«my Lz‘flm rut" ‘ ' ‘ ‘fwfia‘mn‘fi‘g: r g, f m "I" : I' LU‘U " -!.' ,- l‘ rah“)? IL! f: H ana .x“ ,I M 4. l I I l | ‘ “31": 7. ,yr, W, I it?» J a 9" {8‘ ,m 4.5; . 7W"! p) .H ‘ll‘r‘ u ‘v "7"“ ‘ , ‘ ‘ "if.” I ‘ Lfl $ Hifimflt. - I HI‘ ‘U H} V OI I.I| MUHH,’ 1U 'If’ Iv»!!! u-c‘.‘. H“ a ( L In I ‘ a «y 4%} 4.1060 1;.» Q 1.! in. - .. J This is to certify that the dissertation entitled THE NATURE AND SIGNIFICANCE OF “SUPPLY-SIDE ECONOMICS” presented by Oussama Husni Ramadan has been accepted towards fulfillment of the requirements for Ma' f DatelDV. /0’1 /ffiz MS U it an 4077mm” Action/Equal Opportunity Institution 0-12771 MSU LlBRARlES .——. V RETURNING MATERIALS: Place in bodk drop to remove this checkout from your record. FINES will be charged if book is returned after the date stamped below. THE NATURE AND SIGNIFICANCE OF "SUPPLY-SIDE BCONOHICS' BY Oussama Husni Ramadan A DISSERTATION Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Economics 1986 ABSTRHUT THE NATURE AND SIGNIFICANCE OF 'SUPPLY-SIDE ECONOMICS' BY Oussama Husni Ramadan Candidate Ronald Reagan was elected President in 1980. His economic program, usually referred to as "Reaganomics", was an attempt to apply “supply-side economics" (SSE). The speed at which SSE rose to the forefront of economic policy debate led to considerable controversy over what it means, and what it claims. Many economists questioned its origin, policy role, and place within the discipline of economics. Given the controversy over SSE, this dissertation analyzes the sources of controversy (Chapter I), the nature of SSE (Chapter II), its critics (Chapter III), its relation to Reaganomics (Chapter IV), and its significance and place in the economics discipline (Chapter V). The final chapter looks at the whole ongoing SSE episode from a history of thought point of view. The chapter draws an analogy between the 19705 and 19305: During times of ”economic crisis", the status of the economist as "technician" or "expert" is usually jeopardized. This, in turn, provides an opportunity, not only for the development of new theories or "revolutions" against existing orthodoxies, but also for the development of theories or ideologies that search for ideological rather than technical solutions for existing economic Oussama Husni Ramadan problems. The rise of SSE, industrial policy, and possibly religious fundamentalism in the 19808 reflects the existence of such an opportunity. As long as economists find successful technical solutions tn) existing economic problems, the role of the economist as expert seems to hold. Once the technician-— expert-—seems to have "failed“, ideological solutions are called for. This continuing shift from technique to ideology and back again reflects both a continuing search for the identity of a relatively young field that has been separated from philosophy only within the last two-hundred years, and the ideological nature of the field itself. Hence, the place of SSE in the discipline depends, in addition to one's conception of how the economy actually or ideally works, cum one's definition of "supply-side” economics, the concept of a "revolution", and the scope of ”economics" itself. To My Parents ii acrmmcanwrs The invaluable assistance of many people who contributed tn) this dissertation and to my education at Michigan State University is gratefully acknowledged. Members of my guidance committee, Dr. Jeff Biddle, Dr. John Henderson, and Dr. Barry Holzer contributed in many ways to this dissertation. II owe special thanks to Dr. Warren J. Samuels, my major professor and committee chairman. He taught me well and inspired patience and dedication to a high standard in my studies. His patience, understanding, and faith in my ability to do research is greatly appreciated. iii 1-11an or con-mars LIST OF FIGURES O O O O O O O O O O O O O O O O O O 0 CHAPTER I CHAPTER II CHAPTER III INTRODUCTION. 0 O O O O O O O O O O O O 0 Notes to Chapter I. . . . . . . . . . . . THE THEORY OF SUPPLY-SIDE ECONOMICS . . . 2.1 IntrOdUCtion O O O O O O C O O O O O 2.2 The Laffer Curve, Incentives, and Relative Prices. . . . . . . . . 2.3 Substitution Effects Versus Income Effects. . . . . . . . . . . . 2.4 SSE as a Reaction to "Demand—Side Economics" . . . . . . . . . . . . . 2.5 Say's Law and Classical Origins Of SSE O O O O O O O O O O O 0 O O O 2.6 Historical Evidence of SSE in Action Notes to Chapter II . . . . ._. . . . . . CRITICS OF SUPPLY-SIDE ECONOMICS. . . . . 3.1 Introduction . . . . . . . . . . . . 3. 2 The Laffer Curve, Incentives, and Tax Revenues . . . . . . . . . . . 3. 3 Substitution Effects, Income Effects and Factor Supplies. . . . . . . 3. 4 Factor Supplies, the Kennedy Tax Cut, and Inflation . . . . . . . . . .5 ”Demand-Side" Economics, ”Supply- Side Economics," and Inflation . . . 3.6 Say' 5 Law, Classical Roots, and Government Intervention. . . . . . 3.7 Excessive Claims, Omission of Other Variables, and Political Objectives. Notes to Chapter III. . . . . . . . . . . iv Page vi \O 0000 O‘l—l 16 18 25 31 46 46 48 51 53 59 63 69 72 TABLE OF CONTENTS, CONT'D CHAPTER IV CRITICS OF REAGANOMICS. . . . . . . . 4.1 4.2 4.3 4.4 4.5 Introduction . . . . Ex-Post Rationalizations of. the Occurrence of the 1981- -82 Recession and the Rising Deficits. . . . . A. Fiscal Policy. . . . . . B. Monetary Policy and the Gold Standard . . . . . . . C. Fiscal and Monetary Policies in Collision . . . . . . . Ex-Post Explanations of the Occurrence of the So-Called 1983 Recovery . . . . . . . . . . The Future Impact of Reaganomics on the Economy . . . . . . . The Impact of Reaganomics on the Validity of SSE. . . . . . . . . Notes to Chapter IV . . . . . . . . . CONCLUSION. O O O O O O O O O O O I 0 Introduction . . . . . . . . . Absolutism Versus Relativism . . The Significance of the Rise of SSE in the Discipline. . . . . . SSE and the Way the World Works. A. SSE as Ideology. . . . . . . B. The Lack of Coherence in SSE . C. Technical Arguments, SSE, and Ideology . . . . . . . . . . Reaganomics and Political Economy. The Concept of a Revolution, and the Place of SSE in the Discipline Notes to Chapter V. . . . . . . . . . CHAPTER V 5.1 5.2 5.3 5 4 5.5 5.6 BIBLIOGRAPHY. . 98 101 106 110 115 118 121 125 149 150 150 154 160 160 164 167 178 183 200 212 Figure 1. LIST OF FIGURES The Laffer Curve. . . . . vi Page 10 CHAPTER I. INTRODUCTION The ideas of economists and political philo- sophers, both when they are right and when they are wrong, are more powerful than is generally understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.* - John M. Keynes Supply-siders could nevertheless argue that all of the existing empirical work was wrong or might be wrong without being generally dismissed as 'punk' economists! . . .. If the policy makers want to believe something, they will always find an economist who will confirm their beliefs.** - Lester C. Thurow Candidate Ronald Reagan was elected President in 1980. His economic program, usually referred to as “Reaganomics", was an attempt to apply "Supply-Side Economics" (SSE). The speed at which SSE rose to the forefront of economic policy debate led to considerable controversy over what it means, and what it claims.1 Many economists questioned its origin, policy role, and place within the discipline of economics. The controversy arose for the following reasons: 1 First, SSE claims to have a cure for both inflation and unemployment by cutting marginal tax rates on income from both capital and labor. The process by which tax cuts can cure inflation and unemployment is through incentives to work, saving, investment, and consequently, aggregate supply. While many economists recognize that tax cuts can have positive supply-side effects, the speed and magnitude of these effects are a major part of the controversy. In fact, many critics of SSE claim that these effects are both small and weak (especially the impact of those incentives on inflation) and that no hard empirical evidence was forthcoming from the supply-siders to negate that claim.2 Second, SSE claims to be a reaction to, and a revolution against, Keynesian economics (which it claims has been the dominant theoretical basis behind economic policy in the nus. since World war II).3 In relation to this claim, many economists (Keynesian and non-Keynesian) believe that SSE does not have the theoretical basis of a revolution and, consequently, poses no threat to Keynesian economics.4 Third, many economists believe that the speed at which SSE was adopted as the basis for economic policy (in the sense that major turns in economic policy tend to be preceded by long periods of academic debate while SSE was not) was based more on faith in what it can accomplish rather than on convincing empirical evidence.5 Fourth, after SSE was adopted in Reaganomics, specifically in the tax-cut legislation of 1981, some supply-siders lauded its accomplishments whereas other supply-siders admitted failure.6 This led SSE critics to conclude that SSE is not a coherent doctrine and that its enthusiasts are of many minds, conflicting at times as to both the fact and causes of success or failure. Fifth, many economists believe that Reaganomics proved the failure of SSE and that while SSE claimed that cutting taxes was the means and combatting inflation and unemployment were the ends, Reaganomics proved that the means were the ends in the sense that SSE was a political device (to redistribute income) disguised as an economic theory (to fight inflation and unemployment).7 Given this multifaceted controversy, this dissertation has the following objectives: First, to study the meaning, origins, and claimed achievements of SSE as identified by its pmoponents (Chapter II).8 Second, to identify what SSE borrowed from other schools of economic thought, its relation to those schools, and what it adds to the discipline (Chapter II).9 Third, to study the reaction of other schools of thought tn) SSE as depicted by its opponents (Chapter III).10 Fourth, given the Reagan "experiment", to compare the actual accomplishments with the original claims and, consequently, to study the conclusion of both its proponents and opponents as to wherein it failed and/or succeeded (Chapter IV).11 Fifth, to examine the question of whether SSE was an economic "revolution" (Chapter V). Finally, to reach a conclusion regarding the place of SSE in the discipline in Chapter V. The chapter looks at the entire ongoing SSE episode from a history of thought point of view and draws an analogy between the 19705 and the 1930s to conclude that during times of "economic crisis”, the status of the economist as "technician" is usually jeopardized. This in turn gives an opportunity for the development of theories or ”revolutions” like the Keynesian revolution in the 19305. It also gives an opportunity for the development of theories or ideologies that search for ideological rather than technical solutions like SSE, industrial policy, and possibly religious fundamentalism in the late 19705 and early 19805.12 In fact, the role of the economist as technician holds as long as economists find successful technical solutions to existing economic problems. Once the technicians are perceived to "fail", ideological solutions are called for. Moreover, with the increasing role of government in modern capitalism, the ideological debate in economics is apt to become more visible and, probably, more heated. This continuing shift from technique to ideology and back again reflects both a continuing search for the identity of a relatively "young” field that has been separated from philosophy only within the last two hundred years, and the ideological nature of the field itself. Hence, the place (of SSE 1J1 the discipline depends on one's normative (not positive) preconceptions. As an ideology, SSE cannot be proven right or wrong, it can only be either accepted or rejected. N2££§.£2.§h§2£££.1 *John Maynard Keynes, The generel Theery of Employment Ineegese end Meney, (New York: Harcourt, Brace, 1936). P. 383. *Lester Thurow, n ous u n , (New York: Vintage Books, 1983). p. 137. 1Compared to all other theories, SSE was prominent in nonacademic periodicals and lacked professional attention, whereas other theories have had to wait for years until they were applied. See Stephen Rousseas, ”The Poverty of Wealth," u na 0 - e n s' n con 'cs. Vol. IV, No. 2, Winter, 1981-82, p. 193. See also Terry Plum, “Bibliographic Sources as Data: Quantifying the Spread of Economic Ideas,“ History of Economics Society Conference, June 1986. 2See John Palmer and Isabel Sawhill (eds. ) The Reegan Experimeee, (Washington, D. C.: The Urban Institute Press, 1982). p. 37. 3Bruce Kimzey writes that, ”the ability of tax cuts to create positive supply-side incentives has long been recognized by both economists and politicians, but the theory has been given new importance as an alternative to Keynesian demand-management.“ [Bruce Kimzey, Beagenomics, (St. Paul, Minnesota: West Publishing Co., 1983), p. 15.] 4In fact, James Tobin argues that "without a Keynes or Friedman or Lucas, it [SSE] lacks a sacred text expounding its theoretical foundations. It is more spirit, attitude, and ideology than coherent doctrine, and its enthusiasts are of many minds." [James Tobin, ”Supply- -Side Economics: What is it? Will it Work?" in Viegpeints on 522211? 51d e fieeeemiee, Thomas J. Hailstones (ed. ), (Reston, Virginia: Reston Publishing Co., 1982). p. 133.] 5See Gerald Dwyer, "Inflation and Government Deficits: What is the Connection?" in Su pply- Sid e Ec enemiee in the Lgfige, Conference Proceedings, Federal Reserve Bank of Atlanta and Emory University Law and Economics Center, Quorum Books, 1982, p. 173. 6For a detailed description of the tax-cut legislation, see "Economic Recovery Tax Act of 1981," (Puelic Legs 97-34, 13 August 1981), Vol. 95, pp. 172-356. See also Wallace Peterson and Paul Estenson, "The Recovery: Supply-Side or Keynesian?" ou na f s - n ' Ecenemics,‘Vol. 7, No, 4, Summer 1985, pp. 447-462, in which the authors argue against Paul Craig Roberts who claims victory of SSE in urelation to the recovery. See also Michael Evans, b u u - 'd c o ' . (New York: Basic Books, u1983), p. 259, where he argues that Reaganomics was a failure. 