The Demand Side Politics of Supply-Side Economics

by on September 6, 2007 at 4:16 pm in Economics | Permalink

Following Jon Chait, Matt Yglesias writes:

…the central element of the Republican Party’s tax policy — lower taxes
rates will lead to higher tax revenues — is a discredited crackpot
notion.

Fine, but a more fruitful question which I’d like to see Yglesias, Chait and others grapple with is why discredited, crackpot ideas can become central elements of a winning political party in the world’s most important democracy.   Explain the demand side and give us your policy prescriptions.

1 Francis September 6, 2007 at 4:25 pm

why discredited, crackpot ideas can become central elements of a winning political party

because people like the idea of free money.

2 rick September 6, 2007 at 4:38 pm

Am I the only one that finds the notion that lower taxes MAY lead to higher reveniue persuasive. I always thought of it this way– If tax rates are 100 percent, an underground economy will develop and tax revenue will be low because no one will work at a job that is subject to the tax code. So, at some point, reducing the tax rate would reduce the incentive to be employed in the black market (which is illegal, dangerous, etc.) and increase the incentive to become employed at a job that is subject to the tax code– which would increase tax revenue.

Now, if the specific issue is whether reducing it from 37% to 30% (or whatever it was) increase(d)(s) revenue–I dont know. But as a general theory, I dont think it is discredited.

I also think that the government wastes a lot of money and resources. By giving it back to individuals, economic activity is increased and this leads to higher revenue.

3 chris September 6, 2007 at 4:57 pm

Even Yglesias and Chait concede there are some cases where lower taxes spur higher revenue. I’ll bet anything that the capital gains tax cut five or so years ago did.

But what Yglesias, Chait and others on their side of the debate won’t admit is that what’s emerging as a central economic thesis of Dems is also utter nonsense — i.e., hostility to free trade.

4 seven September 6, 2007 at 5:00 pm

“Operating under strict supply-side logic, setting tax rates at zero would create the greatest revenues for the government, an absurd conclusion.”

Martin, the Laffer curve placed tax revenue at zero when the tax rate is zero, so you’re a bit off-base there.

I’ve read all sorts of economists I respect that lower tax rates do not lead to higher revenue, but am I mistaken that (setting aside causality) the JFK/Reagan/W-era tax cuts were followed by higher revenue? The relationship may be tenuous, but “crackpot”?

5 Neil B. September 6, 2007 at 5:09 pm

The idea wasn’t crackpot when it meant lowering rates from 70 or 50% to the thirties or twenties. But then they tried to make it seem like a principle, just keep lowering taxes, as a way to starve government, not a rational assessment of cost-benefit.

6 8 September 6, 2007 at 5:10 pm

How hard is this to understand? The taxpayer doesn’t care about maximizing government revenue.

Politician A: Mr. Joe Sixpack, we can maximize government revenue by raising taxes by 10%, because you see, we’ll only lose 9% to slower growth, so our revenue actually increases! Then we can spend it in lots of ways to make you happy!

Joe Sixpack: So, you’re raising taxes by 10% and you’re going to slow the economy?

Poltician A: Don’t look so glum! It’s for the children!

Politician B: Me cut taxes. You keep money, economy grow fast. Ugh. Me like cookie.

Joe Sixpack: I pick B.

7 Barkley Rosser September 6, 2007 at 5:17 pm

Lost in the shuffle of all this is the alternative to just cutting rates, which is serious
tax simplification. Cutting rates in combination with that can do wonders, as a lot of the
missing revenues at high rates and complicated systems comes from people simply hiding their
income and not wanting to mess with it. The whole “more effort” thing was mostly baloney,
although I do believe the tale of Ronald Reagan not feeling like making another movie when
facing 90+% marginal rates, which was what convinced him.

So, one place that did rate cutting plus simplification was Russia shortly after Putin came in.
A hodgepodge system that led to 90+% (and even over 100% in some cases officially, called, bribe
your tax collector), to a flat 20% led to a surge of revenues. Yes, Virginia, the Laffer curve
exists and it has a hump. Evidence is that revenues did rise from the top 2% of the US income
distribution when their marginal rates went from 70% to 50%, but declined for the rest of the
population.

Thus, for all his thumping for lower rates, Bush would have done better to imitate Reagan in his
second term and pursued serious tax simplification. He had a bipartisan commission that made
some recommendations. Instead, he went off on a stupid bender over social security, thereby
totally depleting what was left of his Iraq-damaged “political capital.” Just plain stupid.

8 russ September 6, 2007 at 5:27 pm

The far left hates the Laffer curve because it implies that the electorate knows where it wants to be taxed(point E), and not lectured by some politician that we need more taxes to do more stuff.

The far right hates the Laffer curve because at point E Gov revenues are maximized, and even Milton Friedman wanted to starve the Beast.

I have taught a class on the Laffer curve at a Community College for 8 years now, and the consensus of my students is that point E is 25%- Total tax, which means all taxes paid, state, Fed,local,sales, property et all.

