What is Supply-side Economics?

A Short History

What is Supply-side Economics?

​Supply-side economics. Since its conception in the 1970s, debating its merits – or lack thereof – has been at the heart of political discourse, demarcating Republican from Democrat, Tory loyalist from Labour devotee, and informing not just an economic outlook, but a world view. 

Its defining feature lies in the assumption that production, rather than demand, is the primary factor in creating and sustaining economic growth. To that end, its proponents advocate the lowering of taxes and removal of regulation. Less taxation, they claim, means more profits for businesses. Then, freed of red-tape and compelled by self interest, those businesses can reinvest their increased earnings to generate a larger supply of goods and jobs. It’s thus that the economy grows - tax cuts pay for themselves.

Redistributing wealth by this means, creating circumstances advantageous for businesses and allowing wealth to 'trickle down', is thought meritocratic, ensuring an equity and efficiency that state intervention simply cannot match. Such conviction places it in direct opposition to Keynesianism, which, anticipating fluctuations of aggregate demand and inefficiencies in the market economy, prescribes an active government that intervenes in economic activity using fiscal and monetary stimuli to help manage moments of instability.

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Reaganomics and the emergence of supply-side

Keynesianism served as the standard economic model from the Great Depression onwards. But, its appeal began to fade in the 1970s, as it struggled to arrest the declining growth and rising inflation - known as stagflation - that plagued many advanced economies. Sensing an opportunity, neoliberals stepped in, pushing supply-side principles as the antidote.

Most famously, the new theory became the bedrock of ‘Reaganomics’ - the economic policy pursued by the United States' first celebrity president - and since then, it’s remained highly favored, despite being shrouded in controversy. As journalist Bill Flax has described, ‘the notion that tax cuts increase tax receipts circled the globe, and was ultimately tried in such previously unimaginable locales as Euroland, Russia, India and China’.

Its theoretical underpinnings and apparent authority derive from the infamous ‘Laffer Curve’, a graph accredited to conservative economist Arthur Laffer. Laffer’s legend began in 1974, at a late-afternoon meeting at the Two Continents Restaurant in Washington. He had been summoned by senior government advisers Donald Rumsfeld and Dick Cheney, and was protesting President Ford’s proposed tax increase that aimed to check the spiraling deficit. It was there, under the expectant gaze of these two Republican stalwarts, that he (allegedly) first sketched his economic vision, quite literally, on a napkin. With just a few strokes of his pen on a crumpled, coffee-stained serviette his curve came to life and the complexities of the tax system were distilled into one small graph.

Despite its inevitable imprecision – the setting did not lend itself to mathematical theorizing – his company was impressed, Cheney, especially, readily converted. And with their endorsement, Ford’s proposals were reversed and the theory was assimilated into the Republican Party policy-making machine. By the time of Reagan, it had become its economic orthodoxy. 

Supply-side economicsThe curve professes to plot the relationship between levels of taxation and government revenue. At one end, where the tax rate is 0%, revenue is zero. No surprise there. At the other, where the tax rate is 100%, the revenue is also zero - for people are presumed not to work without take-home pay. The interesting bit is the inverted U in the middle. Somewhere on the continuum, Laffer argues the existence of a ‘tipping point’, where the incentive to work and invest quickly decreases once tax rates cross this threshold. Explaining his already rather simple model, Laffer declared, ‘tax something, and you get less of it. Tax something less, and you get more of it’. 

As an actual tool, the curve is more theoretical than practical. Its claim of where the tipping point lies is non-specific, a vagueness that’s been one of its greatest utilities. In the hands of a government intent on tax cutting, the tipping point can easily be adjusted to ‘justify’ cuts, and prove that any loss in reduced tax revenue will be offset by an increase in growth.

Big business was immediately taken by the idea, sensing how much it stood to benefit from the curve’s ‘versatility’. Persistent Republican loyalty, on the other hand, is harder to explain, existing in the face of mounting evidence suggesting the curve’s ineffectiveness. Whether a genuine belief in its efficacy or a cynical intellectual cover for vested interests, its motivation is a hard one to discern.

Repeated failure

Indeed, the evidence of supply-side economics' failings is persuasive: US tax cuts in the last 40 years have not been self-financing as promised. Reagan’s cuts, deep as they were, resulted in ballooning national debt, and although the economy grew in the mid-80s as it recovered from recession, there was little to no sustained economic improvement for most Americans. Instead, wealth concentrated at the top and inequality grew. By the end of his government, and after almost a decade of his economic policy, middle-class incomes were the same as they had been 10 years before; poverty rates had actually risen; and there had been no marked productivity growth.

George W. Bush began his presidency in similar fashion introducing big tax cuts for the rich, promising that all would benefit and that wealth would trickle down. Rather than trickling down, however, the dividends flowed upwards, and by 2005, the top 1% had seen their after-tax household income increase by 80% compared with 1979, an increase over 10 times quicker than that experienced by the bottom 25%. As Bush left office some 4 years later, wages were lagging far behind inflation, living standards were stagnating, and employment growth was quickly falling - a stark contrast to the booming Clinton years. The optimism of the 90s had well and truly died.

Old dogs, old tricks

Obama’s administration made some modest attempts to better balance the tax burden, and estimates suggest the richest 1% paid more in tax in 2013 than they did in 1980. But it didn’t last. Any progress that had been made was quickly reversed, when, in 2017, Trump rolled out sweeping nation-wide tax cuts predicted to cost $6.2 trillion in just 10 years. According to economist Paul Krugman, these included ‘a cut in top individual tax rates; a cut in corporate taxes; and an end to the estate tax’. All, he was convinced, would ‘overwhelmingly benefit the wealthy, mainly the top 1 percent.’ The cuts also added more to the national debt than any other single American tax bill in the past three decades, sparking fears of future cuts to social security and Medicare, on which so many rely.  

In spite of the majority of economists standing in staunch opposition, supply-side economics remain inexplicably influential, central to the running of the world’s largest economy. And we shouldn’t forget that Trump’s endorsement is no outlying opinion; it's the glue that’s holding the Republicans together. The party that historically has prided itself on its empiricism now seems blind to evidence. Remember, doing the same thing over and over and expecting a different result is said to be a sign of insanity. Which prompts the question: what do they think has changed? With the answer unclear, the charmed life of supply-side continues.

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