7David Stockman (the ex-director of the Office of Management and Budget) admits that "the hard part of the supply-side tax cut is dropping the top rate from 70 percent to 50 percent. . . the rest of it is a secondary matter.“ [William Greider, ”The Education of David Stockman,” in Viegpe1nes, T.J. Hailstones (ed.), pp. 294- 299. Reprinted from The Atlentlc uenehly, December 1981.] 8SSE advocates claim that their theory has roots in Classical economics. See George Gilder, "The Supply-Side," in supply-side Ecenemlce; A 9:1t1cel Appzeisel, Richard H. Fink (ed.), (Frederick, Maryland: Alethia Books, 1982): P. 14. 91h fact, Martin Feldstein (the ex-president of the Council of Economic Advisors under President Reagan) writes that ”there is, of course, nothing radically new in these [SSE] ideas. They are, in reality, a return to the basic notions that Adam Smith expounded.” [Martin Feldstein, ”The Conceptual Foundations of Supply-Side Economics," in Supply-s1de flcenomles 1n the 12egs, Conference Proceedings, p. 146.] 10Especially the reaction of Keynesian economics against which SSE claims to be a revolution. Wallace Peterson, for instance, argues that "as a body of theoretical ideas, however, it [SSE] has far less substance or elegance than either standard Keynesian income- expenditure analysis or the new classical economics." [Wallace Peterson, lnceme, Employment, end Ecenem1c gregeh, Fifth Edition. (New York: W.W. Norton and Co., 1984). P. 419.] 11For a critical view, see Paul Samuelson, "Evaluating Reaganomics," Challenge, Vol. 27, No. 5, November-December, 1984, p. 11. 12Bruce Bartlett compares industrial policy with SSE to conclude that "they are both.pmimari1y political programs, designed to appeal to political constituencies rather than professional economists." [Bruce Bartlett, "America's New Ideology," American Journal of Ecenomics and Seeielegy, Vol. 44, No. 1, January 1985, p. 6.] CHAPTER II THE THEORY OF SUPPLY-SIDE ECONOMICS The kind and level of taxes are determined by the social structure, but once taxes exist they become a handle, as it were, which social powers can grip in order to change this structure.* - Joseph Schumpeter There is a paradox of redistribution: beyond a certain point, raising the taxes on high income, leads to more, not less luxurious living by the rich, and to less not more, support and opportunity for the poor.** - George Gilder 2,1 Intzedggglog: The term "Supply-Side Economics" (SSE) suggests that it encompasses any work that attempts to understand the role and nature of aggregate supply. This is not true, however. While many economists have worked on the aggregate supply in fields such as: search theory in labor markets, rational expectations in investment theory, neoclassical investment theory, life-cycle saving theory, growth theory, energy policy, industrial policy, and manpower training and support for higher education, SSE consists of only two propositions: Say's Law and the Laffer curve.1 If all previous studies of the nature of 8 the aggregate supply can be called the "old" or ”traditional" supply-side economics while SSE can be called the "new" supply-side economics, this chapter will focus only on the nature of the latter as identified by its proponents. The Laffer curve is a theoretical argument for a tax cut. In fact, the real theoretical core of SSE resides in the belief that the major factor holding back production, causing unemployment, creating inflation, and leaving the government with insufficient revenues and large deficits is taxation. Taxes are a disincentive to produce. Taxes on income from capital discourage saving and investment while taxes (“1 income from labor discourage work and labor supply. This is the essential message of SSE.2 In terms of micro-economics, the Laffer curve is an attempt to apply the law of diminishing returns in terms of tax revenues to marginal increases in tax rates. Thus, SSE advocates insist that their theory consists of the application of micro theory to government taxation of factors of production (capital and labor).3 The Laffer curve is depicted as a dome-shaped curve with tax rates on the X-axis and tax revenues on the Y-axis (see Figure 1). At a zero percent tax rate, tax revenues are zero. But as one increases the marginal tax rate on 10 .em .1 .A.cmv mucouufiflmm .u masons .MMQHmmHaHu ca =.coHuosOOuu:H :< "moflaocoom ocwmlmammsm: .uomwwum .<.m "ocusom o>usu momma: one .H ousmwm ”“33 Hum. .52: . So nQ=QQ>0h unwhw 11 income (from capital or labor), tax revenues increase at a decreasing rate, reach a maximum, and start to fall until they reach zero at the 100 percent tax rate. The rising (positively sloping) part of the curve is called the normal range while the falling (negatively sloping) part is called the prohibitive range.4 Thus, for any value of tax revenues (except the one corresponding to the maximum point on the curve) there are two tax rates that can yield that amount of revenues. Consequently, if actual tax rates are on the prohibitive range, a tax rate reduction would yield higher tax revenues (a move from E to D on Figure 1). This can happen via what is called the 'Laffer-effect". When marginal tax rates are on the prohibitive range, a cut in rates will unleash incentives to work, save, and invest, thereby, increasing the tax base and, at a lower tax rate, yielding higher revenues. SSE advocates are convinced that current (1980) tax rates in the U.S. are on the prohibitive range.5 Furthermore, they believe that the combination of high marginal tax rates on high income brackets, and high welfare compensation for low-income brackets were the cause behind the stagflation era of the 19705.6 In fact, George Gilder insists that inflation is caused by taxes. Taxes decrease aggregate supply by decreasing work, saving, and investment. Gilder adds that 12 due tn) the law of costs, inflation is ”tax-push". Taxes are costs, and when costs increase, profits decrease, output falls, and prices increase.' For Gilder, the price of any good consists of the sum of intermediate costs. Hence, all final prices embody the pyramid of public services, paid for by taxes, at every point in the productive system.7 To further explain how tax rates affect stagflation, SSE advocates claim that there are two important relative prices governing production. One price determines the choice between additional current income and leisure, the other determines the choice between additional future income (saving and investment) and current consumption. Both prices are affected by their marginal tax rates. The higher the tax rates on earnings, the lower the cost of leisure and current consumption, in terms of foregone after-tax income.8 This process is usually explained by the help of the following parables: First, they argue that since there are two uses of time: work and leisure, then the price of additional leisure is the amount of income foregone by not working. The higher the tax rate on income, the smaller the amount of after-tax income foregone by enjoying additional leisure (i.e., the higher the tax rate, the lower the relative price of leisure). 13 Hence, if one takes the case of a physician who encounters the 50 percent rate, SSE advocates argue that for the first part of the year, the physician works for himself. However, he begins working for the government when his income reaches taxable levels.9 The more he earns, the more he works for the government, until rising marginal rates discourage him from further work. Once the physician reaches the 50 percent rate, he is faced with working more for only 50 percent of his earnings. Such a low after-tax return on their efforts, SSE advocates conclude, encourages doctors to share practices, to reduce their working hours, and to take longer vacations. The higher tax rates thus shrink the tax base by discouraging people from earning additional amounts of taxable income. Furthermore, doctors drive up the cost of medical care by reducing the supply of medical services. Hence, a tax rate reduction would raise the relative prices of leisure and result in more taxable income earned and also in a greater supply of medical services. The second example that SSE advocates use illustrates that it is not just the top marginal rate that causes losses to GNP, employment, and tax revenues by discouraging people from earning additional taxable income. The new supply-siders argue that the marginal tax rates that many blue-collar workers face are high enough to discourage them from earning additional taxable income. They give the case 14 of a carpenter facing only a 25 percent marginal tax rate. For every additional $100 he earns before income tax, he gets to keep $75. Suppose that his house needs painting and that the carpenter can hire a painter for $80 a day or hire himself out for $100 a day. However, since his after- tax earnings are only $75, he saves $5 by painting his own house. So, it pays the carpenter to choose not to earn the additional $100.10 :n: this case, SSE advocates conclude, the tax base shrinks by $180, of which $100 are the foregone earnings of the carpenter, and $80 are the lost earnings of the painter who is not hired. Hence, they conclude that a tax rate reduction to 15 percent would change the situation such that it would pay the carpenter to hire the painter which in turn would expand the tax base by $180. While the above two examples were used to show how marginal tax rates affect the choice between additional current income and leisure, the third example is usually used to show how marginal tax rates affect the choice between consumption and additional future income (saving and investment).11 Since there are two uses of income, namely, consumption and saving, and each has a price in terms of the other, then the price of additional current consumption is the amount of future income foregone by enjoying additional current consumption. The higher the tax rate on additional future income, the smaller the 15 amount of after-tax future income foregone by enjoyimg additional current consumption (i.e., the higher the tax rate, the lower the relative price of current consumption). To prove the above, SSE advocates consider the case of an English man facing the 98 percent marginal tax rate on investment income. He has the choice of saving $50,000 at a 17 percent rate of return, which would bring him $8,500 per year before taxes, or purchasing a Rolls Royce.12 Since the after-tax value of that $8,500 additional income is only $170 per year, the price of additional consumption is very low: He can enjoy the Rolls Royce by giving up only $170 of additional income per year.13 Hence, a tax rate reduction would raise the price of current consumption relative to future income, and thus result in more saving, making possible a growth in real investment. A tax rate reduction not only increases disposable income and total spending, they conclude, it also changes the composition of total spending toward more investment (which they believe has a dual nature since it increases both aggregate demand and aggregate supply). Thus, labor productivity, employment, and real GNP are raised above the levels that would result from the same amount of total spending more heavily weighted toward current consumption.14 Finally, the new supply-siders believe that just as higher tax rates lead to less work and less saving, higher 16 welfare compensation (including unemployment compensation) lead to less work and more unemployment by giving low income groups a disincentive to wbrk, and an incentive to quit work and receive unemployment compensation (since the wedge between after-tax income and welfare benefits is smaller).15 Given the above arguments, it is clear that SSE advocates are referring to the role of substitution (incentive) effects of price changes on behavior. Furthermore, implicitly assumed in their argument are high elasticities of factor supplies to tax rate changes and predominance of substitution effects over income effects of price changes (due to tax rate changes).16 ct c c 5 While one can recognize the existence of income effects and substitution effects to price changes, it can be easily argued that SSE advocates give more importance and magnitude to substitution effects than to income effects. A reduction in the tax rate on income from labor (capital) raises the relative price of leisure (consumption) such that people substitute work (saving) for leisure (consumption). This is known in micro-economic theory as the sebst1tut1on effect which works to increase supply of work (saving). The tax cut, however, also 17 provides people with more after-tax income. People can reduce work (saving) and maintain the old level of leisure (consumption). They can decrease work (saving) supply and increase leisure (consumption). This is known in micro- economic theory as the income effece which works to decrease supply of work (saving).17 The final outcome of the two effects, however, is ambiguous.18 In addition to assuming that substitution effects will outweigh the income effects on the micro level, SSE advocates argue that, on the macro level, there can be no increase in disposable income as a first-level effect to tax rate changes. The first-level effect is to change relative prices and, consequently, factor supplies and output. Thus, the change in income is only a second-level effect to changes in factor supplies.19 Hence, the income effect (the second—level effect) is nothing but the result of the substitution effect (the first-level effect). i.e., the income effect exists because of (and not in spite of) the substitution effect. Thus, the existence of an income effect on the macro level (which assumes an increase in disposable income) can occur only if we had a substitution effect (which assumes an increase in supplies of factors of production) on the macro level in the first place.20 This distinction between first-level and second-level effects is