When John Maynard Keynes proposed “government investment” as the cure for a sluggish economy, he thought of it as a flywheel. It would have a “multiplier effect” as boondoggle or bail-out money moved into consumption that might turn up as investment the second time around. But the Keynesians failed to reckon with the fact that “divisor effects” might be more powerful in the long run than anything coming from the multiplier. Keeping a marginal farm going might sell a few hoes, maybe even a second-hand tractor. But it also might divert perfectly good investment money into sterile subsidies that would deprive some inventive soul somewhere of the capital needed to start a new business.
For years, in pushing the “aggregate demand” resulting from the combination of government and private spending, the Keynesians quite overlooked the impact of their policies on supply. They did not see the distortions in prices that were caused by inflation and high taxes. And so they ran us into a high-cost economy in which the tax “wedges” and the bite of inflation destroyed more purchasing power than they created.
Thus the stage was set for the emergence of the “supply siders.” The phrase may be misleading: economics, being fluid, cannot afford to forget that supply and demand are both parts of an integral process. But after forty years of pumping up “aggregate demand” by policies that have severely restricted entrepreneurship, it is time that someone should speak up for the tax- harassed and inflation-bedeviled producer.
To explain the current situation, six economists have collaborated on a stimulating though sometimes cloudy book, Essays in Supply Side Economics, edited by David G. Ra-boy and with a foreword by Edwin J. Feulner, Jr. (Published by the Institute for Research on the Economics of Taxation and the Heritage Foundation, 173 pages, $5.9.5. Available from IRET, 1725 K Street, N.W., Washington, D.C. 20006) Feulner, the head of the Heritage Foundation, says in his foreword that the conviction that supply side theory will work “is for most people a matter of intuitive knowledge.” But, aside from Jack Kemp and a few others, we don’t send people to Congress who are long on intuition. We need something to combat what Feulner describes as “the misconception that supply side economics is a political movement with little or no economic theory behind it.”
Origin of the Concept
The second essay in the book, written by David Raboy, traces “the theoretical heritage of supply side economics.” Logically, this essay should have come first. Raboy, who is director of research at the Institute for Research on the Economics of Taxation, thinks “supply side” is more or less synonymous with classical economics in genera]. The supply siders believe that saving is the driving force of investment, and that without investment there can be no increase in real wages. This is what Adam Smith believed. J. B. Say, the French economist, was a supply sider when he argued that the overall level of demand in an economy is dependent on the level of output and that as investment and production increase, so will demand. (This is often summed up as “production creates its own purchasing power,” which is obvious when you consider that pro duction pays wages and dividends that go into the stream of spending and new investment.) J. B. Say anticipated John Stuart Mill, another classicist, when he said that when any transaction is finally closed, it will be found that one commodity has been exchanged for another. Money, when untampered with, performs a neutral role—sales, according to Say, “cannot be dull because money is scarce but because other products are so.” It is the multiplication of the “other products”—the supply side—that keeps the economic process going.
The “marginalists”—Carl Menger, Stanley Jevons, Leon Walras, John Bates Clark—were all supply siders, as were Alfred Marshall and Vilfredo Pareto. “Menger’s analysis,” says Raboy, “provides a crucial building block for supply side economics . . . economic decision making occurs at the margin. Then the way in which taxes, monetary theory, or government spending will affect economic behavior depends on their effects at the margin, on the valuation of activities or commodities.”
Impact of Inflation on Taxes and Productivity
In the opening essay, “Supply Side Analysis and Public Policy,” Norman B. Ture, who is Undersecretary of the Treasury for Tax and Economic Affairs, says the pertinent question “is how changes in real aggregate demand can occur without a preceding change in total output.” Taxes, of course, alter relative prices or costs. High taxes, reflected in prices, can change the whole “effort-leisure trade-off.” Ture provides an intricate analysis of the drag on the economy that comes with Keynesian stagflation. Inflation, he says, augments the existing tax bias against effort and saving “by increasing the real marginal rates of income tax.”
Mai Nguyen Woo, a research associate at the Institute for Research on the Economics of Taxation, develops some of Ture’s insights in her essay on “Taxation, Savings, and Labor Supply: Theory and Evidence of Distortions.” Constructively, she offers a theory that a tax on consumption would be a great improvement over our present “hybrid” tax system that penalizes capital formation.
The remaining essays in the book are rather specialized. David G. Tuerck, formerly with the American Enterprise Institute, talks about “Rational Expectations and Supply Side Economics: Match or Mismatch?” He concludes that taxes “distort relative prices by forming a wedge between the price offered by buyers and the price received by sellers.” This discourages employment “by forcing the worker to hand over to government part of the wage employers offer for his services.”
Richard E. Wagner, who teaches at Florida State University, discusses “The Enterprise System, Democracy, and the General Welfare: an Approach to Reconciliation.” He makes a distinction between “special interest” democracy and what he calls “consensual” democracy. The “consensual” democrat won’t object to government spending for “general” benefits such as police, fire, sanitation, recreation and transportation. But, after digesting the supply side message, the consensual democrat will oppose “the use of government as a vehicle for transferring wealth.”
Finally, Naomi R. Lamoureaux, a professor of history at Brown University, offers an essay called “From Antitrust to Supply-Side Economics: The Strange History of Federal Intervention in the Economy.” She notes that the “regulatory functions of government” have “destroyed business initiative and diverted the allocation . . . of resources away from their most productive uses.”
