Recapturing Supply-Side Coherence

David Limbaugh

12/19/2008 12:01:00 AM - David Limbaugh

It is widely assumed in conservative circles that Republicans, even under President Bush, pretty much had tax policy right but failed on the spending side. Unfortunately, there's more to it. If conservatives plan to recapture ascendancy on economic issues, they better come to a clearer understanding of supply-side theory. Then perhaps they can articulate it and recapture it as a powerful electoral weapon.

Even when history is on their side, Republicans seem to find a way not to capitalize on it and routinely forfeit the narrative to Democrats, who dwarf them in the communications department from sheer repetition, if nothing else.

The Reagan tax cuts were so phenomenally successful that it's amazing Democrats were able to recover politically as quickly as they did. Despite historical revision to the contrary, all income groups did much better under the Reagan cuts. Remarkably, a Treasury Department study showed that 86 percent of people in the lowest 20 percent of income earners in 1979 graduated into higher categories during the '80s.

The tax cuts skewered then prevailing Keynesian economic theory, producing sustained peacetime economic growth without inflation. The reductions in marginal-income- and capital-gains tax rates even increased revenues.

It doesn't matter how much we repeat this truism or how blue our faces become in the process; the relative deficit explosion during the Reagan years was not caused by the tax cuts but by increases in government spending. Yet Democrats succeeded in establishing the narrative that the tax cuts were at the expense of essential government services and that the cuts increased the deficit and the national debt, thus dubbing the '80s the decade of greed.

President George W. Bush, in campaigning on and implementing his tax cut policy, didn't attempt to sell the nuts and bolts of supply-side theory, only that tax cuts stimulate economic growth. But when he did attempt to articulate the theory beyond a superficial level, he sometimes confused the issue.

Instead of arguing, as did such vintage supply-siders as Ronald Reagan and Jack Kemp in the early '80s, that reductions in marginal income tax rates would spur economic growth because they would provide incentives to produce and invest (supply-side), he said the growth would be (and was) a result of people having more to spend and spending it (demand-side). He compounded the confusion when he attempted to sell his tax rebate plan with the same rationale.

This will play right into incoming President Obama's hands as he rolls out his argument that his further planned tax rebates and his massive spending increases (in the forms of his "stimulus" plan and future bailouts) will stimulate economic growth by increasing demand.

Of course, as a liberal, he believes that, and he's going to continue to say it. But conservatives better get their heads straight on this. The evidence is clear that neither one-time demand-side tax rebates nor Keynesian-type government spending generates economic growth.

The 2008 stimulus bill, which included more than $100 billion in tax rebates on the assumption that people would spend the money immediately, did not work to boost the economy.

People spent less than 16 percent of the rebate money, and no appreciable "jolt" to the economy occurred. That's mainly because these one-time rebates are temporary, and people generally don't increase their spending unless they anticipate or receive a permanent increase in their disposable incomes, such as through salary increases or reductions in their marginal tax rates.

Similarly, policy analyst Brian Riedl, writing for The Heritage Foundation, documents that big-government spending packages, such as that being planned by Obama, almost never work. None of the massive spending hikes tried in the 1930s, 1960s or 1970s worked to stimulate growth. "Yet in the 1980s and 1990s -- when the federal government shrank by one-fifth as a percentage of gross domestic product (GDP) -- the U.S. economy enjoyed its greatest expansion to date."

But Keynesian-type government spending fails to stimulate the economy because it just substitutes one type of spending (government) for another (private-sector). In fact, such spending plans usually produce the negative effect of reducing incentives to produce because they subsidize leisure and unemployment and they are often funded out of growth-zapping tax increases. The government expenditures also tend to reduce production because they are in place of more efficient private-sector spending.

It's too bad that under President Bush, Republicans have been selling supply-side theory with demand-side (consumption-based) arguments. For conservatives to get back in the game and, more immediately, have any impact in blocking Obama's disastrous and reckless stimulus packages and further bailouts, they must relearn, articulate and sell supply-side theory in the spirit of Ronald Reagan and Jack Kemp.

Otherwise, we not only will cede the tax-and-spend issue to Obama Democrats but also will be complicit in the disastrous fiscal policies that will ensue.