necessary, SSE advocates claim, because Keynesian economists assume the reverse to be the case. 18 For Keynesians, the first-level effect to tax rate changes is to increase disposable income and aggregate demand. Hence, the factor supplies and output adjustment is essentially a passive response (second-level effect) to changes iJi supply-side economics in general, and to Say's Law in particular.50 Furthermore, the existence of the dichotomy in economic theory is actually manifested in economic history. Since classical economists reacted to Mercantilist practices at their time, they argue, then our current situation (of demand-side) must resemble Mercantilism when demand-side economics was triumphant.51 In fact, this dichotomy of demand-side versus supply-side is so universal, SSE advocates maintain, it also applies in the field of politics. The adoption of demand-side economics since the 19305, they claim, coincided with the triumph of demand-side politics at that time.52 27 While the demand-side is represented by consumers (especially middle and lower income classes) in economics and by the public in politics, the supply-side is represented by capitalists (upper income classes) in economics and by politicians in politics. If demand displaces supply in politics, the argument goes, then one would end up with alienated electorate and sluggish government. The analogy is then drawn that if demand takes control in economics, one would end up with a sluggish economy, inflation, and lower productivity because capitalists (the supply-side) would be alienated. But in what form can the demand-side take control in economics? It is in the form of increased government spending (especially transfer payments) and in increased progres- ’sivity of taxation to redistribute income from rich (capitalists) to poor (consumers). This will lead to lost incentives on the supply-side leading to both inflation and unemployment.53 In practice, SSE advocates argue, it was due to the continued adoption of Keynesian economics with its focus on equity at the expense of supply that the united States ended up with stagflation. Keynes, they add, encouraged consumption (demand) at the expense of saving and investment (supply). This was done with the help of the paradox of thrift, and the assumption of unemployed resources.54 The adoption of these policies, SSE advocates 28 claim, would have led the Classicals to label them as mercantilista In addition, the similarities between the mercantilist era and the Keynesian era are so overwhelming, SSE advocates insist, such that the need for Say's Law becomes inevitable.55 In fact, Say's Law is even presented as an argument to cut taxes (just as the Laffer curve was) and not only to cut government intervention.56 Hence, if the Classicals believed in Say's Law, and if Say's Law was an argument to cut taxes, SSE advocates maintain, then SSE must have its theoretical roots in the Classical theory of eighteenth century England.57 Furthermore, and because the demand-side versus supply-side dichotomy is universal, it must follow that Keynesian economics has its roots in the Mercantilist doctrines of eighteenth century England. Hence, SSE advocates conclude that since the adoption of supply-side economics helped England develop into the leading "workshop" of the world, it must follow that the adoption of such policies (in the form of rejecting Keynes' Law and adopting Say's Law) would lead the United States into a similar growth path by simply cutting taxes. This idea of the supremacy of supply is so overwhelming, SSE advocates believe, such that the need for less regulation, less taxation, and a smaller public sector become indispensable. This is the case, they maintain, toecause entrepreneurial innovation cannot continue to play its role in a world where the supply-side (the rich, the 29 capitalists, and entrepreneurs) are alienated (because of continued government intervention). In fact, George Gilder insists that: capitalist creativity is guided, not by any invisible hand (a'la Adam Smith), but by the visible hand of management and entrepreneurship (a'la Schumpeter).58 Finally, this universal dichotomy of supply-side versus demand-side leads SSE advocates to interpret major historical antecedents of tax rate cuts in the United States and abroad as successful examples of SSE in action. 215__HiéI91i2sl_EYiésnss_2£_fififl_in_A&£ieu= While they claim history has many examples of SSE in action, SSE advocates refer to the Kennedy tax cut as the best one.59 Although the Kennedy tax cut was enacted following the advice of Keynesian economists and for the wrong reasons (in the hope of increasing aggregate demand), the tax cut worked, they argue, because it increased incentives and aggregate supply, hence acting as a successful precedent of SSE in action.60 Thus, the Kennedy tax cut worked by decreasing unemployment, and increasing saving, investment, output, and tax revenues. Furthermore, and since current tax rates are higher than they were before the Kennedy tax cut, the argument goes, this increases their likelihood of being in the prohibitive range. Hence, there is a need to put taxpayers back into the relative position they had in 1965 30 in order for output and tax revenues to increase, and inflation to decrease. The best path to economic growth, SSE advocates insist, lies in lower taxes and “free“ markets. This is the essential message of SSE.61 31 N9§§§.£9.9h§21§£_11 Joseph A. Schumpeter, "The Crisis of the Tax State," I_ts1natienal_fisen2mis_£aeers 1954. P- 17 George Gilder, t and v . (New York: Basic Books, 1981): p. 172 1In fact, Norman Ture insists that SSE consists of only the application of price theory to tax policy, and that “the mere addition of supply equations to a standard 'aggregate demand' model does not convert that model into a supply-side model." [Norman Ture, "Discussion of the Summers Paper," in - c ' Pelley, Laurence H. Meyer (ed.), Economic Policy Conference Proceedings, Federal Reserve Bank of St. Louis, 1981, p. 165.] Keleher makes it clear that: "Supply-side fiscal policies have ceme to mean different things to different economists. . .. . Several vendors of large econometric models contend that their models encompass supplyeside economics because they include variables measuring aggregate supply or production and tax variables which, when changed, affect aggregate supply. . .. . What is important and what distinguishes supply-side policies from other policies is the manner in which tax changes affect factors of production.” [Robert E. Keleher, W W, Richard H. Fink (ed. ), (Frederick, Maryland: Alethia Books, 1982), p. 264.] 2See Bruce Bartlett. Reaaanem1251__§ueelx:§ide 3W, updated edition. (New York: Quill Books, 1982), pp. 30-31, where he argues that high marginal tax rates lead to the suppression of competition and stifling of innovation. 3See Jack Kemp, "George Gilder on Why Supply-Side Economics Will Work," in Viegpelete, T.J. Hailstones (ed.), (Reston, Virginia: Reston Publishing Co., 1982), p. 169. 4Note that the Laffer curve is not the result of an empirical investigation (as compared to the Phillips-curve for instance): rather, it is a hypothetical relationship that is tautologically true based on the law of diminishing returns in micro-economic theory. Consequently, the shape, the maximum point of tax revenue (which Laffer assumes to be around the 50 percent tax rate), and the existence and magnitude of the prohibitive range are empirically a matter of dispute due to problems of measurement (as will be discussed in Chapter III). 32 5Arthur Laffer believes that higher taxes, per se (or higher than 50 percent), increase the likelihood that a tax is 1J1 the prohibitive range. George Gilder, however, is sure that the mere presence of the underground economy suggests that the U.S. tax rates are in the prohibitive range. In addition, Gilder insists that “the upper ranks of American taxpayers provide far greater proportion of tax revenues than do the wealthy in Europe or Japan. . . . There is no doubt that by any measure the U.S. tax rates are more progressive than those of our major competitors. . . . The U.S. compounds its high direct appropriation of goods and services with what is probably the most progressive, complex, and commercially destructive tax system in the free world. In general it imposes a larger relative burden on the rich and a smaller one on the poor and middle classes than, for example, the systems of Japan, Germany, France, Sweden, Great Britain, or Italy." [George Gilder, Weel;h end Reyerty. (New York: Basic Books, 1981), pp. 183, 184.] Note that many economists disagree with Gilder as to the progressivity of the U.S. tax system when compared with other countries (as Chapter III will show). 6For Paul Craig Roberts, the combination of high marginal tax rates along with rising rates of inflation push tax-payers into higher brackets (bracket-creep) to lower productivity due to less work, saving, and capital accumulation. [Paul C. Roberts, The_§epply;filge ° . (Cambridge, Massachusetts: Harvard University Press, 1984). p. 71.] For George Gilder, high taxes are worse than high interest rates because they choke off emterprise. High taxes on upper income brackets increase the "wedge" between earned income and after tax income and, thus, lead to less saving and investment. High welfare compensation, however, decreases the wedge between after tax income and unemployment compensation for the poor leading to more unemployment (implicit in this argument is the assumption that unemployment is voluntary). [George Gilder, Wealth and_£exertx. pp. 172-173.] "It is a gross perversion of the system," Bruce Bartlett writes, I'when people can live as well or better on unemployment compensation than they could by working." [Bruce Bartlett, Reegeeemigg, p. 52.] 7Although Gilder calls it "tax-push", this is still a cost-push theory of inflation. But since taxes are not market costs (but are exogenously determined by government), Gilder prefers to call it "tax-push". [G. Gilder. Wealth.and.£cxertx. pp. 190-203.] 33 8For more details see Paul Craig Roberts, The Supply- W. p. 2- 9Note that the use of these parables suggests that SSE advocates were writing to catch the ear of political constituencies (as some economists will claim in Chapter III), rather than to catch the ear of professional economists. 10The numbers used in this example are controversial. Is the $80 a day the average wage of a painter for one day? Is the $100 a day the average wage of a carpenter for one day? The result of this example depends totally on the values of these two wages. If the wage of the painter is less than $80 ($70 for example) the result would be the reverse (in the sense that it is profitable to hire a painter). Furthermore, while it is assumed that the carpenter can (has the skill) paint his house, can we assume that this is the case for all people and for all needs (can one always quit one's job to fix one's house or car no matter what?) For a detailed analysis of these parables, see Paul C. Roberts, "The Breakdown of the Keynesian Model,“ in Sepply;§1de_fleehemiee, Richard H. Fink (ed.), pp. 2-4. 11Note that SSE advocates immediately equate saving with investment. See, for instance, Paul C. Roberts in W. R.H. Fink (ed.). p. 4- 12SSE advocates argue that such was the case in England during the seventies and that Americans should expect more, not less, luxurious consumption as U.S. tax rates increase (because they lower the relative price of consumption). “We will see more Cadillacs and Mercedes on the roads and more yachts in the water until the very day the economy falls apart.” [George Gilder, Wealth end mm. 9. 173.] 13Note that also in this example, the crucial numbers are the 98 percent tax rate, and the 17 percent rate of return. Do we have a 98 percent tax rate on investment income in the U.S.? Is the 17 percent rate of return the average rate of return? A different combination of tax rates and rates of return might lead to a different result (maybe the reverse). Note also that increased purchase of cars represents both increased consumption and greater production and investment opportunity. 14Note that SSE advocates argue that Keynesians have focused (“1 consumption at the cost of investment (disregarding their interdependence in the process). 34 15"There is no question that for a significant portion of the U.S. pOpulation,” Bruce Bartlett maintains, "the wedge between what they could earn by working and what they could receive in welfare benefits is quite small." [B. Bartlett, geegahemics, p. 41.] Note that Bartlett assumes unemployment to be voluntary. 16Which is a matter of dispute as Chapter III will show. 17P.C. Roberts argues that to assume that the income effect leads to less work and to more leisure implies that leisure is a luxury good (whose demand increases with increases in income) while work is an inferior good (whose demand decreases with increases in income). For Heberts, "the only kind of people who fit this kind of analysis are people who respond to a monetary incentive in perverse ways." Roberts adds that "since income is command over all goods," then the assumption that work (or goods) is an inferior good, "implies that all goods are inferior goods." i.e., Roberts not only believes that the substitution effect outweighs the income effect, he even questions the direction of the income effect because it seems that he assumes that work is a luxury good (whose demand increases at higher levels of income) for the rich, and an inferior good (whose demand increases at lower levels of income) for the poor. [Paul C. Roberts, "The Breakdown of the . Keynesian Model," in supply-slee Econemies, R. Fink (ed.), p. 10.] . 18J. Tobin insists that "standard micro-theory provides no license for assuming that substitution effects dominate, and certainly none for declaring income effects null and void. . . . Empirical magnitudes of income and substitution effects are not very well established." [James Tobin, "Supply-Side Economics, What is it, Will it Work?" in V1eupe1hh, T.J. Hailstones (ed. ), p. 135.] 