9 RobbL September 6, 2007 at 5:45 pm

“a more fruitful question which I’d like to see Yglesias, Chait and others grapple with is why discredited, crackpot ideas can become central elements of a winning political party in the world’s most important democracy. Explain the demand side and give us your policy prescriptions.”

The demand side is everyones desire to “have all that and a pony too”. The enablers are right wing economiists who put their hands in their pockets and whistle when their compatriots trot out these goofy ideas.

10 Noah Yetter September 6, 2007 at 6:29 pm

martin,
First, you bunged the math, hardcore. At a rate of zero, revenue is zero. No one will or indeed can dispute this, not even the most ardent supply-sider. This fact is represented in every Laffer curve ever drawn by anyone.

Second, why do you characterize wanting to keep more of YOUR OWN MONEY as “greed”? I must not understand what this word means.

11 John Pertz September 6, 2007 at 6:57 pm

The thing that Ive never understood is why cutting tax rates in order to increase government revenues is such a good idea in the first place? If you think that government outlays distort market signals then why would you want the government to have more cash? Cutting taxes is a good thing merely because it increases the amount of money within the private sector.

12 efp September 6, 2007 at 8:21 pm

“…everyone acknowledges that the Laffer curve does exist.”

Show me a nation-state whose sole source of government revenue is a single, universal “tax rate” (on what?) and I’ll believe that a Laffer curve exists. Maybe.

As a previous commenter said, it’s a optimization problem, and one with many many variables at that. It’s not a curve, it’s a landscape. And considering market incentives are part of it, a shimmering one at that.

When the majority of the population organizes their entire lives around the notion that when they die their ghost will forever in paradise (so long as they give 10% of their income to child molesters in pointy hats), how hard is it to conceive of them buying into crackpot economics.

What sells is a SIMPLE message, that they WANT to believe, whether or not its right.

13 thehova September 6, 2007 at 9:09 pm

I hate to repeat myself, but its important.

Most People don’t care how much revenue the government earns. most people do not benefit significantly from government programs designed to redistribute wealth.

most people would rather have the government lessen their tax burden (perhaps a negative income tax for the very poor).

Yglesias has a worthless slogan: You can’t raise government revenue by lowering taxes.

Not to many people swell with pride when their government earns more money (especially in a federalized society.

14 Lee A. Arnold September 6, 2007 at 10:19 pm

In the book Neoconomy, Daniel Altman writes that we are still paying off the Reagan debt. Is that true?

15 liberty September 7, 2007 at 12:16 am

oops, i’m tired, that should have read: “if taxes are paid by labor, because labor is inelastic, then consumption by workers is replaced by government spending; if taxes fall on firms because wages are sticky, then firms have less profit to invest,”

In any case, my point is that it isn’t only about whether or not taxes reduce hours worked (and entrepreneurship) though of course, this is important.

16 Tim Gray September 7, 2007 at 9:25 am

You guys are overcomplicating this: The reason that this crackpot notion endures (and I’m pretty sure Yglesias and Chait say this) is that the funders of the GOP–country club Republicans, rich industrialists, plutocrats, call them what you like–want lower taxes, period, and don’t care about the cost to the country. They’ll advance any argument, no matter how disingenuous, to get them.

What’s more, the idea that this is the media’s fault is hogwash. The mainstream economic consensus on supply-side thinking has been well-covered since the Reagan administration. Paul Krugman, now ensconced amid the high priests of the MSM at the NYT, even wrote a book about it, “Peddling Prosperity” in 1995.

17 anon September 7, 2007 at 9:59 am

The only forms of taxation which are currently on the _left_ side of the Laffer curve are property taxes, natural resource rents and environmental fees.

Of all commonly levied taxes, property taxes put the least burden on the poor, and the most on the rich. Not coincidentally, the US states with the LOWEST property tax rates — like Alabama, Arkansas and Wyoming — also tend to have the worst economies, worst schools and other infrastructure, lowest personal incomes, highest unemployment, etc., while the states with the HIGHEST property tax rates — like New Hampshire, Connecticut and Wisconsin — tend to have the best economies, highest personal incomes, lowest welfare utilization rates, least homelessness, etc. This is the result predicted by supply-side economic theory. There is also good empirical evidence that the US states with the HIGHEST income tax rates tend to have the lowest property tax rates and the highest property prices (think of New York, California and Hawaii), while the states with the highest property tax rates tend to have low income tax rates and low property prices (New Hampshire, New Jersey, Wisconsin).

Although property taxes are clearly better than other commonly levied taxes such as income and sales taxes, they are still much inferior to a land value tax. Other countries that currently have high levels of land taxation are Taiwan, Singapore and HK. In addition, natural resource rents other than site value rents are the majority of government revenue in places like Saudi Arabia, Brunei, Qatar and Kuwait, all of which have shown immense increases in prosperity since beginning to tax resource rents.

