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Drinking the Supply-Side Kool-Aid

by | Mar 9, 2016 | Economy, Taxes

11942712503_31d7b070b9_kThe conservative Center of the American Experiment recently posted a strident defense of supply-side economics on a conservative blog. Most economists have long abandoned supply-side economics—or at least the form of it promulgated by right wing politicians and pundits. But some conservatives are trying to breathe new life into supply-side, even though, by their own admission, many of their colleagues on the right have concluded that “it is no longer a winning issue.”

In a nutshell, supply-siders contend that lower tax rates—especially for high-income households—will boost economic growth by giving people incentives to work, save, and invest more. In other words, the more money that rich people are able to keep, the more the entire economy will expand. The fact that the increased wealth concentration at the top over the last several decades is associated with historically low rates of economic growth—including recurring jobless recoveries and stagnant real wages—has not been sufficient to dissuade believers from the supply-side religion.

CAE’s attempt to salvage supply-side economics rests largely on a “dynamic scoring” model developed by the right wing Tax Foundation (TF), an organization that has been resisting taxation—especially progressive taxation—for decades. The TF model finds that tax increases on lower income households have very little to no adverse effect on economic growth, while tax increases on high income households and corporations are a major drag on the economy. For this reason, they conclude that tax increases directed at low and moderate income households are a far more efficient way to generate public revenue than tax increases directed at corporations or high-income households.

It is critical to note that the Tax Foundation’s “dynamic scoring” model is based on supply-side assumptions. In short, it is a model created by supply-siders for supply-siders. Being deeply rooted in supply-side theory, it is not surprising that it produces nothing but supply-side friendly results.

Furthermore, while the TF model emphasizes the drag that taxes have on the economy, it does not factor in the positive effects that public investments can have. From the perspective of the TF and its model, tax revenue—once collected—is effectively buried in a hole and has no positive economic impact. In reality, tax revenues are used to maintain roads and bridges, provide police and fire protection, build schools and libraries, help clean up some of the environmental messes created by the private sector, and enforce contracts and protect property rights—all things essential for the functioning of a modern economy.

The Institute on Taxation and Economic Policy (ITEP) has issued a systematic overview of the TF dynamic scoring model, concluding that it “takes an exaggerated view of the impact that taxes have on the economy, while at the same time assuming that the public investments funded through those taxes have no economic value whatsoever” and ultimately characterizing it as “unreliable.” Even Forbes Magazine, hardly a bastion of liberal economics, concludes that the TF model is given “more credibility than it deserves.”

Corporate and high-income household tax breaks have consistently failed to bring about the results promised by supply-siders. Among the more recent examples is Kansas, where a conservative governor—relying on advice from supply-side economists—enacted large income tax reductions with the promise of economic boom. However, Nobel-laureate economist Paul Krugman describes what actually happened:

But Kansas isn’t booming — in fact, its economy is lagging both neighboring states and America as a whole. Meanwhile, the state’s budget has plunged deep into deficit, provoking a Moody’s downgrade of its debt.

Closer to home, we have a case study on the impact of supply-side economics. Since the 2010 election of a right-wing governor, Wisconsin has adhered to supply-side dogma, cutting taxes and public spending. Over the same period, Minnesota has followed a different course, choosing to increase state taxes on those who can afford to pay more and increase investment in K-12 education (including all-day kindergarten), higher education, and local services and infrastructure. And over this period Minnesota has comfortably surpassed Wisconsin in terms of job, income, and GDP growth.*

Why have supply-side results consistently failed to live up to supply-side promises? Because it is rooted in two fundamental errors. The first is somewhat technical and will not be gone into in detail here. Suffice it to say that supply-siders (at least those who apply the theory in the political realm) assume that tax rates are already so high that any marginal change in rates will result in an extraordinary increase or decrease in economic activity. In reality, this is rarely the case.

Second, supply-siders assume that providing tax cuts to high income households and corporations will lead them to invest more in job creation. But this will not happen unless there is increased demand among low and moderate income households—where the bulk of consumer demand arises—for the goods and services that businesses produce. The more efficient way to create economic growth during economically distressed times is by reducing taxes for low and moderate income households or by creating new jobs for middle-class workers through intelligent public investment. Trying to create job growth through tax cuts targeted to businesses and wealthy households is like trying to push a rope—job and income growth will not result in the absence of consumer demand from low and moderate income households.

Krugman notes that, sadly, the failure of supply-side economics to produce the results promised by its proponents does not seem to have put an end supply-side charlatanism. The “Kansas debacle” (Krugman’s term for the disappointing results wreaked by supply-side economics in that state) ultimately will not matter, “because faith in tax-cut magic isn’t about evidence; it’s about finding reasons to give powerful interests what they want.”

Krugman’s observation is prescient. The recent CAE post is once again trotting out the same discredited supply-side promises, supported only by a dynamic scoring model rooted in flawed supply-side assumptions. Minnesotans should be careful not to drink the supply-side kool-aid. It hasn’t worked nationally and in other states that have tried it. There’s no reason to believe that it will work here.



*Some have attempted to dismiss Minnesota’s superior economic performance vis-à-vis Wisconsin, noting that Wisconsin’s economy is more heavily dependent on manufacturing, which has struggled in the aftermath of the Great Recession. While it is true that Wisconsin’s economy is more dependent on manufacturing than Minnesota’s, Wisconsin’s GDP growth is still comfortably behind that of Minnesota even if we exclude manufacturing from the GDP growth calculation.

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