N.B. This material is NOT required reading.
However, some of you may find it interesting.
|
| Supply side economics is, as its name
suggests, concerned
with policies affecting the aggregate supply curve. You will recall
that
in the classical model the level of aggregate supply is determined by
the
supply of, and demand for, labor, and the amount of capital in the
economy.
Supply-side economics is concerned with the impact of economic policy
on
these variables. |
| Despite all the vicious rhetoric you may have
heard about
supply side economics, and the vicious rhetoric you will see in the
readings
below, there is nothing dramatic about supply side economics. All
economists
understand that incentives matter: taxes on investment lower the amount
of capital in an economy, and that makes it harder to turn labor into
goods
and services; taxes on wages reduce the incentive to work; welfare
payments
reduce the incentive to look for a job; social security contributions,
minimum wage legislation, and corporate profits reduce the incentive
for
firms to hire workers. |
| But at the same time, the government has
services to
provide. It needs to tax, to raise revenue, to support the provision of
these services. Non-distortionary taxes, such as the poll tax proposed
by Prime Minister Thatcher in the late 1980s, have been rejected as
politically
unacceptable. Similarly, Forbes' flat-tax proposal also made little
headway.
So we are going to have distortionary taxes, and the provision of
government
services is going to have incentive effects. |
| Supply-side economics is concerned with the
simple question
of how big these incentive effects are. How costly, in terms of
foregone
output it it to raise a dollar of tax revenue? |
| This mundane empirical question has become
the center
of a major political storm that has gone on largely unchecked for over
20 years. Beginning in the mid-1970s, some economists (particularly
Arthur
Laffer and, to a lesser extent Robert Mundell) and economic journalists
(particularly Jude Wanniski, then associate editor of the Wall Street
Journal)
made the argument that the incentive effects of taxes were so large
that
one could raise tax revenue by lowering tax rates. Although the
majority
of academic economists rejected the proposition, the so-called
supply-siders
won the ear of the Reagan presidential camp. So the empirical debate
becomes
central to fiscal policy and, before you know it, it becomes central to
one's attitude to government in general, the role of the nuclear
family,
and the meaning of life. |
| The readings below collect a couple of
pro-supply side
arguments, both by Jude Wanniski, and rather more from the
'conventional'
camp. One reading in the latter group -- by Steve Kangas - presents
some
data that might help you make up your own mind. Kangas has strong
opinions
about the debate, which you may or may not agree with, but his numbers
are copied correctly from official sources. Other readings in the
'conventional'
camp are by Nouriel Roubini, who maintains a very good web site at the
Stern School of Business at NYU, and by Paul Krugman. Many of you will
be familiar with Krugman: a brilliantly original academic economist, a
witty writer with an entertainingly bad temperament, and an unfortunate
predilection for immature personal attacks. |
| Politics is important in this debate. But so,
unfortunately,
is a rather trivial set of personal snipes. In attacking Mundell's
association
with the supply-siders (but not his receiving the Nobel prize for
unrelated
work in 1999) Krugman notes in one essay that at one point Mundell had
long hair, and somehow this was relevant to his reliability as a
mainstream
economist. Jude Wanniski writes, in an open letter to (former labor
secretary)
Robert Reich, "I would embarrass [Reich] . . and he would
no
longer be considered the new guru on the block." |
| All this makes for entertaining reading. But
remember,
no matter the political importance of the answer, the debate is about a
mundane empirical issue that really should be the domain of some dull
and
reliable econometricians. |
| Perhaps I should make an apology for the
extra weight
given to the 'conventional camp'. But I won't. I belong there, although
I can't say I lose much sleep over divergent estimates of the
elasticity
of the tax revenue with respect to changes in the tax rate. It also
turns
out to be quite difficult to find reliable writing that takes the
position
espoused by Wanniski. In fact, Wanniski writes himself that his
internet
site "really is the only place in the world where individuals can learn
supply-side political economics." |