Two recent reports help explain supply-side economics, its logical inconsistencies and its failures in practice. One is "Take a Walk on the Supply Side: Tax Cuts on Profits, Savings, and the Wealthy Fail to Spur Economic Growth" by Michael Ettlinger of the Center for American Progress and John Irons of the Economic Policy Institute. The report spends some time pointing out how supply-side economics is questionable even on a theoretical level. Do we really know that tax cuts always result in more work or more savings? What if you have a certain earnings goal or savings goal and you have to work or save less to reach that goal as the result of a tax cut? And how do we know more savings would mean more investment? Couldn't it lead to investment overseas, or maybe lower consumption which could in turn be harmful to the economy?
But things get even more interesting when Ettlinger and Irons look at the empirical evidence to compare economic performance after supply-side tax cuts during the Reagan and Bush II eras to economic performance after the deficit-reduction policies in the Clinton era. They look at the evidence in two ways: first, measuring economic indicators in a period immediately following the introduction of the new tax policy, and second, measuring economic indicators during the first economic expansion to take place after the introduction of the new tax policy. Investment is found to be stronger during the Clinton era than during the two supply-side eras. The same goes for GDP growth and several other indicators.
The second report is "Tax-Cut Snake Oil: Two Conservative Theories Contradict Each Other and the Facts," by Jeffrey Frankel at the Economic Policy Institute. Frankel adds to our understanding of the supply-side theory and the evidence that has discredited it after the tax cutting under Reagan and Bush II. He also adds a lot of interesting information about the key players involved. For example, he provides quotes from economists who worked for Reagan and George W. Bush saying that tax cuts cannot lead to increased revenues, as well as quotes of their bosses saying that they can.
But Frankel describes another development in the anti-tax movement that sits very strangely with supply-side economics: the "Starve the Beast" hypothesis put forward by many conservatives that cutting taxes will reduce revenues, run up deficits, and force politicians to shrink government. (This is put forward by those who believe shrinking the government would be inherently good.)
Frankel points out that it's not at all obvious why lawmakers would feel more constrained from spending under such a regime. Clearly, if constituents are told that increased spending might require tax increases now to pay for it, that might give some pause. But if taxpayers are told that increased spending will result in some future tax increase, that is surely less threatening to constituents and those who depend on their votes, and so there might be less pressure on lawmakers to limit spending. This is exactly what happens under the supply-side regime as deficits soar as a result of tax cuts. And of course, as Frankel points out, the Starve the Beast hypothesis should now be discredited by the explosive spending in the Reagan and Bush II eras.
Most amazing of all is that these two ideas -- cutting taxes is OK because it will lead to increased revenues, and, cutting taxes is good because it will lead to decreased revenues and thus smaller government -- somehow coexist within the same anti-tax movement.