The Triumph of Supply-Side Politics: Where the Supply-Siders Totally Blew It

Editor’s note: This article first appeared at RealClearMarkets.com.

If you’re hoping for an unremitting anti-supply-side diatribe, you will be disappointed. There is, indeed, a major flaw in the supply-side approach and I’ll get to that presently, but first, let’s give credit where credit is due.

Supply-side economics emerged in the late ’70s and was the dominant theme in economic policymaking during the Reagan presidency in the 1980s. It was a timely and much-need alternative to the prevailing Keynesian orthodoxy that placed government in the role of trying to manage “aggregate demand.”

The supply-siders restored micro-economics to its central role in economic analysis. They understood that in the absence of disincentives caused by disruptive, anti-economic government policies (e.g., taxes, regulations, monetary distortions), the demands of individual economic actors, as communicated through market prices, would shape production more rationally (that is to say, economically) and greater prosperity would ensue.

The supply-siders also resurrected Say’s Law, reminding us that, in the real world, production precedes consumption. Say’s Law is the antithesis of Keynesian theory, which posits that government can increase overall supply by first stimulating demand through government deficit spending (theoretically by a combination of tax cuts and government spending increases, though in practice the emphasis was on increasing expenditures) or by inflationary monetary policies. The Keynesian notion that the way to increase supply was to first increase demand was and is mystical nonsense. “Mystical” may seem like a harsh description, but how else would you characterize Keynes’s statement in “Paper of the British Experts,” April 8, 1943, that credit expansion performs the “miracle … of turning a stone into bread” (especially when, in fact, all credit expansion does is distort and redirect production)?

The supply-siders were a motley crew who held widely divergent views on economic policy. For example, some favored a Friedmanite monetarist rule applied to our fiat currency while others favored a return to a gold standard; some favored modest reductions of federal regulations while others favored massive rollbacks; some favored a large welfare state while others preferred to shrink or abolish welfare programs, whether for businesses or for individuals). However, the one public policy about which supply-siders have been virtually unanimous, and which has rightly been regarded as the sine qua non, the identifying characteristic, of supply-side economics was the advocacy of lower marginal income tax rates. The supply-siders claimed that such tax cuts, by lessening disincentives to productive economic activity (i.e., labor, investment, business formation) would unleash strong economic growth.

To sell the agenda politically at a time when shrinking the welfare state was a distinctly minority position, the supply-siders averred that cutting tax rates could increase the overall size of the economic pie so much that, even with a smaller share of the pie due to the lower tax rates, the government might actually see its tax revenues increase—that, in effect, the tax cuts could pay for themselves.

In 1980, presidential candidate (and eventual vice-president and president) George H.W. Bush memorably called the notion that tax rate cuts could increase actual tax revenues “voodoo economics.” Similarly, the progressive left, citing the large federal deficits of the 1980s, have insisted ever since that tax cuts did not shrink federal deficits and therefore supply-side theory is fallacious and even fraudulent. Both Bush and the progressives were wrong and the supply-siders were right. From the time the first round of Reagan tax cuts really took hold in 1983 to when Reagan left office six years later, annual federal revenues increased from approximately $600 billion to nearly $1,000 billion—a massive and rapid increase. Yes, it’s true that federal deficits and debt continued to rise after the tax cuts, but obviously not because government revenues fell. Rather, the deficit problem was a spending problem— federal spending increased even more rapidly than federal revenues. This in no way invalidated the fact that the supply-siders were proven correct when lower tax rates were indeed followed by higher tax revenues.

As John Tamny, a self-described supply-sider, wrote in his blog earlier this year, the dominant supply-side position in the ’80s was that represented by Jude Wanniski, who believed that “Republicans should focus their energy on tax rate reduction” rather than on cutting federal spending. Wanniski and most other supply-siders naively believed that cutting tax rates would lead to economic growth (correct) resulting in less demand for government intervention and consequent shrinking of government (spectacularly incorrect).

The notion that government would simply wither away as a result of economic growth strikes me as being as fanciful as Karl Marx’s assertion that the state would then wither away some time after it had been given all power, enabling it to achieve full socialism. If there’s one thing that history has taught us it is that people who hold power usually don’t walk away from it. Government power doesn’t diminish because those holding the power voluntarily abandon it, but because those subject to such power have fought back against it. For the supply-siders to believe that today’s progressives, social justice redistributionists, and power-hungry political class would stand by and watch the state wither away is not merely naïve; it is either delusional or a matter of willful blindness. It ignores Kershner’s Law: “When a self-governing people confer upon their government the power to take from some and give to others, the process will not stop until the last bone of the last taxpayer is picked bare.” The countless special interests extracting rent and handouts from the federal government will continue to practice what Bastiat brilliantly named “stupid greed”; they will continue to support politicians who peddle the malicious lie that there is such a thing as a free lunch. Together, the politicians and special interests will continue to increase the size of the government by colluding in the unseemly practice of legal plunder, trampling the property rights of their fellow Americans in their lust for other people’s money until the system either collapses or enough people who know better bring a halt to this insidious, invidious process.

