Issue #29, Summer 2013

Burying Supply-Side Once and for All

To read the other essays in the “The Middle-Out Moment” symposium, click here.

If you are going to base all your efforts to win political power on a single economic theory, as conservatism has over the last 30 years, you might want to make sure it works. But that’s what’s so surprising about supply-side economics: Despite the fact that its central claim has been belied by decades of economic experience, it persists.

Supply-side economics assumes that lower tax rates boost economic growth by giving people incentives to work, save, and invest more. A critical tenet of this theory is that giving tax cuts to high-income people produces greater economic benefits than giving tax cuts to lower-income folks. Essentially, the more money the rich are able to keep, the more the whole economy will grow.

But the evidence reveals two fundamental problems with this story. First, its primary prediction is wrong—giving tax cuts to the rich does not increase economic output or create new jobs. Instead, tax cuts for middle- and low-income taxpayers are much more effective at boosting macroeconomic activity. Second, supply-side theory misunderstands the actual mechanism by which tax rates influence macroeconomic activity. While supply-siders maintain that lower rates at the top incentivize people to earn more money, the evidence shows that tax cuts boost output mostly by putting money in people’s pockets and thereby stimulating demand.

These empirical findings carry an important lesson for our tax policy: Rather than increasing inequality by throwing away revenue on tax cuts for the rich, we should ensure that middle- and lower-income Americans have enough after-tax income to maintain strong consumption levels, especially during economic downturns. Moreover, by perpetually fetishizing tax cuts for the top rates, conservatives have disregarded other policies that are more effective at spurring economic growth. Given the mounting evidence against supply-side economics, it’s time for conservatives to go back to the drawing board and come up with a reality-based economic agenda.

The Theory Behind Supply-Side Economics

Supply-side economics starts with a reasonable intuition: If you let people keep more of the income they earn, they will have an incentive to earn more income. Based on this intuition, supply-siders predict that lowering tax rates will encourage people to work, save, and invest more by increasing the after-tax returns from these activities. And they conclude that all this additional working, saving, and investing will generate faster economic and job growth.

Based on this story, supply-siders believe tax cuts will provide a bigger economic boost if they’re directed at rich people, as opposed to middle- and lower-income people. One reason is that rich people can afford to work less when tax rates are high, whereas lower-income people need to work enough to make ends meet regardless of the tax rate. Giving tax cuts to the rich therefore should generate a bigger uptick in work. A second reason is that economists typically think that people’s incomes correspond to the economic value of their labor. According to that logic, incentivizing a CEO to work a few more hours a week is thought to be more economically beneficial than incentivizing a janitor to work the same number of extra hours. A third reason is that rich people can afford to save most of their tax cuts, which in turn will increase investment. In contrast, lower-income people often need to spend the extra dollars.

But the real question for policy-makers is whether modest shifts in the top marginal rates make much of a difference. Sure, taxing wealthy people’s marginal income at 95 percent may create a disincentive to make more money. But are rich Americans really going to work and save a lot less just because income above $400,000 is now taxed at 39.6 percent rather than 35 percent? Given the centrality of supply-side theory to conservative economic arguments, one might imagine we’d have plenty of historical evidence that rich people do in fact respond to such changes in tax rates. But the evidence is in, and it shows no such thing.

History Proves the Supply-Siders Wrong

The best place to start this empirical inquiry is to look at what actually happens when top tax rates change. Do growth and employment shoot up when high earners get a tax cut? Does the economy tumble when their taxes rise?

At first glance, the historical record seems to offer little to support the supply-side story. Consider the last decade. In 2001, President Bush cut the top rate on capital gains and dividend income down to 15 percent from 20 percent—a rate that had already been reduced from 28 percent by President Clinton four years earlier—and cut the top rate on normal income down to 35 percent from 39.6 percent. And yet in the decade that followed we witnessed the worst economic performance since the Great Depression. From 2001 to 2008, before the crisis, economic growth was anemic at best, averaging 2.5 percent. By contrast, although the top tax rate was above 90 percent throughout the Eisenhower years, the economy grew at an incredible pace during the 1950s, with annual growth averaging more than 4 percent. And the jobs picture is even more stark: Under George W. Bush, total jobs grew only 0.8 percent during his term, while under Bill Clinton they grew by 20.7 percent, and under Dwight Eisenhower, 7.1 percent.

