Supply-Side Economics 101

Supply-side economics is a school of economic thought. Its heyday was in the 1980s under President Ronald Reagan. It centers around what is called the Laffer curve. Theorized by Arthur Laffer, it postulates that government revenue can be maximized by setting tax rates at an optimum point. Specifically, it theorizes that setting tax rates too high can decrease revenue because higher tax rates decrease the incentives of citizens to earn money. That is, when something is taxed more heavily, you will get less of it. To understand this "decreasing incentives" idea think about if you had a job that paid $100 an hour. If the government took $95 for every $100 you made would you be more or less likely to work than if the government only took $10 for every dollar you made? Obviously in the former scenario, you would work much less than the latter scenario.

The idea of the Laffer curve is clearest at the two extremes. If the tax rate was 0% obviously the government would not take in any revenue, but if it was 100% the government would not take in any revenue either since no one would work. Somewhere between 0% and 100% lies the optimum tax rate that maximizes revenue for the government.

With this framework in mind, the liberal mantra of "tax cuts for the rich" can be challenged and refuted. "Tax cuts for the rich" is a catchy slogan, but its success in persuading the American public is a risky proposition because it relies on the economic illiteracy of the country.

Since George W. Bush became President of the United States, Congress has passed two major tax cuts in 2001 and 2003. If you are to believe in liberal economic theories then you would expect the amount money coming into the treasury to decrease, since all those "evil, rich people" got to keep more of their money. In fact, the opposite has happened. Since 2003 tax revenues coming into the U.S. Treasury have increased by 20%. In 2005, federal tax receipts were $2.15 trillion, the highest of all time (see here and click on the graph).

This is not a historical fluke either. After President John F. Kennedy cut marginal tax rates from 90% to 70%, actual tax revenues rose from 94 billion dollars in 1961 to 153 billion dollars in 1968. In addition, overall tax revenues increased from $599 billion in 1981 to $909 billion in 1988 after President Reagan cut the tax rates for all Americans.

Critics of supply-side economics are always surprised that cutting taxes increases revenue to the federal treasury, but that is because they believe in a static worldview. They do not realize that lower taxes means more opportunities, and a bigger economy. This in turn leads to more revenue for the government. The fact of the matter is that rich Americans provide opportunities for poorer Americans through the businesses they run. The less the government takes from the "rich", the more people rich Americans can hire and the more money they can pay.

So why do we have large deficits today? The reason is the failure of all politicians to cut spending. Federal spending has exploded over the past several years and entitlements (i.e. Medicare, Medicaid, and Social Security) continue to grow and grow. The problem is not that enough money is not coming into the government. The problem is that it is being wasted by those with who we entrust it. Spending must be curtailed if the deficit is to be tamed, but tax cuts will always help increase the revenue the federal government receives.

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~ The Conservative Guy