The Supply-Side Solution?

Written by Chris Clancy on Thursday, 13 September 2012. Posted in Opinion, Chris Clancy

Supply side measures have proven time and again to be effective at building the economy and providing the means to reduce budget deficits at the federal level. As they worked in the past, they can work again in the post-Obama era.

The Supply-Side Solution?

When President Warren Harding took office, way back in the 1921, he appointed Andrew Mellon as his Treasury Secretary. Harding set Mellon the task of reducing the huge federal debt from World War I. On paper the solution was simple — increase tax revenue and/or reduce spending.

However, Mellon had a problem with the “increase tax revenue” part of the solution. He later wrote: 

“The history of taxation shows that taxes which are inherently excessive are not paid. The high rates inevitably put pressure upon the taxpayer to withdraw his capital from productive business.” 

He used the example of William Rockefeller (brother of J D Rockefeller) as an illustration. When he died in 1922 his estate totalled $51 million. Of this more than $44 million was in tax-free, tax-avoidance investments.

Wiki adds: If the rates were set more reasonably, taxpayers would have less incentive to avoid paying. His controversial theory was that by lowering the tax rates across the board, he could increase the overall tax revenue. 

And this is what he did.

“Economic growth in the twenties surged with the tax cuts, and prices were nearly stable while unemployment rates averaged around 4 percent.[4] The government ran surpluses which allowed it to reduce the federal debt by 25 percent. The decreases in marginal tax rates led individuals to pull their investments out of ones designed to avoid taxes—investments such as tax-exempt municipal bonds, personal service corporations, and other avenues to avoid distributing corporate profits. The result was a rising tide of investment in new, growing, and sometimes risky businesses and industries such as radio, consumer household electric appliances, electric utilities, airplane manufacturers, rubber tire manufacturers, supermarket chains, and so forth. The 1920s were a vibrant, growing decade, and the tax cuts of the 1920s certainly were an important part of what brought this about.” Dr. Gene Smiley

Fast forward to 2012 and the RNC. Romney’s pick for VP was interviewed by Larry Kudlow. His words could as well have been spoken by Andrew Mellon ninety years before.

What Mellon did, and what Ryan proposes to do, are examples of supply-side economics. 

What does this mean?

Supply-side economics is a school of macroeconomic thought that argues that economic growth can be most effectively created by lowering barriers for people to produce (supply) goods and services, such as lowering income tax and capital gains tax rates, and by allowing greater flexibility by reducing regulation. According to supply-side economics, consumers will then benefit from a greater supply of goods and services at lower prices. Typical policy recommendations of supply-side economists are lower marginal tax rates and less regulation.” 

For many and varied reasons, supply-side economics fell largely into abeyance from the 1930s until the 1970s. During this period Keynesian demand-side economics was king. By 1980 it was clear that Keynesian economics was seriously flawed and supply-side economics re-emerged under President Reagan. 

With few exceptions (eg..Clinton’s first term) it remained favoured policy until the onset of the global financial crisis and the election of Barack Obama as President. What happened then was  not just a return to Keynesianism, but a lurch to the Left the like of which is still hard to believe.

George Wallace’s dictum no longer applies. The GOP and the Dems are now two very different animals trying to head in two very different directions. 

In his DNC speech Obama came out with one of his pearls:

“The path we offer may be harder, but it leads to a better place. And I’m asking you to choose that future.”

Sounds great, and delivered brilliantly, but where is the substance? What “path” is he talking about and what exactly is this “better place”? Is he really saying all he can offer Americans is four more years of the same — that he wants Americans to, “choose that future”?

Whatever in the hell that future is?

A future totally bereft of ideas; throw in a few more billion in QE — never mind where it comes from — then fold your arms, cross your fingers and hope that something good will come of it. 

The Romney/Ryan economic plan offers a realistic alternative. 

Recovery through real economic growth — not more pie-in-the-sky stimulus spending — not yet more debt. 

Critics say what they propose is mathematically impossible — that the reductions in revenue cannot be recouped through growth — the same sort of thing was probably said to Mellon.

Ryan believes sufficient new revenue will be generated if they achieve an average target growth rate of 4 percent pa in their first term. This, he estimates, will put twelve million people back to work.

“He argues in supply-side fashion that lowering tax rates and plugging loopholes will produce more income, not less …"Pro-growth policies, energy policy, regulatory reform, tax reform and spending cuts … Let's get the size of government back down to where it has historically been: 20 percent of GDP by 2016." 

Supply-side mentor Art Laffer has been arguing for years that lower spending as a share of gross domestic product is essentially a tax cut to grow the economy. In fact, with a 20 percent reduction in marginal tax rates, and significant spending restraints, it's the most powerful economic-recovery tonic possible. And let's add to that: The Romney-Ryan plan will slash the corporate tax rate from 35 to 25 percent — a monumental growth measure.” - Larry Kudlow.

Can it be done?

Nothing is certain, but my instinct is that it can. The lack of confidence and weakness in the economy is caused by regime uncertainty — no-one knows what’s coming next — least of all the Obama administration.

There’s no shortage of cash both at home and abroad waiting to find its way back into the U.S. economy. And God knows there’s no shortage of talent waiting in the wings to make good use of it.

Given the right incentives, this can deliver Ryan’s critical 4 percent average growth figure.

But only if Romney is at the helm, providing the kind of leadership and direction which the country so badly needs.

About the Author

Chris Clancy

Chris Clancy

Chris Clancy lived in China for seven years. Most of this time was spent as associate professor of financial accounting at Zhongnan University of Economics and Law in Wuhan City, Hubei Province. He now lives in Thailand where he spends his time reading, writing, lecturing and, whenever he gets the chance, doing his level best to spread Austrian economics.

Copyright © Chris Clancy. Used with Permission.

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