19Note that this assumes that the aggregate supply is vertical. Hence, there can be no increase in output and income unless the aggregate supply shifts to the right. Also note that this assumes no increase in employment at the pre-tax-cut price level. i.e., even if the aggregate demand increases due to a tax cut, there can be no increase in output and real income unless factor supplies increase at the after-tax-cut price level. 20P.C. Roberts makes it clear that he assumes a vertical aggregate supply and that an increase in aggregate demand can only increase nominal and not real income: "If 35 taxes are cut and government spending is unchanged (resulting in a budget deficit), the nominal disposable income of taxpayers as a group will rise relative to the nominal disposable income of the recipients of government spending as a group. The former will be able to bid real resources away from the latter. The real income gains of the former will be matched by the real income losses of the latter. Since the bidding will raise prices, the real income loss might be suffered by individuals who hold money. Regardless of who loses and who gains, the individual income effects 'net out', leaving only the 'substitution effects', which unambiguously increase work effort. There can be no aggregate 'income effect' unless the impact of incentives is to raise real aggregate income.” [P.C. Roberts, "The Breakdown," in W Wise. R. Fink (ed.), p. 11.] 21See Norman Ture, ”The Economic Effects of Tax Changes." in W R. Fink (ed. ). p. 47 22According to Ture, the focus on equity has led to reliance on analysis of average tax rates and income effects and neglect of marginal tax rates and substitution effects. [Norman Ture, "The Economic Effects of Tax Changesfl in W R. Fink (ed. ). p. 36 1 23Ibid., p. 64. See also Bruce Bartlett Beeeehem1ee1 Supplx- Side Eggho omies in Ac Q10 h, pp.'27- 31, where he insists that progressive taxes are bad for both the poor and the economy, due to less growth. 24"Welfare now erodes work and family and thus keeps P00r people POOI-' [George Gilder, Hfiél£h_£né_£QY§££lr P- 127.] See also Bruce Bartlett, Beagenom1cs, p. 51, where he argues that unemployment compensation is defended by Keynesians as a stabilizer of aggregate demand. However, Bartlett adds, Keynesians forget that unemployment compensation acts as a destabilizer of aggregate supply by destroying incentives. 25For P.C. Roberts, 'Keynesianism was a convenient way for the government to acquire larger and larger claims on the economy's resources without having to legislate higher tax rates." [P.C. Roberts, "Analyzing Supply-Side Economics: .A Symposium," in y1egpe1hee,-T.J. Hailstones (8d.II P. 71.] 26"The tax burden, of course," writes J. Rutledge, "is not only personal and corporate taxes. And its scope goes beyond the burden of government spending. In reality, the tax burden should be defined as the amount of resources 36 that the government accumulates, acquires, and destroys- with the emphasis on the third." [Ibid., p. 70.] 27In fact, SSE advocates reject the Phillips-curve trade-off in both the short run and the long run periods (vertical Phillips-curve). See Bruce Bartlett, and Timothy Roth (eds.). Wm. (Catham. New Jersey: Catham House Publishers), p. l- -3 of Introduction. SSE advocates borrow the concept of a vertical Phillips- curve from both monetarists (vertical Phillips-curve in the long run) and the rational expectations hypothesis (vertical Phillips-curve in the short run) as will be argued in Chapter III. For N. Ture, "one of the principal analytical outputs of the supply-side economics is the rejection of the so- called 'Phillips-curve' relationship between inflation and unemployment. By the same token, it rejects the view that price level stability can be purchased only at the cost of unacceptably high levels of unemployment or that acceptable growth in employment depends on pursuit of fiscal and :monetary policies likely to spur inflation. There is no analytical basis for seeking a recession as a means of wringing inflation out of the system.” [Norman Ture, 'Implemen-tation of Supply-Side Policies," in shpply;fi1de n ' , Conference Proceedings, Federal Reserve Bank of Atlanta, Quorum Books, 1982, p. 230.] 28Built into this argument are both a vertical Phillips-curve and a vertical aggregate supply curve such that changes in aggregate demand can only lead to inflation with no increases in real output. For a detailed analysis of the link between a vertical Phillips-curve and a vertical aggregate supply, see Rudiger Dornbusch and Stanley Fischer, HQQIQQEQEQEIES: Second Edition. (New York: McGraw Hill Co., 1981), Chapter II: Aggregate Supply. For a simpler analysis, see William J. Baumol and Alan S. Blinder, c - 'c ' c' , third edition. (New York: Harcourt Brace Jovanovich, Inc., 1986), Chapter 16: The Trade-Off Between Inflation and Unemployment, pp. 321-326. 29Supply-siders ('old" and ”new') disagree on the inflationary impact of deficits arising due to a tax cut and, thus, on cutting spending (see Chapter IV below). 3°See Michael Boskin, “Some Issues in 'Supply-Side' Economics," in The_§epply;fi1de_§el_eieh, Bartlett and Roth (eds. ), p. 210. 31SSE advocates claim that changes in taxes were translated into changes in disposable income only and not 37 into changes in relative prices. [David Raboy, "Norman Ture on Supply-Side Economics," in Y1§_221££§r T.J. Hailstones (ed.). p. 62.] 32Note that Keynesians accept that tax changes affect saving and investment but that these changes are less important than changes in the cost of capital and output. Martin Feldstein (a ”traditional“ supply-sider), claims that Keynes argued that the Great Depression was due to inadequate spending or, equivalently, to excessive saving." He adds, however, that this "fear" of saving continued even after the depression leading to a very low rate of investment. Furthermore, Feldstein believes that in Europe and Japan, Keynesian economics was weaker than in the U.S. and U.K.. As a result, ”those countries developed policies that were designed to encourage saving." [Martin Feldstein, “Alternative Perspectives of Supply- -SLde Economics," in supply-siee fleehemiee in ehe lQfiQe, Conference Proceedings, p. 151.] 33Okun's Law is a relationship between real growth and changes in the unemployment rate which says that for every two and a half percentage points growth in real GNP above the trend rate that is sustained for a year, the unemployment rate declines by one percentage point. For a mathematical derivation of Okun's Law, see Rudiger Dornbusch and Stanley Fisher, EQQLQQQQHQELQE: Appendix to Chapter 13, pp. 460-463. ‘ For Otto Eckstein, “Supply-oriented theories were modeled by Harrod and Domar, R. Solow, W. Leontief, Kuznets, Kendrick, Becker, Griliches, and Jorgenson among others. However, aggregate demand analysis seemed appealing because the growth of aggregate supply could be modeled adequately by Okun's Law (which was based on multiplying labor supply by a productivity trend derived by historical extrapolation). [Otto Eckstein, "A Time for Supply Economics." in Sueslr:§i_s_flsenemiss. R. Fink (ed ). p. 233.] 34Redistribution of income was intended to increase total consumption since it was assumed that upper income brackets had a larger marginal propensity to save (and a lower marginal propensity to consume) than lower income brackets. [Bruce Bartlett, Reegehem1ee, p. 35.] 351bid., pp. 35-38. 36See Robert Keleher, 'Supply- -Side Tax Policy," in S.2212:Si_e_fisenemiss R. Fink (ed. ). pp. 267- -271 38 37John Rutledge writes: “Supply-side economics is part of a bigger revolution in the economics profession which recognizes that the basic unit under study - the human being - can think, calculate, speculate, and respond to market incentives. In this sen5e, supply-side economics shares the stage with 'rational expectations' and 'efficient markets'. " [Rutledge, "Analyzing Supply-Side Economicse .A Symposium," in Yi§1221_£§: T. J. Hailstones (ed-)1 P. 70. ] To a certain extent, SSE advocates accept the idea that people are "rational", think, and calculate. This is why they accept the conclusion derived by the rational expectations hypothesis that the Phillips-curve is vertical in the short run (as discussed in note 27 above). 38It is surprising to find SSE advocates talking about lost output and employment due to changes in aggregate demand although they insisted that the Phillips-curve and the aggregate supply are both vertical in the short run and the long run! (see note 27 above). 39See Michael Evans, ”An Econometric Model Incorporating the Supply-Side Effects of Economic Policy," in The_Su221r:Side_Effests_cf_fisenemis_zelisx. Laurence H. Meyer (ed.), Proceedings of the 1980 Economic Policy Conference, Federal Reserve Bank of St. Louis, 1981, p. 65. 40The first group includes George Gilder, Jack Kemp, Arthur Laffer, Paul Craig Roberts, and Jude Wanniski. The second group includes Martin Feldstein, David Raboy, Beryl Sprinkel, and Norman Ture. The third group includes Michael evans, William Philip Gramm, David Stockman, and Murray Weidenbaum, among others. 41This is due to the belief that deficits caused by lower taxes do not crowd-out private investment. For Paul C. Roberts, I'investment is crowded by taxation regardless of whether the budget is in balance. The tax burden would include all of the production that is lost to disincentives --the production that is 'crowded out' by high tax rates." [P.C. Roberts, "Theoretical Foundations of Supply- -Side Economics." in S222l1:Sids_Esenemis__iu_the_12&Qspp. 50 1 42This view is based on two points: first, that the definition of the money supply is always changing and, consequently, difficult to control. In fact, some Lafferites would like to return to the gold standard as a way of controlling the money supply. Second, controlling the money supply is nothing but an aggregate demand approach to inflation which does not work because it is hard to control by government (which is unreliable as 39 compared to a gold standard which is controlled by the world supply of gold). For J. Kemp, "Demand-side economics is made up of a little bit of Keynesianism and a little bit of monetarism. . . . The greatest tragedy, though, is that we do not have a supply-side monetary policy. In my view, the monetarist and the supply-side approaches to money are irreconcilable. . . . Fixing the quantity of money, to the degree that it succeeds, forces the real economy rather than the banking, system to adjust to every change in the demand for money. Therefore, monetarism causes unnecessary gyrations of interest rates and real output. . .. . The definition and quantity of money therefore can only be estimated approximately, after the fact. . . .. The most stable monetary mechanism we have seen was the classical international gold standard." [Jack Kemp, "Supply-Side Economics: .An American Renaissance?“ in u - ' ' , pp. 27-37.l For George Gilder, “like aggregate demand, the money supply is an essentially mathematical concept that means less than it seems. . .. . We have reached the end of the line for demand-side economics, whether Keynesian or monetarist in character. Rather than attempting to rigidly control unruly aggregates, we should focus on the impact of specific policies on the incentive to work and invest. . . . Any attempt to fight inflation by monetary contraction at a time of repeated shocks to supply will cause new, yet more destructive, and more permanent inflation. . . . There is no practicable anti-inflationary program except Lafferite economics and supply-side stimuli. . . . It is not principally the federal deficit that causes inflation. If the deficit were closed by higher tax rates — and the money supply were held constant - the price level would likely rise in the orthodox way of the law of costs." [Gilder, W, pp. 195-205.] Note that the last two sentences by Gilder differentiate the Lafferites from both the monetarist supply-siders and the balanced- budget supply-siders (who feel that deficits are also a cause of inflation). To a certain extent, the Lafferites are offering a "free lunch". Cut taxes, and no one will lose, not even the government. "What the supply-siders have done," writes Orrin Hatch, “is to point out that the war between the proponents of incentives and the federal government's spending constituencies is not necessary." It is possible, he adds, "to get tax rates down and stimulate growth sufficiently to pay for the current rate of social services, hence bypassing the question of whether social spending is too high.“ [Orrin Hatch, "The Politics of Supply-Side Economics," in The supply-$1'de Effecge, L.H. Meyer (ed.), p. 59.] 40 43"The incentive effects will work in America in the 19805," writes Beryl Sprinkel, "but those effects will not work unless there is a fertile, stable monetary environ- ment. You can have the best seeds in the world, but they *will not grow without the proper soil. . . . Inflation, nominal GNP, and interest rates follow M1 growth, and M1 growth in turn follows the growth of the monetary base. The Federal Reserve could, if it chose, control the monetary base to the penny. To those who are skeptical of this approach, I merely say try it, you will like it." [B. Sprinkel, "Reaganomics: The Monetary Component,” in - 'd 'c 'n , p. 280.] Notice the differences with the Lafferites concerning the ability of the FED to control the money supply. Also note monetarist supply-siders' fear that after deficits increase, the government would monetize the debt (if it feels that only taxes and not the money supply cause inflation, a'la the Lafferites) and increase inflation. 