In the 1980s, Supply-side economics gained widespread acceptance during an era of economic prosperity in the U.S., but its popularity waned in the 2000s amid recessions.
What is supply-side economics?
Supply-side economics is a macroeconomic theory that focuses on supply-side factors serving as the driving force of a nation’s economy, leading to an increase in economic output and business and job creation.
One of the major fundamentals of supply-side economics is reducing taxes, on the premise that lower taxes will encourage businesses to spend more—particularly with the hiring of more workers, who, in turn, would have money at their disposal to spend, save, or invest, ultimately leading to economic growth. The government tax revenue that would have been lost with lower taxes would theoretically be made up in the form of increased profitability for businesses and job creation.
As such, supply-side economics is also referred to as “trickle-down” economics on the belief that spending from higher-income households and businesses will work its way down into the workforce and to the rest of society. For example, by reducing the tax rates on the wealthiest 1% of a nation, rich Americans will spend money on goods and services that they would otherwise have used to pay their taxes. For example, the purchase of a second home from tax savings could mean hiring landscapers, buying furniture, and paying utilities that otherwise would not have been possible without tax cuts.
Supply-side economics is also called Reaganomics, after President Ronald Reagan, who espoused the theory into his economic policies in the 1980s.
What are the main principles of supply-side economics?
Proponents of supply-side economics believe in focusing on manufacturers and employers to produce, with the effect of creating jobs and stimulating the economy. Supply-side economics advocates a variety of policies, and some are listed below.
According to trickle-down economic theory, reducing taxes for individuals and companies could lead to an increase in employment, investment, and business activity. Money that would have ended up in the hands of the government would instead work its way into the pockets of Americans, who would then spend more on goods and services, stimulating the economy.
Proponents of Reaganomics posit that reducing government regulation would lower or eliminate barriers to businesses and investors, which would allow more entrepreneurs to set up their own businesses.
Incentives and investment
Incentives can come in the form of tax credits or government subsidies, which businesses can use to invest in expanding their operations or in research and development. Adopting initiatives to boost investment would encourage entrepreneurs to start their own businesses, creating additional employment opportunities.
Labor market flexibility
Supply-side economics suggests that Initiatives such as lowering the minimum wage or reducing the power of labor unions could lead to a more competitive labor market and create employment opportunities.
A brief history of supply-side economics
Supply-side economics emerged into the public consciousness in the 1970s, in response to accelerating inflation and rising consumer prices hurting the pockets of millions of Americans. Keynesian economics, a theory that pins economic growth to aggregate demand, had been prevalent in the U.S. and Western nations since after World War II, but as conditions changed, politicians and economists sought a new solution to the rapid rise in prices.
In the early 1980s, economic advisers under President Reagan proposed using supply-side theory to jumpstart the economy. Under the Economic Recovery Tax Act of 1981 and implemented in 1982, the highest income tax rate was lowered to 50% from 70%, a rate that had not changed since 1965. That tax bracket was lowered further to 38.5% in 1987, and to 28% in 1989. The corporate tax rate for the highest income bracket was lowered from 46% in 1986 to 40% in 1987, and then to 34% in 1988. The 1980s ushered in an era of unprecedented economic growth, just as interest rates declined from their highs.
During the Clinton administration in the 1990s, the government reined in the fiscal deficit, bringing the budget to surplus, but it kept certain aspects of supply-side economics, such as giving tax credits to low-income earners and lowering the individual capital gains tax to 20% from 28%.
The popularity of supply-side economics began to wane into the 2000s as bouts of recession kept individuals and businesses from investing.
What is the Laffer Curve?
The Laffer Curve is named after economist Arthur Laffer, who in the 1970s postulated that there was a tradeoff between tax rates and government tax revenues that could be represented by an inverted U-shaped curve. On the left side of the curve, the tax rate at 0% would mean no revenue for the government, while on the right side, the tax rate at 100% would also mean that the government would collect no revenue because there would be no incentive for people to work. The middle of the curve shows the peak, which represents the optimal tax rate at which tax revenue should be collected.
What are the differences between supply-side economics and Keynesian economics?
There are two main differences between the two economic theories. Supply-side economics focuses on the aggregate supply of goods and services driving the economy, while in Keynesian economics, aggregate demand is the driving force. Supply-side economics advocates reducing government regulation, while Keynesian promotes government intervention to stimulate the economy.
Tax cuts are meant to incentivize spending under supply-side economics, while in Keynesian theory, public spending would lead to money working its way into the hands of millions of Americans.
What are some criticisms of supply-sIde economics?
Critics argue that lowering tax rates means the top income earners would be paying less tax but some reports show that tax revenue from high earners increased in the mid- to late-1980s, just as tax rates in the higher income brackets eased.
Some also argue that a reduction in taxes would lead to greater income disparity, with the tax cuts favoring the rich over lower income earners.
There’s also no guarantee that reducing tax rates leads to taxpayers spending more and that money finding its way to the lowest income earners. Lowering taxes could lead to a shortfall in the federal budget, affecting government programs and services. During recession, supply-side initiatives may be less effective, with individuals and businesses less likely to spend.