Supply-siders often credit President Reagan’s huge 1981 tax cut with spurring robust growth in the ensuing years. But while growth was strong during the 1980s, it was stronger still in the years following President Clinton’s 1993 tax increase on top earners. Whereas GDP grew at an average annual rate of 3.5 percent during the seven years following the 1981 cut, it grew at 3.9 percent per year over the seven-year period following the 1993 tax increase. In addition, nonresidential fixed investment also grew at an annual rate of over 10 percent during those seven years, compared to a rate of less than 3 percent in the years following both the 1981 and 2001 cuts. At the same time, median household income and real hourly earnings both grew faster after the 1993 tax increase than after the 1981 tax cut.

A recent paper by the nonpartisan Congressional Research Service also found no correlation during the postwar years between economic growth and the top tax rates on normal income and capital gains. Moreover, it found no discernible relationship between top tax rates and either investment or private savings, stating that the “reduction in the top statutory tax rates appears to be uncorrelated with saving, investment, and productivity growth.” Obviously, there are many factors that contribute to growth, but economic history clearly shows that there is no correlation between low taxes on the wealthy and high growth rates for the country.

Of course, this economic history alone does not settle the question of whether there are causal links between top tax rates and economic growth. But economists have used a variety of techniques to answer this question. And it turns out that contrary to supply-side’s central thesis, the wealthy are precisely the wrong people to whom to give tax cuts. A recent paper by Owen Zidar, formerly a staff economist at the Council of Economic Advisers, finds overwhelming evidence that tax changes for lower-income people have a far bigger impact on output and employment than tax changes for higher-income people. The paper finds that whereas a “one percent of GDP tax cut for the bottom 90% [of earners] results in roughly 3 percentage points of GDP growth over a two year period,” tax changes for the top 10 percent (those earning incomes above roughly $112,000) turn out to have a negligible and statistically insignificant effect on GDP growth and job creation. Indeed, these impacts grow exponentially larger the lower you travel on the income spectrum.

A growing body of scholarship also suggests that supply-siders are fundamentally mistaken about why tax cuts generate economic activity. Supply-siders believe that tax cuts promote growth primarily by encouraging people to earn more money, which is why they predict that lowering top rates will have an especially big impact. But in showing that this prediction is wrong, Zidar also finds that tax changes for low- and middle-income taxpayers produce big changes in consumption, whereas tax changes for high-income taxpayers do not. The fact that consumption and economic output tend to move in tandem suggests that tax cuts primarily influence output not by incentivizing people to earn more, but by enabling low- and middle-income taxpayers to spend more. Or in other words, tax changes appear to be influencing the economy not through the supply side, but through the demand side.

Recent work by economists like Austan Goolsbee, Emmanuel Saez, and David and Christina Romer backs up this idea by showing that tax changes actually have surprisingly small effects on people’s pretax incomes. For example, a new paper by the Romers finds that large increases in top marginal rates during the interwar years had a minimal effect on rich people’s incomes. And although tax changes sometimes appear to produce large year-to-year variations in income, work by Goolsbee and others has shown that these variations mostly just reflect shifts in how income is reported. These findings directly undercut the supply-side argument that tax rates dramatically influence individuals’ behavior, causing them to earn more income when rates go down and earn less when rates go up. Instead, they suggest that people are fairly unresponsive to tax rates when it comes to how much income they earn.

The Persistent Attraction of Supply-Side Theory

If the supply-side theory isn’t backed up by the evidence, why has it dominated conservative thinking and Republican Party platforms for over three decades?

It’s probably not a coincidence that the biggest beneficiaries of supply-side policies happen to be the same wealthy Americans who bankroll the Republican Party, along with the conservative media and think-tank infrastructure. But I don’t think this is simply a story of bad-faith arguments driven by cynical self-interest. The fact is that there’s something quite seductive about the idea that the best way to stimulate growth is to give yourself a tax cut. And if you happen to be an affluent conservative, there’s also something very appealing about a theory that says that your work and your savings are principally responsible for driving the economy forward. In other words, policy arguments in favor of tax cuts for the rich to induce more wealth generation neatly coincide with and reinforce a world view that holds that individuals become rich only through their own prowess, not because of the investments of others, or heaven forbid, the luck of the draw.