44Hence, they feel that SSE and monetarism are complementary, contrary to the Lafferites. "The root cause of inflation," writes N. Ture, "always has been too fast a growth in the stock of money relative to the growth in real output. . . . Pursuit of a 'tight' monetary policy, . . . is not at odds with high rates of growth in output and employment. On the contrary, an anti- -inf1ationary monetary policy enhances the prospects for successful pursuit of those objectives." [Norman Ture, "The Implementation of _Supply-side Policies," in sepply- s1de Eeehem1c e 1n the lfififls, p. 231.] For B. Sprinkel, ”the goal of the supply-side and monetary elements of our policy is the same: to increase the productive potential of the U.S. economy. The only difference is that they focus on different aspects of government behavior, one on the demand side and the other (Ml the supply." [Beryl Sprinkel, "Reaganomics: The Monetary Component," p. 274.] 45Michael Evans writes: "We can no more cut taxes without restraining government spending. . . .. To the extent that the increase in private sector saving generated by tax cuts is offset by a decrease in public sector saving, additional funds will not be available for investment. Thus tax cuts need to be accompanied by a reduction or at least a slower growth rate in government spending." [M. Evans, "The Bankruptcy of Keynesian Econometric Models,” in Ihe_§epply_§1_e_fiel_§1eh, Bartlett and Roth (eds.). p. 63. ] 46W.P. Gramm argues that "to make supply-side economics work, we not only had to cut taxes to provide 41 incentive, but we had to cut spending growth, not just to try to offset the revenue reduction . . . but simply to control the growth in federal spending." [W.P. Gramm, 'Supply- -Side Aspects of Government Spending,” in supply- WM. p. 260 l The above differences in theory and policy intensified after the 1981-82 recession and the increase in deficits leading to further confusion within Reaganomics (as will be discussed in Chapter IV). 47"In many respects," writes Bruce Bartlett, "supply- side economics is nothing more than classical economics rediscovered. More particularly, it is Say's Law of markets rediscovered. The essence of Say' 3 Law . . . is that goods are ultimately paid for with other goods.“ [Bruce Bartlett, Reaganomics, p. 1.] While Say' 8 Law has many meanings and corollaries due to the many different classical economists who contributed to its development [see Thomas Sowell, 9 ' W. (Princeton University Press, 1972), Chapter One, pp. 3-38], SSE advocates emphasize that part of Say's Law which means that: Supply cueates its own demand (i.e., there can be no deficient aggregate demand) on which Wallace Peterson writes: "Say's Law is a logical necessity for their [SSE advocates] argument, namely, that it is possible to explain how the economy works by approaching it from the standpoint of aggregate supply rather than aggregate demand. Concentrating on supply as the key determinant of aggregate output makes sense only if there is assurance that everything produced ultimately can be sold. Say's Law provides this guarantee, logically, if not empirically." [Wallace Peterson, c ° , fifth edition. (New York: Norton and Co., 1984), p. 419.] 48”Although equity and justice were important elements of taxation,” Robert Keleher and William Orzechowski maintain, ”to these [classical] economists they were always subordinate to economic growth." [Robert Keleher and William Orzechowski, "Supply-Side Fiscal Policy: An Historical Analysis of a Rejuvenated Idea," in s_pply;§1g§ Eggggm1gg, R. Pink (ed.), p. 143.] 49Note that "supply-side" economics is presented as the norm while "demand-side” economics is presented as the exception. Since the Great Depression presented a special case of deficiency in aggregate demand, the argument goes, equity considerations were accepted by economists at the expense of efficiency. However, since the economy is no longer suffering from the Great Depression, economic policy should return to the norm of "supply-side" economics. For 42 R. Keleher and W. Orzechowski, “objectives such as income distribution and trade cycle stabilization displaced the classical emphasis on growth as principal concerns of fiscal policy. Much of the reason for this dramatic shift seems to lie in circumstances of the period. The virtual collapse of aggregate demand during the 19308 had several very important ramifications. . . . With the self- contradictory condition of stagflation, the present orthodoxy [demand-side] is on the defensive. And economists are again turning to the supply-side.” [R. Keleher and Orzechowski, "Supply-Side Fiscal Policy: An Historical Analysis of a Rejuvenated Idea,” in eggply;§1gg figgggm1gg, R. Fink (ed.),Pp. 174-151.] 50"The attack by Keynes on Say's Law, "writes Thomas Sowell, "centered (n1 its denial of a unique equilibrium income. The Keynesian equilibrium income determined by 'the point of intersection between the aggregate demand function and the aggregate supply function' was contrasted with Say's Law as a 'special assumption as to the relationship between these functions.‘ The statement that 'Supply creates its own Demand' meant for Keynes that aggregate demand and aggregate supply functions were 'equal for all values' of income, 'for all levels of output and employment.‘ In short, aggregate supply and aggregate demand functions coincided. . . .Say's Law, for example, meant for Keynes not only a coincidence of supply and demand functions but also the automatic maintenance or restoration of full employment." [Thomas Sowell, $22.5. Law, pp. 201 and 210.] 5In fact, George Gilder insists that "Say's Law was not only refuted, it was implicitly reversed, with cause and effect hopelessly confused in the pr0position that demand creates its own supply. . . . Our current situation recalls the world in which economic science gained its first triumphs. This was the age of mercantilism . . . when Adam Smith reproached the governments of Europe for believing that the power of demand, in the form of accumulated gold, constituted the source of wealth. In The Smith argued that the real riches come from the power of supply." [George Gilder, ”The Supply- Side.' in $22212:Side_figgngmigs. pp. 14 and 17.] 52"The problem of contemporary capitalism,” writes George Gilder, “lies not chiefly in a deterioration of physical capital, but in a persistent subversion of the psychological means of production - the morale and inspiration of economic man - undermining the very conscience of capitalism: the awareness that one must give in order to get, supply in order to demand. . . . The 43 trend seems to have begun in politics. . . . The demand side has all too often triumphed. The problem begins in political philosophy: in the theory of politics and public opinion. . . . The public . . .[is largely a phantom. On many issues, public opinion, as the term is commonly used, does not exist. . . . Successful politicians are engaged not in passive response to public demand, but in the active supply and marketing of ideas. Supply can create its own demand, even in the political realm.” [Gilder, "The Supply-Side," pp. 14-15.] According to Bruce Bartlett, "Keynes succeeded in arguing that the cause of the Great Depression was under- consumption and that government policy ought to be directed towards stimulating demand. . .. . Keynes' theory soon became the new economic orthodoxy largely because his policy prescriptions coincided with the politics of the times." [Bartlett, Rgggangm1gg, p. 2.] Note that Keynesian economics is presented only as a theory of government disregarding in the process its contribution to the discipline (in terms of analysis). This statement is not intended as a defense of Keynesian economics. Rather, its purpose is only to show that SSE had an additional objective of cutting government intervention in the economy while essentially claiming to be a cure for stagflation. 53For Gilder, 'Egalitarianism in the economy tends to promote greed over giving. It downplays the various and specific sources of supply to favor the diffuse and sterile clamor of demand. To the ordinary mind, there is no reason for an assumption of equal importance of the two concepts. Demand attained parity only in our economic texts, and it achieved its deceptive supremacy only in our deluded politics.‘I [Gilder, "The Supply-Side," p. 15.] 54T. Cowen argues that, "because of Keynes' monetary theory of interest, the interest rate is inherently unable tn) equilibrate savings and investment ex ante. However, Keynes' very definitions of savings and investment require that they be equal ex post. Therefore, if there is an increase in planned saving, the interest rate will be unable to perform the function that it does in classical economics - to fall and allow for a correponding increase in investment. The only way the Keynesian model can accomplish the savings-investment identity is for national income to fall, thus extinguishing the once-planned increase in savings ('the paradox of thrift'). Under such a scenario, production itself is not a source of demand since the income resulting from production may be saved instead of spent. If it is saved it will occasion no increase in [demand but only a fall in output." [Tyler Cowen, "Say's 44 Law and Keynesian Economics," in Supp1y-s1gg Economigg, R. Fink (ed.): pp. 179-180.] M. Evans argues that "it is indeed the case that investment will rise if output increases and other factors involving the rate of return are unchanged. Keynesian economics assumes this. However, . . ., a decline in savings will raise the interest rate, which will reduce the equilibrium capital-output ratio, hence lowering rather than raising investment." [Evans, “The Bankruptcy of Keynesian Econometric Models," in The supply-s1dg solut1gn, Bartlett and Roth (eds.)p p. 68.] 55See Robert Keleher and William Orzechowski, 'Supply- Side Effects of Fiscal Policy: Some Historical Perspectives," in W: T.J. Hailstones (ed.)p PP. 140 and 142. 56Ibid., p. 140: "Given that Say's Law indicates that it is production and aggregate supply rather than demand and expenditure that create growth and wealth. . . . If taxes adversely affect aggregate supply or factor inputs . . . these taxes should be either eliminated or minimized.” 57In fact, SSE advocates often refer to Smith as a 'supply-sider' by quoting him saying: "High taxes, sometimes by diminishing the consumption of the taxed commodities, and sometimes by encouraging smuggling, frequently afford a smaller revenue than what might be drawn from more moderate taxes,“ as evidence of the Laffer curve. [Victor Canto, Douglas Joines, and Arthur Laffer, W. (New York: Academic Press, 1983), p. 77.] Note, however, that Smith was talking about consumption and not income taxes. Further- more, Smith assumed consumption goods to be normal goods. Hence, a tax increase would lead both the substitution effect and the income effect to work in the same direction by decreasing consumption of the taxed good. This can be the case because consumption goods can have many substitutes while work (income) can have little (or no) substitutes such that the income effect of a tax increase on work (income) would be to increase work (on the assumption that work is an inferior good) as will be discussed in Chapter III. 58This idea of supremacy of supply is so overwhelming that SSE advocates are willing to go as far as promoting monopoly, thereby, in the view of their critics, contradicting their claim that SSE has Classical roots (see Chapter III). In fact, George Gilder argues against Adam Smith that “capitalist creativity is guided not by any invisible hand, but by the quite visible and aggressive 45 hand of management and entrepreneurship." Gilder writes: 'To the question of how many companies an industry needs in order to be competitive, economist Arthur Laffer answers: One. It will compete against the threat of future rivals. Its monopoly can be maintained only as long as the price is kept low enough to exclude others. In this sense, monopolies are good. . . . The ideal of perfect competition like the ideal of an economy without business power, translates into an economy without innovations. . . . The quality of capitalist society depends not on automath: mechanisms, but on the quality, creativity, and leadership of the capitalists." [Gilder, "The Supply-Side," p. 23.] 59Keleher and Orzechowski refer to the tax cuts of William Gladstone in Great Britain in 1840 and Andrew Mellon in the U.S. in 1920 as examples of SSE in action. Other examples of tax cuts in the twentieth century refer to countries such as: Puerto Rico, Chile, Hong Kong, Japan, and West Germany. [Keleher and Orzechowski, "Supply-Side Fiscal Policy," pp. 142-145.] See also Bartlett, Reagangmigs, p. 201. 60Roberts argues that "since almost all economists in the U.S. in the 19608 and the 19708 were Keynesians, the Kennedy tax cuts have been studied from the demand-side point of view. The economic boom that resulted has been interpreted as a consumption-led expansion caused by higher spending. In actual fact, after the tax cut went into effect, people spent a smaller percentage of their income." [P.C. Roberts, Ihfi.§!221¥:fiié§.3§¥212§12£r p. 76.] 61Bruce Bartlett insists that "there seems to be no escaping the conclusion that the best path to economic growth lies in low taxes and free markets." [Bartlett, Beasangmissp Po 201-1 CHAPTER III CRITICS OP SUPPLY-SIDE ECONOHICS For more than forty years we have shown that an essentially capitalist economy can prosper and grow while the society collectively moderates extremes of wealth and poverty, privilege and deprivation, power and insecurity, boom and depression. Keynes and a generation of economists he influenced believed that capitalism was robust enough to flourish under these compromises with democracy and equality. Both Marxist critics on the extreme Left and conservatives of the extreme Right have always doubted it, and theirs is the essential message of the supply-side counter-revolution.* - James Tobin Unless the art and science of economics succumbs to a romanticized Marxism, escapes from reality into abstract mathematics, or is made irrelevant by instituting a planning system under the guise of an industrial policy, supply-side economics will ultimately prevail. . . . Supply-side economics is the economics of a free society. It will prevail wherever freedom itself prevails.