The “Supply-Side” Allure

Like most Americans, I wish my federal income taxes were lower. I recognize that, as citizens, we all have a moral obligation to pay taxes to the society that affords us the opportunity to generate a plentiful income. But we want that obligation to be no more cumbersome than is absolutely necessary. We certainly don’t want our tax dollars to be used for wasteful government spending.  As a result, political debate regarding taxes and spending will always revolve around varying judgments of what constitutes “wasteful spending” versus “necessary spending” or “prudent investing” for the future.

There are other components of the tax debate too. The United States has a progressive income tax.  Those of us who realize the most gain from our nation’s opportunities are thought to have a greater financial obligation to our society.  Naturally, just how much greater that financial obligation should be in order that it be “fair” is debatable.

To counter the argument that fairness dictates that we should pay more, those of us who are asked to pay the most have an economic theory on our side that declares the health of our overall economy demands that we pay less. “Supply-side” macroeconomic theory proclaims that those of us with the largest incomes are the driving force of our nation’s economy.  We, after all, are the small business owners and the entrepreneurs who produce most of America’s jobs. The more we are taxed, the less money we have available to invest in our businesses, and therefore, the less productive the American economy becomes.

It is not just Republicans who have adopted the belief that lower taxes induce economic growth.  In an effort to stimulate the economy President Obama has prompted Congress to “cut taxes” numerous times since he took office. (The quotes signifying that these “cuts” have mostly been tax credits, rather than reductions of rates.)  In fact, one-third of the often maligned 2009 “stimulus package” was in the form of tax cuts. As a result of President Bush’s and President Obama’s tax cuts, the top income tax rate today is lower than at any time since 1931 (except from 1988 to 1992), and the overall tax burden of Americans as a percentage of the GDP over the last three years has been lower than any other three-year period since 1941-1943.  This relatively low tax burden is of course why our nation’s economy is now so robust.  Well… uh… Perhaps we should rethink our assumptions.

Competent economists know that no economic theory can explain all variables at all times—especially economic theories that are largely the product of factional interests.  Since those of us who earn the most have a personal stake in the principles espoused by supply-side theory, we might be tempted to credit it with too much veracity.  And when politicians take up the mantle of our cause, well, the rhetoric can become downright silly.

We often hear Senators and congressmen on television explain that since many small business owners and entrepreneurs do business as S corporations or sole proprietorships, their businesses are not separated from their personal income.  As a result, the politicians explain, higher personal income taxes take money that could otherwise be used for investments in equipment and the hiring of employees for those businesses.  What these politicians evidently overlook, or perhaps willfully ignore, is that these investments are not taxed at all.  In fact, higher income tax rates for individual business owners can actually induce them to invest in their businesses, rather than take the money as personal income and pay the tax on it.  For example, each year I will do a projection of my income near the end of the year.  If my income is expected to marginally reach into a higher tax bracket, I can then make investments in equipment that I might otherwise delay for some time.  Those investments are tax deductible, of course.  The higher tax bracket can actually induce me to invest in my business.

Supply-side theory is not so blatantly wrong as some politicians’ misuse of it tends to suggest.  Some aspects of the theory are certainly true on the margins under some circumstances.  But however valid it might be under some conditions, it is definitely not applicable to our economy’s current difficulties.  For the most part, we don’t have a supply problem.  We have a demand problem.  I say for the most part because there has been some reluctance on the part of our nation’s banks’ to lend.  But there is no shortage of capital held by most banks, corporations, or wealthy and middle-class individuals.  Personal savings are now higher than at anytime since 1994, and rising rather rapidly.  And American corporations are now holding more cash than at any point on record.  (This suggests John Maynard Keynes was probably right when he said tax cuts are less effective as a stimulus than government spending because people are apt to put the money into savings, rather than back into the economy as intended.)

There are many reasons why there is currently insufficient job-creating demand in the American economy.  Certainly one reason is that President Obama lacks the kind of leadership that instills confidence in consumers and businesses.  Another is that a great deal of current demand is for things made in China or otherwise outside the United States.  This, of course, is why China’s economy has experienced tremendous growth, and why our trade deficit is so large.  It isn’t just Walmart and other retailers buying from Chinese corporations that contribute to American unemployment.  From 2000 to 2009, American multination corporations shed 2.9 million jobs in the United States while adding 2.4 million jobs overseas—a trend that has continued.  Proctor & Gamble, the maker of many of the household products that we have all grown up with, now employs roughly 35,000 Americans, only 28 percent of its 127,000 employees worldwide.  General Electric, IBM, Pfizer, Apple, Hewlett-Packard, AT&T, and undoubtedly many other American corporations now employ more people outside the United States than at home.  (We have no way of knowing how many others because there is no SEC requirement that corporations disclose those demographics.)  This is due primarily to these companies’ doing business in a world market, but it is also due, in large part, to a quest for the cheaper labor and the lax regulation found in the third world.

