Magazine article USA TODAY

Taking the "Voodoo" out of Supply Side Economics

Magazine article USA TODAY

Taking the "Voodoo" out of Supply Side Economics

Article excerpt

"Data from the Reagan presidency, the last time supply side economics actually was applied, confirms that tax rate reductions were followed by significant improvements in employment, output, and income."

The most interesting aspect of Steve Forbes' campaign for the 1996 Republican presidential nomination was the media's reaction to his proposal to scrap the voluminous income tax code in favor of a simple flat tax. The term "flat tax" was mentioned frequently in the evening recap of campaign activities, but the plan's nuts and bolts seldom were the subject of detailed analysis.

The media's response was based on three assumptions. First, Forbes was proposing a supply side policy that allegedly would encourage individuals and firms to work, save, and invest. Second, when similar supply side incentives were tried in 1981, budget deficits soared, and it was charged that the "rich got richer while working men and women were left behind." Third, because of its dismal record in the 1980s, anything tagged supply side economics legitimately could be dismissed as "voodoo." The media concluded supply side economics should be ignored, even ridiculed, and not considered seriously. Ridiculed it was--not just by the media and Democrats--but by other Republicans as well.

The supply side critics lived and worked in the world's premier capitalist economy, the U.S., where jobs, incomes, and products are created by free-market forces of supply and demand. Yet, they readily dismissed this policy as so much voodoo economics. Supply side policies let individuals decide where the new jobs will be created, whereas demand side policies permit "enlightened" bureaucrats to determine which industries will receive new government contracts or benefit from technical changes in the tax code. For individual liberty, the difference is critical.

The real problem the critics have with supply side economics and why it is feared by politicians of both parties have nothing to do with economics, but everything to do with power. It is this power benevolently to guide the actions of "selfish individuals" into more "socially responsible" paths that endangers liberty. "No nation in which the government has the dominant economic role has maintained broad political freedom," claimed the 1982 Economic Report of the President. When paternalistic government is "reluctant to let individuals make decisions for themselves ... the long-term cost ... may be to destroy an individual's ability to make decisions for himself."

To understand the difference between the free market's supply and demand sides, consider the following question: "If lumber prices rise, will people buy more or less?" We know people are drawn to a sale, so we would expect higher prices to repel them. Nevertheless, the correct answer is: "We don't know until we know what initially pushed up those prices." It could have been a new tax provision making home ownership more desirable. If so, increased demand for homes would drive up prices of lumber and construction materials as contractors rushed to build more new houses. The result would be higher lumber prices and higher lumber sales. Or, it could have been a resurgence of the southern pine beetle that destroyed millions of acres of pine timber destined for sawmills. A reduction in the lumber supply would have pushed lumber prices up, but reduced sales. When the market reacted to increased demand, people bought more at higher prices, but when the market responded to reduced supply, people bought less.

In a free market, prices and output don't just happen--they are the product of interactions between the market's supply and demand sides. To paraphrase economist Alfred Marshall, it makes no more sense to argue over which side of the free market is more important than it does to argue over which blade of the scissors does the cutting.

Supply side economics rests upon three propositions: First, any policy change alters the structure of individual rewards, prompting a re-evaluation of current behavior and long-term goals, inducing appropriate adjustments in both. …

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