Supply Side Economics: History and Evidence
A couple of days ago Virginia Congressmen, David Brat, was interviewed about whether he thought that President Trump out to be trying to “primary” those who have voted against bills he supports. The congressman said that the “true” Republican agenda of decreasing taxes, government spending, government regulation, and the size of government are the things Trump ran on, and anyone who does not support Trump’s tax plan is voting against the job creators. Turn on the television on any given day and you may find a Republican congressman extolling the virtues of Supply Side Economics (SSE). This is the cornerstone of House Speaker, Paul Ryan’s, beliefs about the economy and how to approach any problem in the economy.
A couple of questions arise; what exactly is Supply Side Economics, and has it ever been proven to work.
What is Supply Side Economics?
An article in Forbes maintains that what Paul Ryan, members of the Freedom Caucus, and many Republican Congressmen tout as SSE is wrong.
In Brian Domitrovic’s ,article he points out that the main original proponent of this theory, Robert A. Mundell, proposed a combination of two things; tax cuts on marginal income and capital gains together with monetary restriction by putting the dollar on a gold standard.
“Robert Mundell's work is pivotal to the modern understanding of international currency fluctuations and exchange rate regimes. For this, Mundell was awarded the 1999 Nobel Prize in Economics.” Wikipedia
The concept of stimulating the economy through increased production, however, is older than Mundell’s SSE theory. Herbert Hoover tried to stimulate the economy through tax cuts and reduced government spending. Will Rogers, the cowboy comedian, lampooned those efforts by calling the effort “trickle down” economics. “The money was all appropriated for the top in the hopes that it would trickle down to the needy. Mr. Hoover didn’t know that money trickled up. Give it to the people at the bottom and the people at the top will have it before night, anyhow. But it will at least have passed through the poor fellow’s hands.” Will Rogers died August 15, 1935, a year after Mundell was born.. David Stockman, in the Atlantic made the comment that trickle down was supply side and supply side was trickle down. Although Herbert Hoover may have been responsible for the first efforts to stimulate the economy by reducing taxes on the wealthy and decrease regulations on business, Will Rogers may have been the first person to give the process a name.
Supply Side theory was further promoted by Arthur B. Laffer, Mundell’s protégé at the University of Chicago.
Historical Perspective; the Reagan Revolution
Supply Side was the foundation of Reagan’s presidency and the first real test of SSE came during Reagan’s presidency when tax rates were lowered in 1981 and again in 1983 while tax revenues remained revenue neutral. The intent of the reduction of the marginal tax rate was not to cut taxes, but to offset “bracket creep” created by the runaway inflation of the 1970s. New tax evenue was created through a technique termed “base broadening” where tax loopholes were closed.
The Reagan Era tax increases designed to offset the effect of lowering the marginal rates affected everyone including some of Reagan’s principle campaign contributors. Despite pleas to protect their income, Reagan went through with the plan to reduce tax loopholes. What was Reagan’s plan to restore the economy?
“The four pillars of Reagan's economic policy were to reduce the growth of government spending, reduce the federal income tax and capital gains tax, reduce government regulation, and tighten the money supply in order to reduce inflation.”
The fourth pillar in Reagan’s plan failed to come about as planned. Reagan was intellectually in support of a gold standard – part of Mundell’s two pronged approach - but the U.S. Gold Commission recommended against it. At one point in Reagan’s first year the Federal Reserve raised its interest rate to 20% in order to halt inflation.
The impact of Reagan’s presidency was far reaching and changed the way America did business. To give one example; the break-up of AT&T in 1984 broke the monopoly into ATT, the long-distance carrier, and four regional Bell telephone companies for local calls. For a bit customers had to choose their long distance carrier, but that change paved the way for technological changes such as the internet, mobile carriers, and cable that changed everything.
For those who did not live through the break-up, previous to the break-up customers paid a monthly rate for some local service plan. Those plans included how many subscribers were on one line. Private lines were for some a luxury and, particularly in rural areas, more reasonable plans went from two to eight party lines. Long distance calls were charged by the minute.
My first mobile phone service came in the early to mid 1990s. I carried a pager – the service was monthly, and a cell phone. The initial company probably no longer exists. It was bought by cellular one and I bought 30 minutes a month for $30.00. Roaming started not very far away – in my case 13 miles away at the state line and charges were made at $4.00 per minute. Over time service plans changed, phones changed and we have come to a phone that is a miniature computer, shopping cart, encyclopedia and social networking machine. All of that costs a lot more than our black cast iron telephone and the system under AT&T.
Historical Perspective; the Bush Tax Cuts
Perhaps because Reagan did not institute a gold standard for the dollar, modern day SSE advocates like the Freedom Caucus only mention tax cuts in support of the economic principle.
George W. Bush’s tax cuts – without monetary restraint or responsibility for controlling government spending – produced a tiny boom in the early 2000’s followed by the Great Recession of 2008. Bush’s wars in Iraq and Afghanistan were unfunded as well as the Medicare Part D prescription drug plan. Loose money led to the housing bubble and the subsequent collapse of the economy when it burst.
A 2006 Treasury report predicted that sustaining the Bush era tax cuts could only be funded by reduced government spending. Future increases in tax rates would not be sufficient to recover from the increased debt cost.
Historical Perspective; What about the gold standard?
When I got married in 1966 the price of gold was fixed at $32.00 per Troy ounce. Just five years later, in 1971, gold was deregulated resulting in rampant speculation during which time the price soared to a little over $800.00 per troy ounce in 1980. The price has fluctuated between $320.00 and $480.00 per ounce for a number of years since the height of speculation.
