Friday, April 06, 2007

Are we all Supply Siders?

Bruce Bartlett has an interesting op-ed in the NY Times today here

His main argument is that we should lay rest to the label "supply-side economics" because a) all the good stuff about supply-side economics has been incorporated into mainstream economic thinking and b) the term is being mis used to support dubious tax cuts that are not economically efficient. Here is the main point of the article

"It’s important to remember that at the time supply-side economics came into being, Keynesian economics dominated macroeconomic thinking and economic policy in Washington. Among the beliefs held by the Keynesians of that era were these: budget deficits stimulate economic growth; the means by which the government raises revenue is essentially irrelevant economically; government spending and tax cuts affect the economy in exactly the same way through their impact on aggregate spending; personal savings is bad for economic growth; monetary policy is impotent; and inflation is caused by low unemployment, among other things"

"The original supply-siders suggested that some tax cuts, under very special circumstances, might actually raise federal revenues. For example, cutting the capital gains tax rate might induce an unlocking effect that would cause more gains to be realized, thus causing more taxes to be paid on such gains even at a lower rate.
But today it is common to hear tax cutters claim, implausibly, that all tax cuts raise revenue."

Since the main tenets of supply side are now mainstream economic thought, there is no need to use the term anymore since using it is often invoked to support "Child Tax Credits" and "Tax rebates," taxes that are not very economically efficient.

Mark Thoma, a Keynesian Economist, defends keynesianism here

His main point is that a new form of Keynesianism can explain many of the faults of the 1970's (high inflation, low growth) quite well. Additionally, whether new Keynesian economics is usable is still an open question (Pres Bush employed quazi-Keynesian policies during the last recession). It depends on whether the "shock" to growth is a supply shock (where Keynesian theories cannot help much) or a demand shock (where he believes they can).

Personally, I believe Bruce Bartlett's rejoinder answers this criticism.

Interesting discussion. However, I think Mark misses the historical context of my analysis. In the 1970s, we were unaware of real business cycle theory or New Keynesian theory. We were confronting Old Keynesian theory. What Mark has basically done is take a current theoretical debate and superimposed it on the 1970s.

I wasn't around during this time period, but I have read a bit about it. While there may have been a good explanation offered from theoretical economists who knew about these complications, I don't think the public or the politicians were aware of it. Hence, a more old school simplistic Keynesian theory was what was usually debated. The old supply siders were countering this doctrine with a bout of tight monetary policy and cuts in the marginal tax rates.

It is still an open question whether these cuts in marginal tax rates stimulate long term growth. (discussion about to get technical). Personally, if you are looking at a simple labor supply elasticity, probably not. But if you are looking at career formation choices, I think there has likely been a greater response to lower marginal taxes (see Martin Feldstein's research for empirical evidence).

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