BY MOST STANDARDS the U.S. economy performed very poorly during the 1970s: both inflation and unemployment increased, and the growth of real incomes slowed substantially. The causes of this poor economic performance are the subject of sharp debate among economists. Those subscribing to supply-side economics blame excessive government in the form of regulation, taxes, and spending. In particular, supply-side economists have argued that increased tax rates have seriously eroded incentives to work, save, and invest.
The role of incentives has long been explored by economists from both theoretical and empirical perspectives. But there is renewed interest in the subject as a result of the large expansion of government's role in the economy and growing concern with the slow growth of labor productivity. Unfortunately, discussions about incentives have often been marked by conflicting claims, stridency, and overstatement. This has obscured points of agreement and disagreement and has made it difficult to identify areas where the empirical evidence is strong and those where it is weak.
In this study Barry P. Bosworth, a senior fellow in the Brookings Economic Studies program, attempts to clarify the basic analytic issues about incentives and to summarize the empirical evidence. He relates these to a discussion of the need for policies that focus on the supply side of the economy and the alternative forms they might take. While the sharp decline in U.S. productivity growth is a central motivating factor behind the debate over the need for supply-side policies, the causes of that decline and the role of capital formation, technological change, and the quality of the work force are subjects of continuing dispute. In addition, the debate over the specific policy actions that should be taken is dominated by differing views about the effectiveness of taxes in altering incentives for saving and work effort. The author examines the difficulties of coordinating tax incentive measures with fiscal and monetary policies.