As a short-term strategy in the ’80s, the supply-side tax cut agenda brought political success to the Republican Party and an economic boom to the country that lasted for two decades. The problem is that the short-term strategy of focusing on tax cuts and ignoring the spending problem got locked onto autopilot and became a long-term strategy. This was a natural consequence of the dynamics of democracy. In a democratic political system, politicians win over voters in two ways—either by spending more dollars that confer benefits on voters or by reducing the pain of taxes by cutting them. Thus, the Democrats perennially advocate more spending while the default position of Republicans is, “Cut taxes.” Each party took one of the two politically expedient paths of least resistance; neither party dared speak out for the politically unpopular option of cutting spending. The result was predictable and inevitable: Federal spending, deficits, and debt relentlessly continued to swell. Now here we are, several decades later, drowning in $18 trillion of explicit debt, with multiples of that amount in unfunded future government liabilities, and the government continuing to spend over $3 trillion per year. When asked about the long-term consequences of government deficit-spending, Keynes glibly quipped, “in the long run, we are all dead.” By remaining largely silent about the long-term costs and consequences of ever-increasing federal spending, the supply-siders have been complicit in bringing us to our current untenable fiscal predicament. Welcome to the long run.

While the supply-siders’ willingness in the early ’80s to ignore the government spending problem and focus on tax cuts might be excused on the old “Rome wasn’t built in a day” principle, the fact that supply-siders, in the three decades since then, generally have continued to fail to take a strong position against spending has been unconscionable. They have forsaken and betrayed sound economics. The supply-siders, of all people, should have taken a clear, principled stand in favor of reining in federal spending because government spending retards economic growth. Back in the ’80s, there were economic studies showing (just as clearly as recent studies show today) the empirical evidence that economic growth is negatively correlated with government spending as a percentage of GDP. Furthermore, economic theory supplies at least three reasons why federal spending is inevitably anti-growth:

1) It is acatallactic—an old-fashioned word, favored by Ludwig von Mises, meaning that, as the tragic experiments with socialism so vividly proved, government never knows as well as the people themselves do what the people want. Only free markets with their price signals reflecting supply and demand can coordinate production to optimally address people’s most highly valued wants. The more government spends, the more production is diverted from the most highly valued needs.

2) Federal tax dollars pass through bureaucracies which are inherently uneconomic, wasteful, and—worst of all—promulgators of regulations that severely burden production.

3) Most fundamentally, every dollar that the federal government spends is, in its fundamental identity, a tax. The $18 trillion of federal debt are simply tax dollars that haven’t been collected yet—at least, not explicitly, although currency depreciation and the suppression of the crucial interest rate market via Federal Reserve manipulation already has siphoned (taxed) considerable wealth away from American citizens. Thus, George W. Bush (despite his early supply-side tax cuts) and Barack Obama are the two greatest taxers in American history because they are the two largest spenders in American history.

The supply-siders failed us all by not making a case against leviathan government. They never put forth a coherent voice addressing the key political question that our founding fathers grappled with at the constitutional convention: What should government do? The founders, such as John Adams and Madison, understood the suicidal tendencies of democracy and concluded that our liberty and prosperity depended on keeping government small and limited (see Ninth and Tenth Amendments); the supply-siders, by contrast, have been largely silent about the proper scope of government. Nor have they examined the question of the proper size of government from a more practical, utilitarian standpoint by asking the question: What does government do well? The answer to that question suggests a far more modest, constrained role for government.

What the supply-siders never realized was that supply-side economics has been eclipsed by supply-side politics. The supply-side insight that supply creates its own demand (Say’s Law) is every bit as true in the political realm as in the economic. By making their services available to those who seek to transfer wealth from other citizens to their own benefit, politicians have tapped into a rich vein of political support. Indeed, by supplying the service of enriching people through the political process, politicians have unleashed a powerful tsunami of demand for that service, and so government spending has continued to grow, impairing economic growth. Unless we find a way to break free from this self-destructive dynamic, our fiscal situation will some day come to be seen as hopeless as Greece’s today. Will the next generation of supply-side economists make amends for their predecessors’ negligence and stand forth to be counted in this existential battle? We shall see.