** - Paul Craig Roberts 3.1 Iggggggctign: Criticisms of SSE can be classified into three categories. and theoretical foundations of its propositions, third category focuses on the so-called: political objectives (or implications) of SSE. 46 The first and second focus on the empirical and the implicit 47 Since SSE argued that U.S. taxes were (1980) on the prohibitive range of the Laffer curve, then the correct measurement of the Laffer curve (especially the position of the point of maximum revenue on the curve) becomes crucial. This, in turn, leads to an empirical and theoretical debate over the shape of the curve itself, the position of the point of maximum revenue on the curve, the position and magnitude of the prohibitive range, and the strength of supply-side incentives (or Laffer-effects). These effects are, in turn, a function of the elasticities of factor supplies (which are at best ambiguous). Hence, another debate arises over the outcome of tax cuts on revenues, output and productivity, and, finally, inflation (since SSE was presented as a method of inflation control), depending ion the elasticities of factor supplies (which are, in turn, related tn) the values of the substitution and income effects) with respect to tax rate changes. Moreover, and given the ambiguity of the empirical evidence, critics of SSE focus on the assumed political motives (or implica- tions) behind the SSE proposition to cut tax rates.1 Criticisms of SSE do not only focus on the Laffer curve, however. There are also reactions to the acceptance of Say's Law, the interpretation of the Kennedy tax cut as an historical evidence of SSE, and the claim that SSE has "Classical” roots. 48 T nc n ' s d Tax Revenues: Critics of the Laffer curve first argue that the shape of the curve itself, the position of the point of maximum revenue, and the size of the prohibitive range are all ambiguous.2 Second, even if the Laffer curve is a well- behaved function, they add, there are problems of measurement. A certain tax rate cut, they argue, may lead to an increase or decrease in revenues depending in part on the slope of the curve.3 Finally, the impact of tax cuts on revenues, output, and, consequently, inflation, they conclude, all depend on the values of factor supply elasticities (of labor and capital) to tax rate changes which are controversial.4 The controversy over the Laffer curve stems from the fact that no one knows the exact shape of the curve and, thus, the position of the U.S. on the curve, or how it changes over time (if in fact it does change). The point of maximum revenue is the most disputed aspect of the Laffer curve. While Arthur Laffer assumes that point to be around the 50 percent tax rate, critics of the Laffer curve depict that point to be at a higher tax rate.5 While there is no consensus among the critics concerning the position of the point of maximum revenue, some critics suggest that the U.S. is not on the prohibitive range (even if the maximum revenue point is at the 50 percent tax rate.)5 In 49 fact, by just postulating the existence of his curve, their argument goes, Arthur Laffer falsely concludes that the U.S. is (”1 the prohibitive range. Hence, they conclude, the need to prove the latter was, according to Laffer, unnecessary.7 In theory, Laffer's critics claim that the argument of the Laffer curve is only an extension of Alfred Marshall's notion of a demand curve. By substituting the tax rate for price and taxable income for quantity demanded, then the total revenue curve for such a demand curve can be called the Laffer curve.8 Hence, while it is possible to accept the existence of a Laffer curve, at least in theory, the critics maintain, the position of U.S. taxes on the curve, however, is a controversial empirical issue due to the existence of measurement problems. 18 there a separate Laffer curve for every individual, they ask, or one Laffer curve for the entire population? Is there a separate Laffer curve for every tax, or one Laffer curve for all types of income taxes? Can one accurately measure the prohibitive ranges and the maximum revenue points for all the Laffer curves suggested above? In addition, can one accurately measure the extent of the underground economy?9 Finally, can the third point (corresponding to the 100 percent tax rate) on the curve logically exist (in the sense that if it could not logically exist, then the prohibitive range also could not 50 exist)?10 Critics of the Laffer curve doubt the accuracy of the measurements of such variables. If every individual has a separate Laffer curve, they argue, then the maximum revenue point would differ for each taxpayer. In addition, if one aggregate rate is depicted for all types of income taxes, then the exact magnitude of the needed tax cut (to maximize total revenue) for each tax type is difficult to determine.11' Furthermore, the Laffer curve, they claim, faces the problem of omission of other variables. For SSE advocates, the critics argue, the only factor affecting tax revenues is the marginal tax rate: Consequently, they disregard the impact of other variables, such as the institutional constraints on hours of work and different elasticities of different professions and of different sources of income to tax rate changes. In fact, if one accepts the incentives hypothesis of the Laffer curve to be true, the critics maintain, one would expect employment in occupations that permit more tax evasion (relative to other occupations) to increase when tax rates increase.12 Moreover, the impact of omitted variables, they argue, can lead to the existence of a whole set of different Laffer curves (even if we depict one Laffer curve for the whole taxpaying population and one aggregate tax for all tax types).13 Finally, they suggest, the shape and position of the Laffer curve are largely affected by different elasticities of factor supplies to tax rate 51 changes. These elasticities are, in turn, a function of the magnitudes of the substitution and income effects.14 u ' u ' c nd u 'e : For a given tax rate, the higher the supply elasticity, the greater the likelihood that the tax rate falls on the prohibitive range (and vice versa).15 Hence, the claim that U.S. tax rates are on the prohibitive range implies that SSE advocates believe that the relevant factor supply elasticities and/or tax rates are relatively high.16 Those who say that U.S. tax rates are on the normal range, however, believe that factor supply elasticities and/or tax rates are lower, and those who deny the existence of the inverse relationship between tax rates and tax revenues (i.e., that there is no prohibitive range) believe that factor supply elasticities are zero or negative (e.g., that (a higher after-tax income leads to less work). In fact, each possible value of factor supply elasticities determines a different Laffer curve. Since empirical estimates of these elasticities in the U.S. are ambiguous, Laffer's critics conclude, then the Laffer curve itself is ambiguous.17 One variable affecting the value of factor supply elasticities is the definition of the tax rate (the variable on the x-axis). The probability of being on the prohibitive range increases for narrowly defined taxes and 52 decreases for broadly defined ones. This is because broadly based taxes tend to have smaller elasticities as compared with narrowly based ones.18 Hence, as was mentioned above, the smaller the elasticity of factor supply, the lower the probability of being on the prohibitive range. Since income taxes (from both capital and labor) are broadly based ones, the critics argue, then the probability of such taxes being on the prohibitive range is low indeed.19 Furthermore, magnitudes of factor supply elasticities are very much a function of the magnitudes of substitution and income effects. Particularly, the higher the magnitude of the substitution effect (as compared with the income effect), the higher the elasticity of factor supply.20 Hence, by ignoring the income effect and concentrating on the substitution effect, SSE advocates assume high elasticities of supply for both labor and personal saving.21 Even if one accepts the assumption that the substitutirui effect outweighs the income effect, the critics argue, the final response of labor supply and personal saving would have to be much larger than current estimates suggest in order for the tax cut to be self- financing. While SSE advocates disagree with such estimates, the critics conclude, they present no conclusive evidence to the contrary.22 53 Since the magnitudes of substitution and income effects are difficult to gauge, the critics are skeptical about the assumed response of factor supplies by SSE. Furthermore, while one can accept the fact that tax rates can affect factor supplies, at least in theory, the critics argue, the extreme SSE conclusion was the result of misunderstanding of microeconomics by its advocates.23 In addition, the argument goes, the complete concentration by the "new“ supply-siders on the impact of tax cuts on labor supply and personal saving leads them to omit other important variables that can affect such factor supplies.24 More importantly, and even if labor supply and personal saving increase, the critics conclude, the impact of tax cuts on inflation will be lower than assumed by SSE due to the slight expected increase in factor supplies. u s d x Debate over the impact of both labor supply and personal saving on inflation is, once again, an empirical matter. While one can accept the argument that increased labor supply and personal saving can affect inflation, the magnitude of such an effect is controversial.25 Further- more, critics of SSE argue that the inflation of the 19708 was not necessarily the result of lower levels of saving and labor supply.26 In addition, such critics claim that SSE wrongly argues that an increase in personal saving will S4 automatically lead to increased investment and capital stock leading to higher productivity and lower inflation, because of the following three assumptions: first, that personal saving finances investment. Second, that capital formation is hindered by lack of personal saving. Third, that increased productivity leads to lower inflation. Critics of SSE suggest that a major part of business investment is financed by business saving and bank credit, and not by personal saving. Personal saving, they add, 27 Moreover, the mainly finances residential construction. SSE assumption that an increase in personal saving implies an immediate increase in investment, the argument goes, neglects the many coordination problems between saving and investment.(i.e., even if total saving increases, one cannot be sure of an immediate increase in investment due to the volatile nature of business investment which, according to the critics, is affected by many variables other than tax rates, such as business confidence.)28 Furthermore, the assumption that capital formation is hindered by lack of personal saving, the critics argue, arises due to confusing personal saving with total saving (which is composed of personal saving, business saving, and government saving). In addition, critics of SSE suggest that while the marginal tax rate can affect people's decisions to save and invest, the most important factor affecting business investment is total sales (which is a 55 function of consumption). Consequently, they conclude, investment was low in the 19708, not because personal saving was low, but because of slow growth in total sales.29 Finally, while one can accept the notion that an increase in productivity can lead to lower inflation, the critics insist, the empirical magnitude of such an effect is very small. The "supply-side" of the price equation (or supply prices), their argument goes, is dominated by two aspects, namely, the productivity of utilized productive factors, and the prices of the productive factors. By concentrating on productivity aspects and neglecting prices of factors of production to control inflation, the critics maintain, SSE advocates expect an unprecedented increase in productivity. Even if productivity increases, the critics add, there is no assurance that inflation will decrease because prices of factors of production might increase to outweigh the impact of the increase in productivity on inflation.30 Hence, as a theory of inflation, the critics conclude, SSE provides little relief and must be accompanied by other measures on the aggregate demand side of the equation. In fact, with the prospect of an increase in the deficit after a tax rate cut, they insist, the need for demand-management becomes inevitable.31 56 Given the criticism that the impact of a tax cut on factor supplies, output, productivity, and inflation is at best ambiguous, the new supply-siders, in the view of their critics, relinquish quantitative empiricism in favor of story telling by counting past instances of tax cuts that were followed by growth as evidence of their theory.32 The main evidence supporting SSE has taken the form of a retrospective look at the Kennedy tax cut. While U.S. modern history had only two cases of massive tax cuts, in both cases evidence of SSE in action is uncertain and subject to considerable debate.33 Advocates of SSE argue that the Kennedy tax cut worked to increase growth (or aggregate supply) by increasing saving and investment and not by increasing consumption (or aggregate demand). This was the case, they insist, because a marginal tax rate cut affected relative prices such that supply incentives (substitution effects) worked to increase both saving and investment leading to an increase in growth and tax revenues. The first-order effect of the tax cut, they maintain, was to increase saving and investment via the substitution effect. Any increase in income (and, consequently, consumption) was only a second-order effect to the increase in factor supplies. The most important conclusion that they reach is that the expansion following the 1964 tax cut was not totally "demand-1ed".34 To prove the above, advocates of SSE search through National Income 57 