Conservatives also seized on supply-side economics as a tool to shrink the size of government. As anti-government activists like Grover Norquist realized long ago, Americans usually aren’t so keen to slash public programs. But tax cuts offered a way to attack spending indirectly by starving the government of revenue, driving up deficits, and then forcing politicians to cut spending in response. The supply-side story synced up nicely with conservatives’ anti-government ideology—if, like President Reagan, you already believe that “government is the problem,” helping it survive with sufficient revenues is probably not going to be appealing.

Beyond Supply-Side

All this empirical work carries at least three important lessons for policy-makers. First, giving new tax cuts to rich people is a very bad idea unless your goal is simply to make rich people richer. Unfortunately, supply-siders’ decades-long fixation on cutting top tax rates has done just that, thereby exacerbating economic inequality. We know that America’s hyperinequality is deeply unfair and that it is reducing upward economic mobility, corroding our democracy, and eroding social cohesion. But as the other contributors to this symposium make clear, widening inequality also poses a serious threat to America’s future economic growth.

Second, we could raise top marginal tax rates quite a bit without reducing future growth or job creation. Such a policy would have the dual benefits of raising badly needed revenue while also mitigating inequality.

Third, targeted tax cuts for lower-income Americans, especially refundable tax credits like the earned-income tax credit, can be a powerful way to boost the overall economy. This is especially true during recessions when aggregate demand falls and people are unemployed for extended periods of time. Under these circumstances, as Larry Summers and Brad DeLong have recently argued, fiscal stimulus can significantly improve long-term growth by getting the economy moving again and thus preventing lasting damage to the productivity of workers and physical capital.

But in addition to distorting American tax policy, perhaps the most troubling legacy of supply-side theory is that it has led generations of conservative politicians and policy-makers to obsessively focus on tax cuts as the tool to promote growth, to the exclusion of many others. This myopia has been especially harmful because tax cuts have significant opportunity costs. For instance, by reducing government revenue, they can crowd out high-return public investments in areas like education, scientific research, and infrastructure. These investments are critical to America’s long-term growth and we shortchange them at our peril.

Supply-side theory also fails to address the most pressing challenge the American economy has faced since 2008: namely, insufficient demand to foster economic growth. In a world where people don’t have enough money to buy things and thereby create more demand for goods, a policy that focuses attention on tax cuts for people who are not going to spend them is ineffective at best.

While progressives may not have all the answers to achieve equitable growth, conservatives have the wrong answers. If conservatives are serious about promoting economic growth and prosperity, they need to stop fetishizing tax cuts and start proposing policy ideas that are based on actual facts. Indeed, history would tell us that investing in the middle class and those who want to rise into it is the best long-term economic growth strategy.


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Issue #29, Summer 2013
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By oversimplifying the idea of "conservatives," you demonstrate your laughable ignorance and common sense as a "liberal." Simply put, if there were a simple tax code in place that did not cost millions to implement, we could save on both ends. But this would not serve your "liberal" agenda of involving government in every facet of our lives while screaming "leave our vagina alone" to those who want to allow states to decide what their constituents want. Hypocrisy at its finest, no doubt.

Jul 6, 2013, 6:14 PM

If you had any readers they would laugh at your conclusions. Remember- it AINT your money to fiddle with; rich people dont become rich b/c of your theories. they do so buy EARNING a living. It's THEIR money.

Jul 6, 2013, 7:21 PM
Tom Plotkin:

The author calls supply side "discredited," yet his bio indicates he is a) of the center for American progress; b) an Obama administration ACA apparachik; and c) a former Hilary Clinton aide. He has as much credibility as Rachel Maddow, he's a paid hack no matter how many degrees he may hold. Keeping his party overlords in power and riding their gravy train us all he cares about not some nonexistent middle class that exists only as thumbscrews for his class enemies. Such people exist to prove love, empathy, and reason are lies, because the advocates are liars.

