With its emphasis on aggregate supply, rather than aggregate demand (as in Keynesian economics), supply-side economics is concerned with the productive capacity of the economy.
Free market supply-side economics emerged in the 1980s as the complement to monetarism.
Government measures included: tax cuts; measures to facilitate the mobility of labor; reduction in public expenditure; and deregulation.
Also see: Thatcherism, Reaganomics, Say’s law, new classical macroeconomics
Supply-side economics developed in response to the stagflation of the 1970s. It drew on a range of non-Keynesian economic thought, including the Chicago School and New Classical School. Bruce Bartlett, an advocate of supply-side economics, traced the school of thought’s intellectual descent from the philosophers Ibn Khaldun and David Hume, satirist Jonathan Swift, political economist Adam Smith and United States Secretary of the Treasury Alexander Hamilton.
However, what most distinguishes supply-side economics as a modern phenomenon is its argument in favor of low tax rates primarily for collective and notably working-class reasons, rather than traditional ideological ones. Classical liberals opposed taxes because they opposed government, taxation being the latter’s most obvious form. Their claim was that each man had a right to himself and his property and therefore taxation was immoral and of questionable legal grounding. On the other hand, supply-side economists argued that the alleged collective benefit (i.e. increased economic output and efficiency) provided the main impetus for tax cuts.
As in classical economics, supply-side economics proposed that production or supply is the key to economic prosperity and that consumption or demand is merely a secondary consequence. Early on, this idea had been summarized in Say’s Law of economics, which states: “A product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value.” Supply-side economics rose in popularity among Republican Party politicians from 1977 onwards. Prior to 1977, Republicans were more split on tax reduction, with some worrying that tax cuts would fuel inflation and exacerbate deficits.
In 1978, Jude Wanniski published The Way the World Works in which he laid out the central thesis of supply-side economics and detailed the failure of high tax rate progressive income tax systems and United States monetary policy under Richard Nixon and Jimmy Carter in the 1970s. Wanniski advocated lower tax rates and a return to some kind of gold standard, similar to the 1944–1971 Bretton Woods System that Nixon abandoned.
The Laffer curve embodies a postulate of supply-side economics: that tax rates and tax revenues are distinct, with government tax revenues the same at a 100% tax rate as they are at a 0% tax rate and maximum revenue somewhere in between these two values. Supply-siders argued that in a high tax rate environment lowering tax rates would result in either increased revenues or smaller revenue losses than one would expect relying on only static estimates of the previous tax base.
This led supply-siders to advocate large reductions in marginal income and capital gains tax rates to encourage greater investment, which would produce more supply. Jude Wanniski and many others advocate a zero capital gains rate. The increased aggregate supply should result in increased aggregate demand, hence the term “supply-side economics”.
In the United States, commentators frequently equate supply-side economics with Reaganomics. The fiscal policies of Republican Ronald Reagan were largely based on supply-side economics. Reagan made supply-side economics a household phrase and promised an across-the-board reduction in income tax rates and an even larger reduction in capital gains tax rates. During Reagan’s 1980 presidential campaign, the key economic concern was double digit inflation, which Reagan described as “[t]oo many dollars chasing too few goods”, but rather than the usual dose of tight money, recession and layoffs, with their consequent loss of production and wealth, he promised a gradual and painless way to fight inflation by “producing our way out of it”.
Switching from an earlier monetarist policy, Federal Reserve chair Paul Volcker began a policy of tighter monetary policies such as lower money supply growth to break the inflationary psychology and squeeze inflationary expectations out of the economic system. Therefore, supply-side supporters argue that Reaganomics was only partially based on supply-side economics.
Congress under Reagan passed a plan that would slash taxes by $749 billion over five years. Critics claim that the tax cuts increased budget deficits while Reagan supporters credit them with helping the 1980s economic expansion that eventually lowered the deficits and argued that the budget deficit would have decreased if not for massive increases in military spending. As a result, Jason Hymowitz cited Reagan—along with Jack Kemp—as a great advocate for supply-side economics in politics and repeatedly praised his leadership.
Critics of Reaganomics claim it failed to produce much of the exaggerated gains some supply-siders had promised. Paul Krugman later summarized the situation: “When Ronald Reagan was elected, the supply-siders got a chance to try out their ideas. Unfortunately, they failed.” Although he credited supply-side economics for being more successful than monetarism which he claimed “left the economy in ruins”, he stated that supply-side economics produced results which fell “so far short of what it promised”, describing the supply-side theory as “free lunches”.
President Clinton presided over the budgets for fiscal years 1994–2001. From 1998 to 2001, the budget was in a surplus for the first time since 1969. Economists Jeffrey Frankel and Peter Orszag summarized Clintonomics in a 2001 paper: “It sought to adopt some of the pro-market orientation associated with the ascendancy of the Republicans in the 1980s, and marry it with traditional Democratic values such as concern for the environment and a more progressive income distribution.”
