Supply-Side Economics: The “Voodoo” Elixir

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A Laffer Curve shows the relationship between tax revenues and marginal tax rates. Image by Djzanni

In the 1980 Republican presidential primary race, candidate George H.W. Bush famously referred to Ronald Reagan’s tax-cut laden economic plan to stimulate the moribund economy “voodoo economics.”

Eight years later, after the longest post-WWII peacetime expansion on record, Reagan was firmly entrenched as a conservative icon, whereas Bush was challenging the electorate to pay very close attention to his lips.

Supply-Side Economics and Trickle-down Theory

Ronald Reagan popularized supply-side economics, a set of principles by which barriers to capital investment and the production of goods and services are lowered in order to create cheap, plentiful supplies, which lead to sustainable economic growth.

It has often been referred to pejoratively as “trickle-down economics” by detractors, although the two concepts have only tangential similarities. Supply-side proponents argue that some tax cuts may result in greater activity and, thus, higher gross tax revenues.

Trickle-down economics (a phrase purported to have been coined by Will Rogers) places the emphasis on tax breaks and other economic benefits to businesses and the wealthy, positing that said benefits would eventually work their way through the entire economy.

Reagan remains the archetypal Republican supply-side bastion. Image courtesy of the U.S. National Archives

The two are not completely separate and distinct philosophies. As a centerpiece platform, Reaganomics featured draconian marginal tax rate reductions for the wealthy. Furthermore, special tax concessions and other loopholes were also created, primarily for the benefit of the upper end of the income bracket. David Stockman, Reagan’s budget director and economic architect, was quoted as saying, “It’s kind of hard to sell ‘trickle down,’ so the supply-side formula was the only way to get a tax policy that was really ‘trickle down.’ Supply-side is ‘trickle-down’ theory.”

The Laffer Curve

Central to supply-side economics is the belief in the validity of the Laffer Curve. Dr. Arthur Laffer, considered by many to be the father of supply-side economics, created a simple-yet-powerful graph with tax revenues collected by the government on one axis and marginal tax rates on the other. At a 0% tax rate, the government would collect no revenues. Likewise, at 100%, it would also receive no revenues, as there would be no incentive to produce goods or services. Somewhere between the two extremes is the optimal tax rate, and at points along the curve, reductions in the marginal tax rate increase net collected revenues.

Dr. Laffer was a member of Reagan’s Economic Policy Advisory Board for both of his terms. He was prominently mentioned in a March, 1999 Time magazine cover story about the greatest minds of the 20th century. His theories, without question, dominated economic policy in the 1980s.

Supply-Side Economics Versus Keynesian Economics

Supply-side economics is the near-opposite approach to Keynesian economics. Whereas supply side theories have, as a core principle, minimalist government, the latter requires significant (sometimes massive) amounts of government intervention. Supply-side economics attempts to stimulate production with the notion that cheaper and more plentiful goods and services will inevitably lead to greater consumption, whereas Keynesian economics utilizes government fiscal and monetary policies in an attempt to spark demand.

Economic strategies have swung between the two extremes over the past 30 years. Although Bill Clinton reversed some of Reagan’s tax cuts, he may have been the most effective in blending the concepts of supply and demand-side economics during his tenure.

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