Jul 7, 2013, 6:39 PM

Funny how it worked for Reagan, I remember very well how RR turned things around in this country after the disastrous years of Jimmy Carter 1.0

always trying to rewrite history to fit the liberal agenda...

Jul 7, 2013, 7:03 PM

The writers comment about job growth in the Clinton years is all you need to read to determine the lack of logic. He describes how job growth was stronger under Cintin than Obama, but suggests it is because Clinton raised the top marginal rate to 39.6%. But the additional revenue went to the gov to be wasted....not to lower wage earners. So why woud any logical person think that the extra revenue would have been better spent by a corrupt bureaucracy than the rich person who created it or earned it in the first place?

Jul 8, 2013, 6:51 AM

Who let the trolls out?

If you guys can't argue against the facts which the writer presents, maybe you shouldn't say anything at all.

BTW, I loved jay's statement about "buy EARNING a living". Just where does one buy this earning, jay? Sam's Club?

Also, what is this so called "liberal agenda"? Is that code speak for something else? I've never received a copy of this "liberal agenda" in all of my years so I am just curious as to what you are all referring to. TIA

Jul 9, 2013, 6:30 PM
Kris (@lovedothscathe):

I love that so many of these comments slam the author's credibility but cannot refute any of the many facts cited in this article.

The non-partisan congressional CRS found no correlation between tax cuts for top earners and economic growth - isn't that enough to quiet all of you right-wing barking dogs?

Jul 25, 2013, 9:12 AM
Kris (@lovedothscathe):

I love that so many of these comments slam the author's credibility but cannot refute any of the many facts cited in this article.

The non-partisan congressional CRS found no correlation between tax cuts for top earners and economic growth - isn't that enough to quiet all of you right-wing barking dogs?

Jul 25, 2013, 9:15 AM

Notice something about those who have left comments about this article disagreeing with its premises. So far, as I add my comment, not one of them have even tried to respond to the economic ideas, studies, or facts. I assume that is because they have nothing to say about that and most importantly there is no known credible economic information to refute the premises of the article. What they do instead is make an outdated, pathetic political argument, e.g., referring to bogeymen like the "liberal agenda," whatever that is supposed to be. The economic analysis presented in this article does not represent any political agenda, but rather sound economics which could lead the country out of the horrible mess we are in right now. It just so happens that liberals (Democrats?) seem to be the only persons brave enough to look beyond the next election (politics at its worst) to discover what is best for the country in the longer term, to discover and implement those economic policies which offer the best likelihood of moving the country toward an environmentally sustainable, growing, full-employment, low-inflation, and increasing standard of living economic system.

Jul 27, 2013, 8:42 AM
Saundra Ragona (@Ssragona):

The assumption that rich people earn their money is really false. Some rich people earn their money while others make it off the backs of laborers. By keeping the laborer poor and taking the cream of the crop, the rich get richer and the poor get poorer.

Nov 2, 2013, 4:37 PM

Tax brackets and pitting rich against poor has nothing to do with supply side economics. Supply side is limiting government spending and revenue collection. Government does not create utility or provide a money multiplier. Only the private sector or financial sector can provide this. Hence, government tax collection is a leakage in the money cycle.

In addition, government spending has risen to historic levels under both GWB and BO. Neither exhibited conservative values regarding governmental spending. This argument is far bigger than political affiliation.

Your argument should present a theory and prove it. Not simply state some coincidental observations and draw inferences.

I am tired of poorly represented conservative ideas and outright lying to promote fear mongering in order to rally support of political agendas.

Nov 4, 2013, 4:29 PM

What created the worst economic downturn since the "Great Depression" was the failure of the government backed (and bank forced) policies in the housing industry. When you have hundreds of thousands of people given loans on houses they couldn't afford, just because of their skin color or ethnicity, then it was bound to collapse. This is what happened in 2008. It has nothing whatsoever to do with tax policy. It's the result of liberal policies of telling banks how to lend money. Yet another example of how liberalism creates the exact opposite effect of their stated intent.

Nov 12, 2013, 5:41 PM
Bob Goldschmidt:

The key take away here is that neither government or business acting alone can ensure a stable, productive future. For our economy and citizens to prosper, they must work together to ensure a healthy balance between worker and stockholder interests.