Clinton signed the Omnibus Budget Reconciliation Act of 1993 into law, which raised income taxes rates on incomes above $115,000, created additional higher tax brackets for corporate income over $335,000, removed the cap on Medicare taxes, raised fuel taxes and increased the portion of Social Security income subject to tax, among other tax increases. Frankel and Orszag described the “progressive fiscal conservatism” of the 1993 package: “Such progressive fiscal conservatism combines modest attempts at redistribution (the progressive component) and budget discipline (the fiscal conservative component). Thus the 1993 package included significant spending reductions and tax increases. But it concentrated the tax increases on upper-income taxpayers, while substantially expanding the Earned Income Tax Credit, Head Start, and other government programs aimed at lower earners.” President George H.W. Bush had raised marginal income tax rates in 1990. The tax increases led to greater revenue (relative to a baseline without a tax increase).
The bill was strongly opposed by Republicans, vigorously attacked by John Kasich and Minority Whip Newt Gingrich as destined to cause job losses and lower revenue.
Economist Paul Krugman wrote in 2017 that Clinton’s tax increases on the rich provided counter-example to the supply-side tax cut doctrine: “Bill Clinton provided a clear test, by raising taxes on the rich. Republicans predicted disaster, but instead the economy boomed, creating more jobs than under Reagan.”
Supply-side economist Alan Reynolds argued that the Clinton era represented a continuation of a low tax policy (from the 1980s):
In reality, tax policy was not unambiguously better in the eighties than in the nineties. The highest income tax rate was 50 percent from 1983 to 1986, but below 40 percent after 1993. And the capital gains tax was 28 percent from 1987 to , but only 20 percent in the booming years of 1997-2000. On balance, there were good and bad things about both periods. But both the eighties and the nineties had much wiser tax policies than we had from 1968 to 1982.
In May 2012, Sam Brownback, Governor of the state of Kansas, signed into law the “Kansas Senate Bill Substitute HB 2117”, which cut state income taxes deeply and was intended to generate rapid economic growth. The tax cuts have been called the “Kansas experiment”, and described as “one of the cleanest experiments for how tax cuts effect economic growth in the U.S.” The law cut taxes by US$231 million in its first year, and cuts were projected to total US$934 million after six years. They eliminated taxes on “pass-through” income (used by sole proprietorships, partnerships, limited liability companies, subchapter S corporations, for the owners of almost 200,000 businesses, and cut individual income tax rates as well.
The original bill proposed by Brownback offset the losses expected to result from the cuts with increases in the state sales tax, as well as the elimination of numerous tax credits and deductions, but by the time the bill came to the governor to be signed these had been removed. Brownback then argued that the cuts would pay for themselves by increasing revenue by boosting the state’s economic growth. Supporters pointed to projections from the conservative Kansas Policy Institute predicting that the bill would lead to a $323 million increase in tax revenue.
Brownback forecast his cuts would create an additional 23,000 jobs in Kansas by 2020. On the other hand, the Kansas Legislature’s research staff warned of the possibility of a deficit of nearly US$2.5 billion by July 2018. Brownback compared his tax cut policies with those of Ronald Reagan, but also described them as “a real live experiment … We’ll see how it works.” The cuts were based on model legislation published by the conservative American Legislative Exchange Council (ALEC), and were supported by The Wall Street Journal, supply-side economist Arthur Laffer, and anti-tax leader Grover Norquist.
By 2017, state revenues had fallen by hundreds of millions of dollars causing spending on roads, bridges, and education to be slashed, but instead of boosting economic growth, growth in Kansas remained consistently below average. A working paper by two economists at Oklahoma State University (Dan Rickman and Hongbo Wang) using historical data from several other states with economies structured similarly to Kansas found that the Kansas economy grew about 7.8% less and employment about 2.6% less than it would have had Brownback not cut taxes. In 2017, the Republican Legislature of Kansas voted to roll back the cuts, and after Brownback vetoed the repeal, overrode his veto.
According to Max Ehrenfreund and economists he consulted, an explanation for the reduction instead of increase in economic growth from the tax cuts is that “any” benefits from tax cuts come over the long, not short run, but what does come in the short run is a major decline in demand for goods and services. In the Kansas economy cuts in state government expenditures cut incomes of state government “employees, suppliers and contractors” who spent much or most of their incomes locally. In addition, concern over the state’s large budget deficits “might have deterred businesses from making major new investments”.
Economist Paul Krugman wrote in 2017: “Sam Brownback, governor of Kansas, slashed taxes in what he called a “real live experiment” in conservative fiscal policy. But the growth he promised never came, while a fiscal crisis did. At the same time, Jerry Brown’s California raised taxes, leading to proclamations from the right that the state was committing “economic suicide”; in fact, the state has experienced impressive employment and economic growth.”
Gov. Brownback himself strongly rejected criticism of his cuts or any need to adjust the law, declaring the cuts a success, blaming perceptions to the contrary on a “rural recession,” and on “the left media” which “lies about the tax cuts all the time”.