accounting and Internal Revenue Service (IRS) data to show that, before the tax cut, tax rates were on the prohibitive range of the Laffer curve.35 Critics of the SSE interpretation of previous tax cuts argue that, since the Kennedy tax cut was implemented as part of a Keynesian "demand-side" approach to increase aggregate demand, the tax cut worked to increase consumption, via the income effect, leading to an increase in aggregate demand and real output. In fact, such critics suggest that while saving actually increased after the Kennedy tax cut, it was a second-order effect following the increase in income that occurred due to the increase in consumption and real output (i.e., the first-order effect of the Kennedy tax cut was to increase disposable income leading to an increase in consumption which, in turn, led to an increase in aggregate demand and real income allowing the increase in saving to occur as a second-order effect). Furthermore, the increase in investment was possible, not because of the increase in personal saving, they argue, but because of the investment tax credit and an increase in business and government saving. Moreover, the critics maintain, the Kennedy tax cut was designed to enhance both human and physical capital (as compared with tax cuts proposed by SSE).36 Finally, they conclude that while personal saving increased (due to the increase in income) 58 after the Kennedy tax cut, there is little evidence to support the claim that work supply increased.37 Since SSE was presented as an argument to cut personal taxes tn) increase aggregate supply by unleashing the incentives of the upper income brackets to save and invest, critics of SSE suggest the following: first, there is no evidence that an increase in personal saving is a necessary prerequisite to an increase in investment. Second, there is no evidence to suggest that expansions associated with a decrease in the marginal tax rate are unique in generating more growth from the upper income classes. Hence, they argue, the claimed SSE objectives of an increase in growth and a decrease in inflation can be achieved by means other than a marginal tax rate cut.(i.e., if high tax rates are not the only cause of inflation, then lowerinflation is not a necessary - or not the only - result of lower taxes.)38 Third, even if a tax rate out can lead to the superior growth claimed by the new supply-siders, the critics insist, extrapolation from previous incidents of tax rate cuts may not be conclusive given the different circumstances in which those tax cuts were implemented.39 The controversy over the ex-post interpretation of the 1964 tax cut arises because while one can notice the correlation between saving, investment, and growth, it is 'very difficult to determine cause and effect because variables incorporate many effects in them. While the new 59 supply-siders continuously argue that the 1963-65 expansion was led by the marginal tax rate cut to increase incentives to save and invest, critics of SSE suggest that there were :many factors that affected such an expansion. In fact, they argue, a marginal tax rate cut in the 19808 may not initiate the same growth path as in the 19608 due to the inflationary environment of the 19808. The maximum that a marginal tax rate cut can do, they suggest, is to offset bracket—creep (without much effect on inflation control). Moreover, if the impact of the tax rate cut is to increase aggregate demand, then the impact on inflation control is ambiguous. Hence, they conclude, the SSE interpretation of previous tax cuts is simplistic and is not built on conclusive evidence, but on interpretations which presume the correctness of SSE.40 ' d- " c ' " _ c n 'c ' d ' n: For more than a decade, the problem of inflation has been one of the most controversial issues in the economics discipline. In fact, many studies look at the 19708 to search for key variables affecting inflation during that time. Since SSE has been presented as a solution (in fact ‘the only solution) to that problem, it is interesting to see how other theories (or schools of thought) react to such a claim. 60 Critics of SSE suggest that the problem of inflation was not necessarily the result of government taxation. It was the result of many interconnected variables such as shortages in food and energy supplies, lack of growth in investment demand due to the lack of growth in total sales, changes in the composition and size of the labor force (due to the baby-boom generation entering the labor force), structural changes and sectoral shifts (due to the increasing shift from a manufacturing-based to a services- based economy), problems of illiquidity due to monetary crises and credit crunches leading to less expenditures on research and development (R and D), the wage-price spiral in labor markets along with the ensuing increases in inflationary expectations and lack of business confidence, and the Vietnam war (among other variables).4 While there is no consensus in the discipline as to the most and least important variables, tax rates are considered by the critics to be among the least important ones.41 Since the advocates of SSE blame the occurrence of inflation on the continued adoption of Keynesian economics through the increases in deficit spending to boost aggregate demand, Keynesians, in response, argue that, in fact, the increases in government spending were a result and not a cause of the inflationary process. Due to the lack of liquidity, the lack of business confidence, and the wage-price spiral, they argue, recessions were stopped from 61 running their full course by profit-sustaining government deficits. Business profits declined, they maintain, because of the accelerating increases in costs of production. Moreover, the increased expenditures on transfer payments were a result of the inflationary process. (When inflation increases, transfer payments were increased to keep up with the increase in prices, via the cost-of-living adjustments, they maintain.) Keynesian economics was right, they add, because the only way to prevent deep recessions and depressions during that period (due to the decline of business profits and lack of business confidence) was to boost aggregate demand. Increased government expenditures were not the cause, they conclude, but the result of accelerating inflation (which they attribute mostly to increasing oil prices.)42 In addition, Keynesian economists argue that the performance of Keynesian economics should not be judged solely on the experience of the 19708. Keynesian economics, they insist, produced one of the greatest periods of development from World war II to the beginning of the 19708. Increases in deficit spending were not the result of the continued adoption of Keynesian economics, they claim, but due to the lack of it. Increases in the deficits, they add, were less the result of Keynesian theory and more the result of the political process.‘433 Moreover, the new supply-siders‘ claim that Keynesian 62 economics focused on demand-side at the expense of supply- side, they argue, represents both a misunderstanding and a misinterpretation of Keynesian theory on their part.44 Keynesians argue that, in fact, the simple dichotomy of demand-side versus supply-side is an oversimplification of economic theory. The supply-side, they insist, was implicitly modeled in Keynesian theory in the form of inventory investment.45 Productivity and aggregate supply were a function of investment which was a function of consumptirn: (or total sales). Keynesian economics, they add, recognizes the dual nature of investment (that an increase in investment generates both increased income and increased productive capacity) and that, in the long-run, growth depends on productivity and the availability of factor supplies (capital and labor).46 What Keynes added, they maintain, was that, in the short run, growth was largely a function of the volatile nature of the demands for labor and capital (which are a function of aggregate demand and total sales).447 To argue that “supply creates its own demand,“ they conclude, is a call to forget fifty years of development in economic theory.48 In fact, this dichotomy of demand-side versus supply-side, the critics suggest, was a result of the new supply-siders' literal interpretation of Say's Law, to which we not turn. 63 ' ss'c o 8 nd v n n Intgrygnt1on: Critics of SSE argue that there is in the new supply- sfders' acceptance of Say's Law an implicit confusion of its meaning. While it is true that, in a money economy, the value of aggregate supply equals the value of aggregate demand (i.e., that a given output can - but not necessarily will - be purchased by the income generated in its production) on the macro level, the critics maintain, advocates of SSE wrongly argue that Say's Law also applies on the micro level due to their confusion of "demand- management" with "demand-theory".49 This confusion, the critics claim, is best exemplified by their statement: because there is no demand for new and unknown goods, preoccupation with demand fosters stagnation.so While one can separately study the impact of policy (changes in tax rates) on demand (consumers) and supply (producers) on the micro level, the critics argue, it is difficult to do so on the macro level. On the macro level, the critics insist, changes in policy simultaneously affect aggregate demand and aggregate supply such that it would be difficult to identify one effect from the other. Hence, the critics conclude, the artificial and selective separation of aggregate demand from aggregate supply on the macro level is misleading.51 64 Thus, the acceptance of Say's Law, the critics maintain, is more the reflection of the new supply-siders' value theory (that taxes are costs and costs set price) on the micro level, and less the reflection of their understanding of demand-management on the macro level.52 Even if one accepts the SSE view that cost sets price, the argument goes, then the quantity bought and sold is still determined by both supply and demand. If demand is too low, then the quantity bought and sold would be low (and vice versa). Hence, if demand affects total sales, and if total sales affect future investment plans of all firms, then demand affects supply (on both the micro and macro levels).53 In addition, critics of SSE argue that the new supply- siders accept the validity of Say's Law for three reasons: first, Say's Law provides a guarantee, theoretical, if not empirical, that savings always lead to investment.54 Second, the acceptance of Say's Law, the critics argue, reflects their belief that money is a neutral link between transactions. It does not allow money to enter into motives or decisions, as money does, through liquidity preference, in Keynesian theory.55 Finally, the critics conclude, Say's Law was a logical necessity for the new supply-siders' basic argument, namely, that it is possible to explain how the economy works by approaching it from the standpoint of aggregate supply rather than aggregate 65 demand. Concentrating on supply as the key determinant of aggregate output makes sense, the critics argue, only if there is assurance that everything produced ultimately can be sold. Say's Law provides this guarantee on the basis of dubious assumptions and not empirically.56 By resurrecting Say's Law, the new supply—siders do not distinguish between Say's Identity (that there is in general no excess demand for money holdings and/or that such excess demand for money is a consequence rather than a cause of disequilibrium in the economy) and Say's Equality (that a given output can - but not necessarily will - be purchased by the income generated in its production, i.e., that there is an equilibrium point between aggregate demand and aggregate supply). By restating their faith in Say's Law, the new supply-siders implicitly accept both Say's Identity and Say's Equality. Consequently, their argument that ”Keynes' Law" was a complete reversal of Say's Law, critics of SSE argue, represents an oversimplification of what Keynes said since it implicitly assumes that Keynes rejected Say's Identity and Say's Equality.57 While it is true that Keynes rejected Say's Identity (since he argued that there can exist an excess demand for money holdings leading to disequilibrium in both the money and labor markets leading to unemployment even if the goods market was in equilibrium), the critics insist, he did not reject Say's Equality (the possibility of there being an 66 equilibrium point between aggregate demand and aggregate supply). For Keynes, they add, the difference between Say's Equality and Say's Identity was in relation to the path towards full employment equilibrium. While Say's Equality assumes an equilibrium point for the economy (between aggregate demand and aggregate supply at full employment), Say's Identity was an assurance that the economy would reach that full employment equilibrium by itself. Hence, for Keynes, the critics maintain, Say's Equality says nothing about the actual path required to reach that equilibrium, how long it will take, and how much "suffering" will be required in the process, or whether there are less ”painful” alternative routes. Keynes, they add, rejected Say's Identity to offer his own alternative less “painful" and "faster" (than the "laissez-faire') route by introducing demand management. By resurrecting Say's Law, the critics conclude, SSE advocates are in fact resurrecting Say's Identity (that the laissez-faire route to full employment equilibrium is faster and less painful than any "interventionist" alternative). In fact, the new supply-siders' dichotomy of demand-side versus supply-side, the critics insist, merely reflects their dichotomy of "more government” versus "less government" intervention.58 Since the supply-side was defined as the upper income classes and the entrepreneurs, and since the new supply- siders argue that capitalism depends on "freedom" of the 67 supply-side, critics of SSE claim that implicit in the new supply-siders' argument is a call for less