At the present timer it is apparent that federal intervention is sorely needed to restore that balance. The form of that intervention should be the subject of debate, not the personal and federal debt which is merely a symptom of the current imbalance.

Dec 8, 2013, 11:51 AM
Joe T:

good ideas. good luck breaking through america's wasp outer shell. also, forget republican; these trolls do not care about a stronger republic, they care about their power over people.

Jan 22, 2014, 2:53 AM

Seems pretty simple.

If you're poor and you get extra money, you have to spend it right away. On real goods, mostly.

If you're rich and you get extra money, usually you keep it, investing it in corporations...and the money that you spend on stocks goes straight to other rich people. Who also keep it, mostly, paying the schmucks who work for them as little as possible.

We're starving the money machine by letting rich people sit on all the cash there is.

We could print more, and then we end up like Mexico in the seventies. Or we could change the tax code.

Oh, and PJD? "Government does not create utility or provide a money multiplier." Aren't they one of the biggest purchasers of this "supply" you want to create with your tax cuts? If everyone's broke, you can't sell your crap.

Apr 10, 2014, 10:18 AM
Steve M:

A response to Oddity. All economists (myself included) agree that the U.S. Federal tax code is a mess, and that billions could be saved by replacing it with a tax on a broader base at lower marginal rates. But this position has little to do with supply-side economics. The author of the article is correct....there is no evidence to back up the supply-side argument about lower tax rates on the rich leading to a boom in economic growth and more tax revenues.

May 7, 2014, 2:39 PM
dave bowen:

Supply side"slight of hand" economics has never worked. It did not work when Ronald Regan shoved it down Americas throat,it does not work now. The fact that middle class wages have flat lined over the last thirty years,while the income of the "job creators" has jumped as much as 400%. I am sure Regans heart was in the right place,but he was simply naive. He expected that the wealthy would voluntarily share these tax windfalls,with the people whose hard work and productivity made them rich in the first place.It never happened. Not surprising,since most wealthy people I know hold on to a dollar so tightly it makes Washington's nose bleed. Being stingy is one of the reasons they got rich. Then,of course came Dubya,and his supply side on steriods. More tax breaks for the tightwads,wholesale deregulation of Wall Street,gutting the fda,epa,usda,making peoples lives harder and more dangerous. Not to mention all of those business friendly executive orders he signed,that had Obama signed them he'd have been called a criminal. Example:allowing heavy industry to dump more poison in our ground water. Gutting the Clean Air Act,the Clean Water Act,and his Healthy forests Initiative,more aptly called,"no tree left behind" which allows timber companies to virtually clear cut virgin forests,without replacing,or reforestation.

Aug 4, 2014, 4:55 PM

The author is completely wrong. He should have all of his degrees taken away from him for not understanding supply-side economics. There is no historical evidence to prove that monetary issues are not at the core of supply-side economics. You cannot just pick out one detail of a policy and analyze it. When researched correctly, all evidence points to a long-term economy that is based on supply-side economics. The entire definition that goes along with supply-side economics is the following: lower government spending (aka handouts to people that do nothing for themselves), lower taxes for all tax brackets (especially for lower tax brackets), reduce government regulation (Free Market Economy). Put all those together and you have the perfect world. The problem is that the world is not perfect and there are times of war (during the Reagan and Bush eras) that prohibit government spending, thus producing ridiculous assumptions by Liberals that supply-side economics does not work.

Aug 5, 2014, 4:52 PM

I meant to say she haha. And times of war "increase government spending."

Aug 6, 2014, 9:41 AM

I find most of the people commenting here hilarious. Reduce government regulation, that is what you are living now with the collapse of your housing market. How is that going for you. You are all arguing for the rich and if you don't have a Bugatti in the driveway you are basically arguing for the other guys.

Sep 9, 2014, 4:53 PM
Jake Eagleshield:

I have no doubt Regan thought he was doing the right thing by shoving slight of hand,David Copperfield economics down the nations throat. But he was naive. He expected the rich to actually share all those tax windfalls with the people who do the real work. He did not anticipate the inherent greed of the wealthy,which is how they got wealthy in the first place,by holding on to a dollar so tight,Washington's nose bleeds. 'Can't tax the 'job creators' So where are the jobs? Consumer demand creates jobs,not off shore bank accounts. The more people earn,the more they spend. People like Mitt Romney,whose income is mostly UNEARNED,and virtually tax free,create nothing.lowr taxes on the rich do not create jobs. Better wages for working people does.