Another explanation for insufficient demand for American-made products is the conundrum that Americans are saving more, which is good, and thereby spending less, which is bad.  There are other factors too, but here the subject is taxes—whether we are currently being asked to contribute too much or too little, and whether or how the economy is affected by progressive income tax rates.

Certainly one of the key factors in undermining consumer confidence is our nation’s massive budget deficit and the political gamesmanship that has greatly exacerbated its debilitating effect.  The main thing that will fix the deficit is economic growth.  But economic growth is stifled, in part, as a result of the deficit.  So it needs to be dealt with in a way that instills confidence, whether by reducing it now, or by implementing a plan that will ensure its reduction in the near future.  We necessarily have to reduce spending and/or raise taxes.

Supply-side theorists and the politicians who exploit supply-side assumptions insist that we cannot raise taxes on the affluent because it would harm the economy.  The affluent, after all, are the job creators.  These politicians contend that the only solution to the deficit and our currently sluggish economy and unemployment problem is to reduce government spending—to, ironically, put more people out of work.  They say “our country is broke” and that we cannot afford the current level of spending on Medicare, Medicaid, welfare, scientific research, resource management, and the many other things undertaken by the federal government.  Some have included defense, and still others have even included Social Security in the mix.

As we can see, raising taxes is much less harmful to the economy than some proclaim.  The two most prosperous decades of the twentieth century were the 1950s, when the top income tax rate was 91 percent, and the 1990s, which immediately preceded all of the many tax cuts enacted at the urging of the Bush and Obama administrations.

Our country is certainly not broke either.  Individuals and corporations are holding enormous amounts of cash.  So then what’s the debate really about?  What are the real choices?

It’s about the size and scope of government and the kind of society in which we choose to live—not economics.  Our major entitlement programs that take up such a large percentage of the budget will either undergo the minor adjustments necessary to make them sustainable in the long term, or they will be significantly downsized, privatized, or completely eliminated, as preferred by those who subscribe to the atheistic worldview of Ayn Rand—the view that the world is made up of “producers and moochers.”  The choices we have to make regarding taxes and government spending are choices about what we can accomplish as a cohesive society, versus what is best left to individuals.  We can certainly debate what, if any, things might be done most efficiently by government or what philanthropic endeavors warrant our contributions to government initiatives.  But let us not confuse those preferences with self-interested macroeconomic assumptions.

Because it serves our most immediate personal interests, supply-side theory is rather easily adopted as a major pillar of our ideology.  To shore-up that ideology, we have a number of think tanks, a couple of television networks, and a major political party all working toward the institutionalization of our favored economic assumptions.  The trouble with ideologies, however, is that, like political parties, they induce what the legal community calls “willful blindness.”  It is what happens when we choose to believe anything.  We will naturally seek conformation of the wisdom of our choice, while, either consciously or subconsciously, avoiding conflicting information.  Once a preferred belief has been expressed, pride can then become a powerful force in the hardening of an ideological stance.  We hate to be wrong more than just about anything.  This is why we should always endeavor to avoid ideological thinking or a proclaimed allegiance to a political party.  These things are not only acts of laziness, they are terribly blinding.

In conjunction with the economic contraction that occurred from December 2007 through July 2009 and the unemployment that followed, it has been the alluring but misapplied and ultimately misguided supply-side economic theory, along with an unwillingness to pay for the wars and entitlements we have purchased, that now accounts for our nation’s $14 trillion debt and the current $1.3 trillion deficit.  Whatever we may decide about just how much government is preferable, our nation’s economy now depends on our ability to stop fooling ourselves and to pay our bill.  Virtually everyone who is employed should have to contribute at least something, but since 20 percent of Americans hold 84 percent of our nation’s wealth and only 1 percent of Americans hold half of that, then we simply cannot avoid invoking the (bank robbing) Willie Sutton rule.  The very wealthiest of us have to contribute disproportionally, “because that’s where the money is.”