In my recent post on Obama’s “bottom-up economics” I referred to supply-side economics and largely positive but with shortcomings. My reference to shortcomings generated multiple comments and questions on- and off-line. Let me explain—at the risk of oversimplifying some complicated issues.
Economics is about supply and demand, but most “mainstream economists” tend to emphasize the latter. When consumers demand more goods and services the economy grows. This is true to a point, but Keynesians and other demand-side economists are shortsighted. Their solution to a stagnant economy is always about increasing demand and they prefer government spending to tax cuts because they can directly control how the money is spent. This ultimately leads to more centralized control, large deficits, and the like.
Supply-side economists like famous Reagan advisor Art Laffer emphasize the other side of the equation. From this perspective, lower barriers to production and greater access to capital increase supply and grow the economy. Laffer is known for the “Laffer curve,” a simple but powerful supply-side concept about tax rates and tax revenues. According to the Laffer curve, when tax rates become too high, a cut in taxes can actually increase government tax revenues by increasing incentives for companies to produce and individuals to work. There are a lot of other factors that influence government tax revenues, but the Laffer curve helps explain why Reagan’s tax cuts spurred both economic growth and increased government revenues. Reagan fell short of tackling the deficit, but that was largely a spending problem, then as it is today.
There’s no question that supply-side economists offer a breath of fresh air to a Keynesian-dominated world. Supply-siders attack burdensome regulations and confiscatory tax rates, both of which are byproducts of a demand-side approach. Unfortunately, they don’t go far enough. Most supply-siders don’t object to Federal Reserve intervention in an economy. While they tend to be more sensitive than demand-siders to Fed abuses, they take a middle-of-the-road approach and fail to see the long-term problems with an activist Fed.
Second, supply-siders don’t directly address the problem of cronyism, the ongoing collusion between politicians/bureaucrats and private interests. While a regulation rollbacks and tax cuts tend to reduce the influence of cronyism, most supply-siders are satisfied with a tax system with certain elements of social engineering (i.e., special deals designed to favor special interests) and heavy government control in select industries like healthcare and education.
My views are more closely aligned with the Austrian school of economics. Austrians realize that most—not just some—government intervention in the economy is detrimental. They don’t just favor tax cuts, but instead a complete overhaul of the tax system in favor of a fair tax or a flat tax with low rates and few deductions. They also insist on substantial reductions in government spending, not just minor tweaks, reductions in spending increases, or spending freezes. Government spending has always been and continues to be the number one problem. Austrians understand the importance of addressing this head-on.
At the end of the day, I agree with much of what supply-side economists have to say. Reaganomics was certainly a step in the right direction, but the current situation is dire and requires stronger medicine. The Austrian approach offers a more complete solution.