May 05, 2009

“Supply Side” RIP

I?ll admit that, mostly due to my age, the associations I have with Jack Kemp are almost entirely negative?he was after all the commissar of Housing and Urban Development, the cheerleader for open-borders, affirmative action, the war in Iraq, and much else. And in this since, I agree with Peter Brimelow, ?Jack Kemp’s moment came, and went. If America’s moment has not yet irretrievably passed, it is no thanks to him.?

Still, as Paul Craig Roberts points out in his remembrance of his former friend and boss, Kemp did achieve something groundbreaking and lasting leading the charge for ?supply side economics? and a simplified tax code in the late ?70s ad ?80s. 

And it?s difficult to overestimate the kind of unlikely rout the supply-siders achieved. For thirty-five years, the Washington consensus had held that enlightened planners could push the economy up and down the Phillips Curve, trading off a little unemployment here, a little inflation there, and finally engineering things just right. By the late ?70s, this policy had hit the rocks as planners were getting inflation and unemployment??stagflation??no matter how they fiddled with the controls. Supply-siders, and the ?Chicago School? in general, offered a coherent, practical solution to this crisis, and for a twenty-five year period that coincided with an extended bull market in equities, most everyone in both parties believed that easing capital formation (and not ?replacing demand? through government deficit spending) would generate prosperity.

As was obvious to anyone who ever saw him speak, Jack Kemp was not a formidable intellect, though he was clearly sincere in his conviction that lower marginal tax rates would spur job growth and not just line the pockets of the rich. Quite often, congressmen find themselves the unlikely standard bearer of certain ideological causes they did not originate?at the beginning of his career, Kemp stood up for a good one, and for the past twenty years, he?s championed some very, very bad ones.

We?ve obviously entered an entirely new world now, with Keynesian ideas resurrected, bailouts ad absurdum, zero percent Fed interest rates, etc. And so it?s useful to look back at what supply-side economics actually was.

Writes Roberts: 

Capital formation was a difficult issue. Keynesian economists believed that capital formation was driven by consumer demand. If more capital was needed, the answer was to rev up consumer demand with larger budget deficits, and companies would invest to meet the increased demand.

Conservative economists and Wall Street believed that investment was determined by the interest rate.  According to their theory, bigger deficits would drive up the interest rate and curtail investment.  Conservatives and Wall Street wanted balanced budgets.

Neither economists nor Congress appreciated that capital formation was an important issue.  Inflation had reared its ugly head and was destroying the real value of the depreciation allowances.  Depreciation was drawn out over so many years that companies could not recover the value of their capital investment.

Obviously, Congress was not going to cut any spending programs to make room for faster depreciation. Thus, the Ford White House understood that capital formation would have no support from liberals or conservatives.  Moreover, any such initiative would be demonized as handouts to business and ?the rich.?


Supply-side economics added to the knowledge of economists by establishing that fiscal policy affects supply. Marginal tax rates determine important relative prices that govern the choice at the margin between work and leisure and saving and consumption.

High marginal tax rates make leisure cheap in terms of foregone current income, and they make current consumption cheap in terms of foregone future income. Thus, the higher the tax rates, the less the supply of productive inputs.

Low tax rates make leisure expensive in terms of foregone current income, and they make current consumption expensive in terms of foregone future income.  The lower the tax rates, the greater the supply of productive inputs.

With their fixation on managing demand, Keynesian policymakers did not understand that the combination of high demand and high tax rates resulted in stagflation.?Pumping up consumer demand while high tax rates restricted the supply of productive inputs resulted in demand increasing relative to supply. The result was rising prices.

Keynesian policymakers believed that economic growth had to be ?paid for? by accepting higher inflation.  But the trade-off worsened and finally broke down.  Milton Friedman summed up the demise of the trade-off between employment and inflation with the phrase, ?more inflation, more unemployment.?

The breakdown of the Keynesian model opened the door to the supply-side revolution.


Kemp led an economic restoration that lasted until offshoring undermined American job growth.

Today, the supply-siders have returned to the wilderness, and this time around, their exile is mostly their own damn fault. Not only did Kemp & Co. become advocates of terrible policies (the Iraq war, mass immigration, etc.) that were completely external to the supply-side cause, but they often threw intellectual seriousness out the window as well. The obsession with tax cuts, tax cuts, tax cuts led many to act as if they believed Dick Cheney?s axiom that ?Reagan proved deficits don?t matter? and defend the Bush years as a great era of free-market capitalism. (Bruce Bartlett being a notable exception.) The obsession with “growth” led many to view a low target interest rate as a end in itself, as if Greenspan and Bernanke could expand credit indefinitely?in good times and in bad?and goose the economy back into shape whenever a recession loomed on the horizon. And the supply-siders blithe, Pollyannaish, ?it?s getting better all the time? optimism made one question whether they had any connection with American or European conservatism at all. 

America is swiftly becoming less free and more indebted by the day, and it seems impossible that hefty corporate and income tax hikes can be avoided in the near future (unless, of course, the government simply plans on reneging on its obligations and paying out welfare and social security with the printing press). The supply-side era is kaput, and the cause of economic liberty needs new champions.       

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