The Mises Institute monthly, free with membership
October 1996
Volume 14, Number 10
The good news is that supply-siders want to cut taxes. The bad
news is...well, let's accentuate the positive for the moment. The
supply-siders reject Washington's tendency to think in static
terms. To most politicians and bureaucrats, the economy is a pie
for the tax collectors and special interests to slice up and
gorge themselves on. Then they are shocked when the economy stops
growing.
In truth, people respond to policy changes in ways Washington
can't anticipate. When capital formation and value creation is
taxed, there is less of it. Unlocking that capital by reducing
taxes on income and investments is a sure path to economic
growth. So far, the supply-siders are correct, and a big
improvement on Keynesian-style D.C. economic theory.
Liberals say tax cuts only help the rich. But by definition,
the rich are the ones with the financial means to invest and
create jobs. If it's economic growth and restored prosperity that
we're after, no plan that punishes them disproportionately is
going to succeed.
The static attitude of Washington spills over into all areas
of fiscal policy. Especially pernicious is the doctrine of
"revenue neutrality," which says that tax cuts are forbidden
unless they can be "paid for" with equal spending cuts. At the
same time, the doctrine hasn't restrained spending. Thus taxes
can never go down so long as static analysis prevails.
For that reason, the supply-siders have warned that fear of
deficits is little more than a smokescreen for keeping deficits
high. As political analysis, this is true. When the 104th
Congress shifted its focus from cutting government to cutting
deficits, it doomed itself to failure. In fact, in the sweep of
American history, the debt has been reduced primarily in times of
tax cutting.
The main trouble with this doctrine is that it puts too much
emphasis on the incentives introduced by tax rate changes and not
enough on the overall tax burden. For example, supply-siders at
the Wall Street Journal disparage the idea of allowing
tax credits for children because it doesn't cause people to churn
their investment accounts. Guru Jude Wanniski has attacked Bob
Dole's proposed tax credit as "very expensive for what it would
yield in added economic growth."
Expensive for whom? The government, of course. But from the
point of view of the family, it's a wonderful thing, as is any
tax cut, anywhere any time. It allows people to keep more of
their own money, an essential precondition for restoring
prosperity.
Neglecting the overall tax rate leads to other errors. The
supply-siders back flatter taxes, on grounds that progressive
rates penalize wealth accumulation. But if these flatter taxes
end up as higher taxes (as they do in most proposed reform
packages), it would be for the worse. It's better to have three
progressive rates of 15%, 28%, and 33% than a flat rate of 30%.
It's not the flatness that counts so much as the overall level.
It's a danger to view taxes as a tool for social or economic
planning, even when the planning involves policy changes friendly
to the free market. People's actual behavior will always surprise
the planners. One example: if taxes were dramatically lowered
working mothers might decide to leave the work force, thus
causing a statistical "loss of jobs," fewer tax receipts, and,
even, a supposed economic slowdown. Would supply-siders tolerate
this, even if American families were made better off?
The strength of supply-side doctrine is its attention to the
disincentives that high marginal tax rates create for saving and
investment, the pillars of economic growth. Its weakness is that
it does not go far enough: it's not just ascending marginal rates
that dampen economic growth, but all taxes that redistribute
wealth from the private to the public sector. The overall level
of all taxes--including payroll taxes, excise taxes, and
inheritance taxes--matters just as much as how those taxes are
structured and which sectors they hit.
So much for the soft claims of supply-siders. In the best
light, it's classical economics marketed for our times, and
praiseworthy as far as it goes. But there is another side to
supply-side tax doctrine that deserves more scrutiny, beginning
with its claim that tax cuts tend to pay for themselves. This is
a doctrine constructed mainly for political advantage. It
relieves tax-cutting candidates from having to specify spending
cuts.
The empirical example usually cited to prove this claim comes
from the 1980s: rates went down, growth went up, while revenue
went up. Sadly, the data usually consider only income tax rates,
which were indeed cut, and leave aside all other taxes, which
were vastly increased. For example, the primary text defending
the 1980s, Robert Bartley's The Seven Fat Years,
suppresses all discussion of Reagan's tax increases.
Ironically, it was Bob Dole who watered down the tax cut of
1981, and eventually pushed through a reversal when he served as
chairman of the Senate Finance Committee. Dole claimed frequently
on background to the New York Times that tax cuts are
potentially inflationary.
The ink was barely dry on 1981's tax cuts when Dole and Pete
Domenici devised new tax increases totaling $48 billion. By the
end, this had ballooned to $122 billion, and it included a repeal
of the third installment of cuts. Dole shepherded it through the
Senate on a partisan vote, with Democrats voting against tax
increases. In light of what was then the largest tax increase in
U.S. history, it's hardly surprising that revenue increased.
There's an even darker side to supply sideism, typified by
Jack Kemp's wild spending when he was head of Housing and Urban
Development. While calling for tax cuts, he demanded far more for
his own department than even a Democratic Congress would
consider. If his requests had been approved, HUD would have grown
by half; as it was, he managed to expand it by a third.
Was this the exception to the supply-side rule? Sadly not.
Their writings express the view that we can keep the mixed
economy just as it is--dominated by the world's largest system of
transfer payments--so long as we reconfigure the tax code.
Private enterprise can be enlisted, unwittingly, to pay for
ever-higher public spending.
To make tax cuts a reality and a public benefit, government
must be made to curb its appetite for spending. Without such a
curb, the spending will be paid for in other ways: through
increased borrowing, which crowds out private investment, or
through debt monetization.
A similar problem spoils supply-side monetary policy. Many
advocate a gold price rule for monetary management. But the chief
benefit of gold is that it shackles the ability of government to
borrow and monetize debt. All that government spends must be
collected in taxes or else. Loose money is absolutely prohibited.
The benefits of gold derive from the fiscal discipline it
imposes, the discipline supply-siders reject as "root-canal
economics."
Should we cut taxes? The more the merrier. It doesn't matter
whether it's socialists, free marketeers, or supply-siders doing
the cutting, so long as the burden of government is reduced. But
let's not fool ourselves into thinking that tax cuts can make
today's socialistic policies fiscally feasible. The goal is to
hinder the planners--whether they seek to control what the people
demand, supply, or both.
--------------------------------------------
Llewellyn H. Rockwell, Jr. is president and founder of the Ludwig von Mises Institute
Back