Monday, January 8, 2007

Facts on Supply Side Economics

An intelligent friend of mine, with little experience in economics, recently asked me to explain supply side economics to him. Specifically, he was curious about the belief of supply-siders that tax cuts actually pay for themselves by increasing economic growth.

Although I was able to confidently tell him that the economics I had studied refuted this claim, I was not able to do so in a convincing manner, nor was I able to readily cite specific economists or other authorities to back up my claim.

Now I can.

Gregory Mankiw, formerly the Chairman of President Bush’s Council of Economic Advisors, recently made a statement estimating that cuts in capital gains taxes only recoup 50% of the revenue they lose – even over the long-term when investment and resulting economic growth are included. Cuts in income taxes do even less, he said – recouping only 17% of the revenue they cost.

If you are in need of a second source, the Congressional Budget Office recently released its own estimates. To quote the Washington Post article that provided the figures:

“On the most optimistic assumptions it could muster, the CBO found that tax cuts
would stimulate enough economic growth to replace 22 percent of lost revenue in
the first five years and 32 percent in the second five.”

These numbers speak for themselves and I would contend they are as reliable as any other set one could find.

The President recently disagreed with this assessment, "…it is also a fact that our tax cuts have fueled robust economic growth and record revenues."

He did not cite who or what institution provided him with his analysis.

I obtained my quote from Mankiw and the CBO from this editorial.


Bryan said...

Interesting article Jared. I think the President is an eternal optimist. I find supply-side economic theory very compelling in certain conditions. However, the big question is whether or not we are experiencing economic conditions that lend themselves to supply-side tactics. I trust the markets to drive change and always get nervous when the government tries to manipulate the economy. The government definitely has a responsibility to oversee the economic big picture. However, the government is made up of politicians, and politician too frequently go with the theories that lead to them gaining power. I hope both sides can develop more respect for the other parties ideas. Here is an another interesting article that discusses this issue.

Bryan said...
This comment has been removed by a blog administrator.
Bryan said...

Here's another attempt at inserting
the link to the article

Unknown said...


I wonder if this question is about perspective and whether it has to do with the Laffer Curve - meaning, if we are above the optimum point on a particular tax on a certain group, lowering the tax would increase revenue and vice versa?

Jared said...

Chris - You are right. I shouldn't have categorically railed against supply-side economics without citing the Laffer Curve. For other readers, you can get a summary of the Laffer curve here:

Basically, the Laffer Curve claims that at a certain tax rate and insitutations, lower taxes can increase overall revenues. This principle is primarily true when tax rates are high enough to actively discourage additional economic activity and innovation. So with respect to this post, you need to ask yourself if 2000 tax rates were high enough to materially restrict economic activity in one or more sectors.