Enough with the Supply Side Already

Forbes.com recently (http://tinyurl.com/cpm8xf, 9 March 2009) carried the Limbaugh-like comments of Washington columnist John Tamny to the effect all the government ever needs to do in a downturn is cut taxes and get out of the way. He also said that he likes unemployment because it is a chance to get rid of "a lot of marginal, inefficient or simply mismatched workers." Also, "bargain-hunting businesses … are often able to hire--relatively cheaply--well-trained workers…"

Probably even most Forbes.com readers disagree with those tasteless remarks. Still, many misunderstand economics enough they attack the already passed Recovery Act. They are dogmatic "supply-siders." Since Ronald Reagan was sucked into this, we have been beset by it, and most of us have suffered greatly.

This school of thinking has the idea that reducing taxes on the rich makes them invest their added keepings on investments in new or expanded business. This supposedly increases overall economic activity and thus the total tax take. There are many fallacies here.

The biggest is that often downturns occur not because of choked supply but, as now, weak demand. The tiny rate of inflation today shows that demand is not there. Even if cutting taxes led the rich to invest in businesses, it would only make the problem worse. Businesses are not even trying to expand today, not borrowing. With lower taxes, the rich will put their savings into higher living or offshore accounts, and the federal deficit will go up with lost revenue.

A supply-side myth says the economy grows so much with lower tax rates that tax revenue increases! Only with very high top tax brackets (found in computer models—like 75%) does that happen in theory. Real world top brackets are half that in the U.S., so the major effect of lowering taxes without lower government spending is more deficit.

Finally, more money to the rich never trickles down to the middle class and the poor—the rich have a far bigger piece of the pie now by far than when Reagan was president.

In Reagan's time there was a kind of supply side trial. Prices went way up, as people hoarded against inflation provoked by an oil price spike, and supply could not keep up. We had a stagnant economy with inflation—"stagflation." Naively, the Federal Reserve put its foot on the money supply, to reduce inflation, not realizing that actually caused inflation. The result was no money to expand production, and more inflation. Reducing taxes was the chosen remedy, although it caused big deficits. Production expanded over a few years, mostly as the government pumped money into defense contractors, and OPEC cut oil prices. Inflation came down, followed by a low-demand recession.

Conservatives and Republicans like this fellow Tamny today flog lowering taxes to enable expansion on the supply side. Whatever may have worked in a hoarding situation, it won't work when demand goes away, as it has.

Companies need to sell products and services, and have marketed heavily to sell what they produce. So consumer spending has gone up, from about 62% of GDP in 1959 to near 70% in 2006, on average over 3% more dollars every year. Spending by all levels of government, including defense, plus business is down to near 30% of GDP.

Marketing is great at increasing consumer spending. The past decade many of us borrowed against the cash value of our homes to get money to spend. While home prices grew in a bubble that worked, but eventually we had an economic disaster.

In 2006, as the housing bubble leaked and burst, people turned around and started saving instead of spending. We have been losing jobs and production since then, and prices of some goods and services have gone down. We are near to hard-to-reverse deflation. There is not enough demand to keep prices up. Now what?

Should we try primarily to spur demand by consumers, as with the "stimulus" of spring 2008? People wisely paid off debt or banked the stimulus. Also, consumer over-spending is what got us into this mud in the first place, by running us out of money and credit. We need a non-consumer demand-side solution.

Since the 1980s, we have deferred maintenance of public facilities—like schools, roads, public transportation, water and sewer systems. They are in bad shape. Why? Because the federal government cut taxes, listening to supply-siders. It shifted costs to the states, which made it up by deferring maintenance.

There is a perfect way to increase demand: repair our public facilities and create new ones (as we did with the Interstates starting in 1956, a tremendous boost to the economy)—a demand-side, non-consumer solution. Americans are clever, and will figure out how to perform these new jobs. Make way for coming prosperity.