What Are EMarichconomists Think About Supply-Side Economics?

Supply-side economics revolves around the belief that lowering taxes and reducing government regulations can boost economic growth more effectively than Keynesian methods, which involve high taxes and massive government spending. Many economists support supply-side economics, as evident from the recent economic success highlighted by the Trump administration.

The Triumph of Supply-Side Economics

Under President Donald Trump, the U.S. economy experienced a boom characterized by: A significant increase in Gross National Product (GNP) Job growth at unprecedented levels The lowest unemployment rate in decades, particularly among historically marginalized groups such as African Americans and Hispanics A surge in business investments and job opportunities An increase in the labor participation rate and average wages Exponential wealth growth for millions of American workers and retirees, especially those with 401k savings plans

Why GDP Data Shouldn't Be Interpreted Through a Keynesian Lens

Advocates of supply-side economics argue that GDP data should not support interpretations that favor government spending. The classic example often cited is that, contrary to popular belief, Reagan actually performed better in terms of job creation and economic growth than Obama.

The Core Principles of Supply-Side Economics

Economic Growth Through Tax Cuts and Regulation Reduction

The foundational ideas of supply-side economics can be summarized as follows:

Economic growth can be increased by reducing taxation and regulation that act as a tax burden or 'rent' on goods and services, leading to decreased costs and increased market efficiency. There is a diminishing return on government tax revenue as tax rates increase. High tax rates can lead to a decrease in the total volume of tax revenue. In high-tax environments, reducing tax rates can lead to higher economic growth, thereby increasing tax revenues on profits and allowing for greater overall tax revenues.

My Perspective

The logic behind supply-side economics is not inherently flawed; the idea of stimulating economic growth by reducing taxes certainly makes sense. However, when large macroeconomic variables such as national debt, currency value, and inflation are at play, the positive effects of supply-side stimulus can be overwhelmed by negative impacts.

A Real-World Example

Let's consider a hypothetical situation:

The federal tax rate is 18% Deficit spending is 15% of the federal budget The national debt is 120% of GDP The dollar is declining in value, causing inflationary pressures Treasury interest rates increase by 125 basis points (1.25%)

Assuming the policy is to cut taxes from 18% to 17%, economic growth appears to increase by 0.5 to 1%. However, this results in a decrease in tax revenues by $40 billion, while generating about $200 billion in GDP growth. The new taxable income, taxed at 17%, will generate $3.4 billion in new tax revenue. Thus, there is a net decrease in tax revenue of $32.6 billion one year later.

In this scenario, despite the initial positive growth, the negative impacts—such as the devaluation of the dollar, increased inflation, and higher interest rates—can stifle economic growth.

A Balanced View of Supply-Side Economics

While supply-side economics offers valuable insights, it is crucial to consider its limitations. The effective federal tax rate must be balanced to avoid overly stimulative policies that can lead to high inflation and currency devaluation. Similarly, removing necessary regulations can have negative consequences if it allows for market misinformation and economic risks.

Ultimately, simple economic principles like those found in supply-side economics should adapt to the complexity of real-world economic scenarios to remain valid.