalo, New York.

Unfortunately, Jude put the same effort into advocating some bad ideas as he had for some good ones. In recent years, he became convinced that Saddam Hussein was innocent of the charges against him, and he looked ridiculous even to those who opposed the war in Iraq as strongly as he did. Jude also maintained a close relationship with Louis Farrakhan of the Nation of Islam, despite the latter’s frequent anti-Semitic ravings.

The excerpts below are from a terrific article by Bill Kucewicz. They contribute to a good example of some supply side angles on the 1990's. The graphs are a must see.

Frankly, Democrats haven't been able to fashion a credible economic policy since the Phillips Curve bit the dust. The Keynesian party now claims, for example, that balanced budgets (and not deficit spending) are the sine qua non of economic growth.

It's a ruse, of course. If the Democrats were serious about balanced budgets, they'd speak not only of tax hikes but also spending cuts. Instead, they are using the balanced-budget argument as a means of keeping money in Washington in the belief that the indefinite expansion of government, both in scope and size, is their surest way of securing and maintaining political power.

Fact is, most Democrats are willing to sacrifice jobs and business creation in order to keep the federal government's take of the national economy large. Their income-tax policies actually aim to swell the federal treasury at the economy's expense.

An economy depends on the availability of financial capital to fund new ventures, transform ideas into reality, and raise productivity. Pumping in investment capital thus creates new jobs, boosts real wages, and ups living standards.

But Washington's tax-and-spenders ignore financial capital's crucial role. They treat this money as if it can be taxed away from individuals (and corporations) with impunity.

Nothing could be farther from the truth. The propensity to invest rises with income. Indeed, there appears to be a threshold level, perhaps around $70,000 a year, at which households seriously begin to invest significant amounts of earnings. Those making less money typically spend most, if not all, of their income on consumption.

But economic growth isn't driven by consumption; it's driven by production. And production requires two types of capital — i.e., labor capital and financial capital. When Washington siphons off significant amounts of financial capital through taxation, the economy is less able to employ the other form of capital, namely labor. Which helps explain why the U.S. slips into recession whenever the tax burden becomes too great.

The lesson of the '90s then is that the forces of technological and demographic change were so strong as to overcome the negative consequences of the 1993 tax increases. The economy boomed despite the tax hikes, not because of them.

The increasing tax burden couldn't be shouldered forever, and the economy hit a wall after federal tax receipts as a percentage of nominal GDP reached a record 21.1 percent in the first quarter of 2000. (Since the end of World War II, the average has been 18.1 percent.) Year-on-year GDP growth fell from 4.9 percent in the second quarter to 3.5 percent in the third and 2.2 percent in the fourth quarter of 2000 — and continued sliding into the 2001 recession.

Higher tax rates don't grow an economy; high levels of investment do. And one is antithetical to the other.

Some of the better supply-siders said that the 1993 tax hike would cause problems later as the burden rose, but that since the tax on capital gains was not raised at the time things would be ok.

I have studied many strains of economic thought including Keynesian, Austrian and an updated version of Classical economics dubbed Supply-side. It's been a valuable source of good ideas!


johnt said...

I would have to do a quick re read but I think the first supply sider was Jean-Baptiste Say. Regarding tax rates,two thoughts; even with the hikes of '93 rates were considerably lower than pre Reagan,liberals didn't have the muscle to suffocate the economy much as they would have liked. Secondly,if economists would dispense with the five thousand word essays for a while they might consider a most elementary idea, the people are the economy,mom & pop stores,huge corporations,the small investor,the billionaires,the whole lot of us. If the people,crowded under the heading of free enterprise,have more money guess what? Here I think your guess will be quite the same as mine. A side note; in late December '93 while Hillary's health care plan squatted on Cogress and the nation like a giant toad,a cautious and low drumbeat was started on behalf of a value added tax. Two articles were front paged in the NT Times over three weeks,amost identical. Hymms were sung to the glories and promise of an additional finacial savior,unnamed Administration sources were quoted as expressing keen interest,the groundwork was being laid,soon millions of liberals would have taken to the streets screaming for a VAT and denouncing cold hearted rightists. Then the health care plan collasped,Hillary blamed Bill and probably hit him with a lamp and the Clintonistas awaited the arrival of Field Marshall Dick Morris to instruct them on being politicians and centrists. Remember,this was 3 months after our 2nd federal tax increase in two years. A window to their souls.

Joe said...

I love the Kucewicz quotes, especially this one: "[Democrats] are using the balanced-budget argument as a means of keeping money in Washington in the belief that the indefinite expansion of government, both in scope and size, is their surest way of securing and maintaining political power."

Alas, this criticism is no longer true just of Democrats. It's enough to make small-gov't types despair.

Bret said...

Nothing's changed. The party out of power always favors federalism and fiscal restraint (since the money won't be spent on their projects anyway) and the party in power always favors a big federal government and lots of spending. That's just human nature.

The difference is that Democrats prefer taxation and republicans prefer debt. I prefer debt and I'll eventually explain why in an essay I've been working on for over a year (and I'm counting on you to read it and give me feedback).

Small gov't types should always vote for split government. My preference is for a Democratic President and a republican congress. Government might not shrink, but the rate of expansion might be constrained.

Howard said...

touche' John - I didn't go into an explanation of Say's Law (supply creates its' own demand) which is a corollary of his supply-side ideas - very impressive!

jr - I too used to despair over ever seeing smaller government. Most of the electorate does not focus on that - the way to get there is with a flatter tax structure(flat or national sales tax) and to redirect social spending and entitlements towards ownership and empowerment...
Any progress in that direction should be welcomed - perhaps our children will get to enjoy...

Joe said...

I completely agree that Rate of Expansion is a metric that deserves more attention when evaluating the success of our governors.

You're right, of course, that the parties exist to serve themselves, and that one-party rule = one party helping themselves at the trough.

When splitting, I agree with your bias toward Rep. congress/Dem. presidency, and more hesitantly agree with favoring debt over taxation. The caveat, of course, is "how much debt is too much?" When debt is vastly out of proportion with taxation, doesn't the one thing inevitably turn into the other...?

I'm already looking forward to your post on the debt/taxation balance. Keep up the good work, guys!