Oct 3, 2014, 10:23 AM
Jake Eagleshield:

Rich people get rich due to the hard labor and productivity of the people they keep ar poverty level wages. They did not do it all on their own.
I have no doubt that President Regans heart was in the right place when he shoved voodoo,slight of hand economics down our throats.

He was just a bit naive,in thinking that all those tightwad business people would VOLUNTARILY share those windfalls with the people who do the real work.

'You can't tax the job creators' Okay. Where are they?

Supply side economics,and its evil spawn,"right to work" which is nothing more than government sponsored employee abuse,are the primary weapons in the conservative thirty year war of economic genocide on working people. Numbers don't lie.Conservatives can't twist and distort facts,to fit their ideological agenda,the way they twist and distort,history,the Constitution and scripture.

Oct 31, 2014, 12:14 PM
Jeff Tacina:

Bravo!! It's time to bury supply-side economics once and for all! What's most disturbing is that this anti-family brand of economics is supported by people who supposedly stand for the family, like James Dobson, Gary Bauer and Tony Perkins. Those people really aren't for the family. If they were, either they'd vote for Democrats or they'd be trying to get the Republican Party to change its economic policies.

Nov 19, 2014, 4:53 PM
Howbout Numbers:

Thirty two years ago, in 1980, we in the US made a decision to not fund big public works projects like the Apollo program or the interstate highway system. We collectively decided that we would prefer to experiment with the economy theories of Arthur Laffer. The hypothesis was that we would maximize growth by finding a "sweeter spot on the tax curve". Those theories don't appear to have generated the higher levels of growth expected (I based my numbers on search from Wolfram Alpha). Average (mean) per capita GDP growth from 1981 to 2013 (1.08% per quarter year) are well below the growth from the previous 32 year period of 1948-1980 (1.752% per quarter year ) when Keynsian economic policies were dominant.

High risk/unknown reward situations like the NASA of the 50's and 60's, the ARPAnet and early internet of the 1980's and early 1990's, and the human genome project were funded by governments not companies. Companies, because they have a profit motive cannot spend "Moonshot money". This limits our collective spending on infrastructure, collective services, and "Moonshot" engineering and science programs. The return on those collective investments appears to be radically better than investments made by wealthy shareholders.

Nov 21, 2014, 2:56 PM
David Caulfield:

How can anyone who has lived through the incredible greed and lust for power that executives and owners like Ken Lay, Jeff Skilling, Andy Fastow, Morgan Chase's Jaimie Diamon and a host of others who got richer by screwing their employees, customers and the rest of us, still be naive enough to believe these bastards got rich by just working harder than the rest of us. Ask not for whom the bell of future abuse and possible poverty toll. It tolls for thee, sweetheart. I tolls for thee and thine.

Dec 10, 2014, 3:09 PM
David Caulfield:

Go Neena Go! You have verified the theme of my soon to be published novel Ever a Fighter. We are lonely voices is a tsunami of lies and misinformation. But we must keep fighting the good fight. Thank you Neena.

Dec 10, 2014, 3:20 PM
jacob Eagleshield:

First of all,contrary to waht one person said on this site,rich business people did not get rich by their own hard work alone.A lot of hard working people broke their backs working for chicken feed. No good workers,no successful business person.
When Ronald Regan shoved voodoo economics down the nations throat,I have no doubt his heart was in the right place,and he actually believed that slight of hand economics would work.
Problem is,Regan was naive. He assumed that the wealthy would VOLUNTARILY share their tax cut windfalls with the people who do the real work,through,raises,more jobs,better benefits and working conditions.That never happened. The 'trickle down' stopped at their Cayman Island bank accounts.Regan,unknowingly ushered in the culture of greed.
Add to that supply side's evil spawn,Right to Work,and the war against working people goes on.

Jan 12, 2015, 6:36 PM

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