During the 1800s and early 1900s a script dollar could be exchanged for gold. The result was several bank panics at times when holders of currency became cautious about the U.S. economy and tried to exchange their currency for gold. In order to cover these withdrawals during times when too much money had been printed additional gold was placed in the treasury to back the currency. A shipment from South Africa sank during a storm resulting in the panic of 1857. Perhaps the worst bank panic occurred in 1893 after the Reading Railroad went into receivership. This bankruptcy was the last shock that caused a lack of investor confidence and the result was a recession/depression that lasted through most of the 1890s. This was just one of the depressions, recessions and bank panics that occurred up until 1933. The market crash of 1929 and the resultant depression had caused many banks to close or declare a banking holiday. By March 3, 1933, 5,504 banks with deposits of almost $3.5 billion had closed. Franklin D. Roosevelt used a 1917 law against trading with the enemy to protect the Federal Reserve and protect assets in banks.
Franklin D. Roosevelt used Keynsian economic theory in an attempt to pull America out of the Great Depression.
How do Keynesian and Supply Side Economic Theory Differ?
Supply Side Economics places the stimulus on the economy on the side of production. It assumes that as production increases, due to lower taxes and access to capital, labor will benefit, have more disposable income, and demand will increase. Demand depends on private industry hiring employees and spending coming from the employed.
“The theories forming the basis of Keynesian economics were first presented by the British economist John Maynard Keynes during the Great Depression in his 1936 book, The General Theory of Employment, Interest and Money.Keynesian theory holds that economic expansion is triggered by increased demand. That demand comes through increased access to money, whether from private company wages, or government spending. Government spending might be on infrastructure or even in the form of living assistance. Increased demand would than trigger companies to make products and provide services to consumers.”
Roosevelt, acting in response to a complete lack of consumer confidence, deflation, unemployment and stagnant production stimulated the economy through government spending programs such as the WPA and CCC. Recovery was slow, but by 1939 the country was starting to emerge from the worst downturn in its history. Critics of FDR’s approach argue that the U.S. didn’t really recover until production was artificially increased in order to meet the requirements to wage WWII. There is no doubt that that was a tremendous stimulus, but it was still created through government spending.
Given the fact that what modern Republicans call Supply Side Economics is not, what evidence is there to support the claims of conservatives that it is an economic panacea?
The short answer is none, because SSE as envisioned by Mundell has never been fully implemented. It remains an unproven theory. Reagan’s measures did stop the “stagflation” that had plagued the Carter presidency, through high prime interest rates, and the tax reform – in which income tax rates were reduced while regaining revenue through a reduction in tax deductions – fixed the problem of “bracket creep”.
Arguably, there is evidence that Keynesian economics created the recovery from the Great Depression.
Whatever the mechanism of stimulating the economy, a balanced and long term approach is not likely to happen. The wealthy want tax cuts, deregulation of business, decreased government spending and ready, low interest money. Decreased government spending is seen as a decrease in healthcare, social security, and assistance to the poor and disabled. A balanced approach in which spending on the pentagon and military spending is never really considered. Controlling the value of money is part and parcel of supply side economics, and that requires some mechanism like high interest rates or a standard, such as gold.
The middle class wants an approach that increases jobs and wages, provides services to the needy, and access to housing and education. There would be no problem with this except for the fact that once a government program of any kind is implemented by which some segment of society benefits Congress never wants to do away with the program once it is no longer needed.
During the Great Depression there were a number of work programs that were done away with when they were no longer needed to stimulate the economy.
The biggest problem with SSE is that the entire model by which money trickles down no longer works. For the past several decades business has increased production through decreasing the costs of labor. This has come about in two ways; decreasing benefits to employees through the use of part time and temporary labor, and automation which has been an even bigger factor in the destruction of the working class and middle class.
The only system that can work now is a bottom up, Keynesian approach to stimulating the economy through government programs to hire labor to improve infrastructure. Awarding contracts to companies that use automation to do make these improvements will do nothing to stimulate the economy.
The following figures are interesting. They represent the economic growth during each post WWII president’s term as measured by the GDP.
Economic Growth by President
Jeffrey H. Anderson
Recently released GDP figures for the second quarter of 2016 invite the question of how the gross domestic product has fared under each of the dozen post-World War II presidents, a period spanning 70 years. According to figures from the U.S. Commerce Department’s Bureau of Economic Analysis (BEA), average annual real (inflation-adjusted) GDP growth in the United States since 1946 (through 2015, the last full year for which figures have been released) has been 2.9 percent.
While that has been the postwar norm, however, average annual real GDP growth has varied greatly by president, ranging from a high of 5.3 percent under President Lyndon Johnson to a low of 1.5 percent under President Barack Obama, as the following chart conveys.
Here is the complete list of average annual real GDP growth by postwar president (in descending order):
Johnson (1964-68), 5.3%
Kennedy (1961-63), 4.3%
Clinton (1993-2000), 3.9%
Reagan (1981-88), 3.5%
Carter (1977-80), 3.3%
Eisenhower (1953-60), 3.0%
(Post-WWII average: 2.9%)
Nixon (1969-74), 2.8%
Ford (1975-76), 2.6%
G. H. W. Bush (1989-92), 2.3%
G. W. Bush (2001-08), 2.1%
Truman (1946-52), 1.7%
Obama (2009-15), 1.5%
During the first two quarters of Trump’s presidency the real GDP has been 1.0%
It is hard to talk about economics without talking about markets. One difference in SSE and Keynesian economies is that with SSE the market is shaped by the producer. In Keynesian systems the market is shaped by the consumer.
In the first we buy what we are offered. In the latter we buy what we need or want.