Historically, increases in land taxation were followed by notable increases in prosperity in ancient Egypt and Rome, Moghul India, Qing China, Meiji Japan, the western USA and Canada in the late 19th and early 20th C, and in numerous other historical cases. In the 50 years between the end of the US civil war and the beginning of WW I, a period of very rapid economic growth in the USA, the majority of all government revenue was from taxes on land. Conversely, when those societies allowed their land tax revenues to decline, their wealth did, too, leading in some cases to societal collapse.

18 atlas September 7, 2007 at 11:23 am

There’s another alternative that neither side has considered. Instead of continually bickering about revenue maximization, how about exploring ways to minimize expenses.
Its not a revenue problem, its a spending problem.

19 R.J. Lehmann September 7, 2007 at 3:51 pm

There is also good empirical evidence that the US states with the HIGHEST income tax rates tend to have the lowest property tax rates and the highest property prices (think of New York, California and Hawaii), while the states with the highest property tax rates tend to have low income tax rates and low property prices (New Hampshire, New Jersey, Wisconsin).

I’m somewhat sympathetic to the Georgist cause, but I believe you’re just making this bit up out of thin air. New York and New Jersey BOTH annually rank at the very top in property tax rates AND property values. How you can claim the former as a low-rate state or the latter as as a low-price state is beyond me.

20 Dick King September 7, 2007 at 4:38 pm

Let me offer some evidence that we’re reasonably close to the point where increases in tax rates don’t increase revenue.

There is a class of people in most of the United States who have a marginal tax rate of about 15% more than most of their neighbors. These people are non-custodial parents of a minor child where child support payments have been ordered. The child support enforcement establishment has seen enough reduction in work effort in non-custodial parents paying child support that they’ve had to invent the notion of “imputed income”, where they can assess child support of 15% of what the NCP “should” earn, not what he actually earns.

Please note that I am talking about child support, not alimony. In the case of child support, even if the payer hasn’t internalized a positive term in his utility function for the well-being of the child, he is unlikely to have internalized a negative one, and certainly less likely to have done so than an ordinary tax payer is to have internalized a negative term in his utility function for governmental transfer payment recipients.

This understates the reduced work effort that would be induced by a 15% increase in marginal tax rates, because it omits long-term decisions. For example, no child support court will impute income based on the Ph. D. the NCP could obtain to increase his earning capacity, so such degrees discouraged is not part of the imputed income process although it would be part of the tax rate process. Furthermore, such self-investment normally takes place before a person discovers he will become an NCP at some point, but he would have a general feel for tax rates.

This is a qualitative argument, but it does tell me that the higher marginal tax rates needed to significantly start choking off work effort is not in the stratosphere; it’s only about 15% more than the current marginal tax rates in the US.

21 David Stewart September 9, 2007 at 9:04 am

The concept “lower taxes rates will lead to higher tax revenues” is not only not the central element of the Republican Party’s tax policy, it is not the concept of supply-side economics.

At SOME RATES a reduction in rate can lead to higher tax revenues. But that is not the point of supply-side economics. It is, however, true, and not discredited, but indeed proven. Not once, but again and again.

It is amazing that these guys would propagate the multiple lies in the claim, but then that is what they’ve done for almost 30 years.

22 yank_in_oz September 10, 2007 at 2:45 am

One demand side explanation is that voters, who are older than the median-aged citizen, would prefer to let future generations pay for their government spending. I’ve always thought that the Bush tax cuts should generally be interpreted as yet another instance of giving the baby boomers what they want. It is probably not a coincidence that relatively lower taxes on capital income were implemented at a time when Baby Boomers were finally in a position to earn a big share of the dividends. Ditto on the repeal of the estate tax, as the boomers’ parents are beginning to pass away. Just to go back a ways, one might also see the inflation in the 1970s as eroding the real value of debts incurred by baby boomer students and relatively recent home owners.

Incidentally, this also provides a non-ideological reason why young guns like Yglesias and Klein are all over this. Its not just ideological, it’s generational.

This is not to say that there aren’t other reasons to support or oppose tax cuts, it is only an explanation of their political salience at a given point in time.

23 Consumatopia September 13, 2007 at 11:24 pm

he is unlikely to have internalized a negative one, and certainly less likely to have done so than an ordinary tax payer is to have internalized a negative term in his utility function for governmental transfer payment recipients.

This is definitely extremely false.

The far right’s answer, I imagine, would be something like there is no policy prescription to prevent crackpot ideas from taking hold of major political parties, and so we should minimize their potential for damage by placing limits on the government’s ability to act, and instead rely more on the market, where competitive pressures, incentive effects etc. tend to prevent crackpot ideas from taking hold, or at least minimize them to a greater extent than in government. So what is the left’s prescription?

Crackpot asset bubbles happen all the time in the marketplace–the only thing more nonsensical that election results is the stock market. The left solution? That’s like asking for a solution to the heat death of the universe–it’s just human nature to be duped by stupid crap, and we’ve got to do the best we can to stay on guard. As Churchill put it, democracy’s the worst system of government except for all the others that have been tried.

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