government intervention, and a confusion of the process of capitalism itself. Capitalism, the critics claim, depends on freedom of action and the fulfillment of self-interest, and not on capitalists. Hence, by attributing the outcome of capitalism to certain individuals and not to the culmination of a process, the critics argue, SSE advocates contradict almost all economists before them including, ironically, the Classicals.59 It is the system that produces Henry Fords, some critics insist, not Henry Fords who produce the system.60 Moreover, if capitalism depends on freedom of the supply-side, as the new supply-siders claim, the critics maintain, then any distortion of that freedom leads to lowered supply-side incentives. According to the new supply-siders, the critics add, modern capitalism has continuously distorted or contaminated their ”pure" form of capitalism (usually referred to as pre-World War II laissez-faire).61 For the new supply-siders, the critics conclude, the sources of contamination and distortion include welfare compensation, regulation of businesses, and higher tax rates; namely, government intervention. According to SSE, the critics argue, the poor will not work more because they have too much money to spend on 68 leisure, the rich will not save and invest more because they do not have much money to do so, and businesses will not innovate and produce more because they do not have much money either due to regulation or taxation. The SSE solution, the critics claim, is to reverse the process by removing the sources of contamination and distortion.62 If allocation in the market depends on relative prices, the critics add, then, for the new supply-siders, taxes distort goods prices leading to inflation, and welfare compensation distort input prices leading to unemployment. Hence, the critics conclude, the liberation of the supply-side a'la SSE can only occur by giving more money to the rich and less money to the poor, less regulation, and less government intervention. In fact, the critics maintain, by completely blaming government intervention for the occurrence of both inflation and unemployment and neglecting other variables that have an impact on such problems suggests that SSE advocates are concerned with a process (redistribution of income) and not outcome (less inflation and unemployment).63 Finally, critics of SSE argue that there is little correlation between the size of government (or the public sector) and economic performance. In addition, they claim that when compared with other countries (such as Japan), the U.S. public sector is smaller.64 Moreover, the growth in the U.S. public sector, they insist, was an 69 institutional adjustment to the growing needs of modern capitalism. It was due to the growing number of externalities following the increasing complexity of the productive system, they argue, that the need for government intervention increased.65 Furthermore, the increasing shift from manufacturing to services, they believe, has led to the increase in the size of the public sector since the government is a major supplier of services.66 Conse— quently, the focus on cutting taxes as the only cure to the problems of inflation and unemployment, the critics conclude, represents a sales pitch on the part of the new supply-siders tn) convince the people and the politicians that cutting taxes can lead to prosperity while hiding the redistributional content of such a policy.67 x ' ' 8 . d . 'c b' . : To convince the politicians and the electorate of their theory, critics of SSE argue, the new supply-siders devised a "painless" solution to the problems of inflation and unemployment.68 That painless solution, the critics add, was built on the Laffer curve which promised a ”free- lunch": cutting taxes would unleash the supply-side incentives leading to growth, higher revenues, and less inflation.69 Theoretically, the critics claim, it was enough in their opinion to argue that tax cuts can lead to increased factor supplies via the substitution (Laffer) 70 effect outweighing the income effect. No conclusive evidence was necessary, the critics maintain, because the new supply-siders wrongly assumed that economic history was full of successful SSE experiments.70 This painless approach to the problems of inflation and unemployment, the critics suggest, was a result of their (the new supply-siders) depiction of two polar cases of demand-side management versus supply-side management leading to the following omissions: first, by arguing that tax cuts are the only cure for inflation and unemployment on the supply-side, the critics argue, the new supply- siders omit many prior studies that focused on the aggregate supply.71 Second, the complete concentration on the supply-side, the critics add, leads them to neglect all that has been said about demand-side problems.72 Finally, the dichotomy of supply-side versus demand-side, the critics maintain, leads the new supply-siders to completely overlook all the studies that go beyond supply and demand such as the studies of the institutional framework within which the economy operates.73 Inflation and unemployment, such critics argue, are not the results of lack of incen- tives, but the result of the breakdown of institutions.74 Increasing the monetary incentives of the supply-side (the rich and entrepreneurs) by cutting taxes, they insist, may not lead to more investment, productivity, and growth (as SSE claims).75 71 These omissions, the critics suggest, occurred for two reasons: first, they argue, the new supply—siders did not have complete knowledge of economic theory. In fact, some critics question the academic credentials of SSE advocates.76 Second, critics of SSE claim that a tax out has little impact on the actual real and psychological factors affecting the aggregate supply. Hence, they conclude, the term ”supply-side economics” was just used to "sell" the idea of a tax cut.77 In fact, the critics maintain, SSE was a collection of ideas borrowed from other schools of thought and tailored in such a way to rationalize a tax cut leading to internal contradictions, to which we now turn in Chapter IV.78 72 W *James Tobin, ”Supply-Side Economics: What is it? Will it Work?, in V1ggpg1g1§ - 'd ' , Thomas J. Hailstones (ed.), (Reston, Virginia: Reston Publishing Co., 1982), P. 138. ** . . . Paul Craig Roberts, - u o . (Cambridge, Massachusetts: Harvard University Press, 1984), p. 311. 1"One of the most attractive economic propositions for politicians," writes Peter Gutmann, "is the proposition, advanced by Professor Arthur Laffer of the University of Southern California, that a reduction in tax rates can increase the amount of government revenues collected. This most happy result solves the politician's dilemma. . . . He can advocate, at one and the same time, tax reduction and a balanced budget.” [Peter Gutmann, "Taxes and the Supply of National Output," in The Supply-51de solut1on, B. Bartlett and T. Roth (eds.), (Catham, New Jersey: Catham House Publishers, Inc., 1983), P. 265.] 2David Henderson suggests that since the Laffer curve was the result of a hypothetical relationship, the exact shape of the curve may not be as simple as predicted by Laffer. Due to the interrelationships between substitution and income effects (which are themselves ambiguous), the curve may not have one dome or hill. Henderson argues that the curve can have two or more hills. Consequently, it will have more than one point of maximum revenue which lead to a set of prohibitive ranges. Finding the position of U.S. tax rates on such a curve, Henderson concludes, will be very difficult. For more details, see David Henderson, “Limitations of the Laffer Curve as a Justification for Tax Cuts." in - ' c 'c M. Richard Fink, (ed.), (Frederick, Maryland: Alethia Books, 1983), pp. 224-225. 3In fact, even if taxes were on the prohibitive range, the outcome of a certain tax cut on revenues depends on the slope of the Laffer curve, the position of tax rates in relation to the point of maximum revenue, and the magnitude of the tax cut. If the Laffer hill is relatively flat, then a move from a point on the prohibitive range to a point on the normal range can lead to a minimal decrease (or increase) in revenues. However, if the Laffer hill is relatively steep (i.e. yields higher revenues at all tax rates except the zero and 100 percent rates), then the same tax cut can lead to a huge decrease in revenues. Note decl haVe impo. be 0 73 that, again, the slope of the curve depends on the values of the substitution and income effects. "The one hope that a cut in tax rates will increase tax revenues,“ Miller and Struthers write, “is the 'Laffer- effect', but this is a slim hope at best. It depends on the assumption that people will work significantly more when their after tax wage rises or when their after tax profit or rate of return rises. . .. . Since no one knows the shape of the curve or the location of the point of maximum revenue, it would be very difficult to cut tax rates correctly." [Preston J. Miller and Alan Struthers, "The Uncertainties of the Laffer Effect," in y1egpo1nee, pp. 115-117.] Note that the position of the maximum revenue is important in terms of determining the amount of the needed tax cut. If taxes are way down on the prohibitive range, then a small tax out can lead to higher revenues. But, if taxes are just slightly above the maximum revenue point, then a small tax cut can lead to lower revenues (a movement from a point on the prohibitive range to a point on the normal range). 4"The lost tax revenue may be recovered," Bruce Kimzey argues, "but only if economic growth is greater than it would have been without the tax cut because of the new investment and new incentives to produce. But once again these are difficult, if not impossible, to nmasure and assign to specific causes. . . . The success of a tax cut as an anti-inflationary tool depends on the value of the Laffer curve to predict accurately the response to the cut.“ [Bruce Kimzey, Reagenem1ee. (St. Paul, Minnesota: West Publishing Co., 1983), pp. 21 and 54.] 5"Laffer himself," Thurow writes, "has never attempted to specify empirically where the breaking point [maximum revenue point] occurs, although he usually draws his curve with the breaking point at the 50 percent tax rate. Those who have actually tried to estimate where the point might be put it at somewhere around the 80 percent tax bracket." [Lester Thurow, Qengerege QQIIEDE§§ The stete of Egenemige. (New York: Vintage Books, 1984), p. 235.] Similarly, Paul W. McCracken argues that ”the trouble is that the sum total of the analytical literature establishing the case for the Laffer curve is apparently an envelope on whose back has been drawn a curve . . . what, however, are the parameters of the curve? At what level of tax rates does a further rate increase produce an absolute decline in revenues? Are we already in that zone? There have been no careful empirical analyses to answer these important questions. If important public policies are to be based, at least in part, on this concept, answers to Side Prob brack PGICe the I tax 1 C°mpax Laffe QVQIY [EVQnu margin that r inCIEa effect theSe ' 74 these questions become important. For the Phillips Curve, Professor Phillips produced a long article carefully analyzing empirical evidence (which spawned extensive further work by others); there is no such analysis for the Laffer Curve." [P.W. McCracken, "Reaganomics: A Midterm Examination," in Reaganom1cs; Meen1ngI Means, end Ends, P.W. McCracken and John Kenneth Galbraith, The Charles C. Moskowitz Memorial Lectures, College of Business and Public Administration, New York University, New York: The Free Press, 1983, pp. 82-83.] 6Note that the proof by the "new" supply-siders concerning the position of the U.S. on the prohibitive range was built on three assumptions. First, the mere presence of the underground economy, ipso facto, was assumed to be a proof of high marginal tax rates. Second, the fact that marginal tax rates were higher in 1980 than they were in 1965 after the Kennedy tax cut was another proof of high marginal tax rates. The third proof referred to the claim that the U.S. had higher tax rates than other industrialized countries (see part 2.2 in Chapter II above). In an opposing view, David A. Levine asks: "Can we really trace our low productivity to too high taxation when the data clearly show that we are one of the lowest-taxed peoples in the industrial world?" [D.A. Levine, 'Monetarists vs. Supply-Siders," Policy Reflex, vol. 22, Fall 1982, p. 4.] For Thurow, "whether the breaking point is at 50 or 80 percent, very few people in the U.S. are above the necessary percentage. . . . The average American tax rate (federal, state, and local combined) was 32 percent in 1980, and the average marginal tax rate was only slightly higher at 34 percent.” [Thurow, Dengerege Currents. p. 135.] 7Note that, to a certain extent, the new supply- siders' argument concerning the position of the U.S. on the prohibitive range mainly reflects their focus on the top bracket (or tax rate). If upper-income brackets face a 70 percent marginal tax rate, and if upper-income brackets are the "power" behind aggregate supply, then their marginal tax rate was on the prohibitive range (70 percent as compared to 50 percent) and must be cut. In a sense, the Laffer curve was built on individual micro analysis. If every person has his own Laffer curve (with the maximum revenue point being at 50 percent), and since the highest marginal tax rate was above 50 percent, then a decline in that rate would unleash incentives, increase revenues, and increase output. Hence, on the macro level, the total effect of a tax rate cut would just be the addition of these individual micro responses to tax cuts. Had the 75 Laffer curve been built on macro analysis (in the sense of looking at the average marginal tax rate as was argued by Thurow above), however, one would reach the conclushmi that, as a whole, the average marginal tax rate was on the normal range. See Thurow, Qenge;eee_§e11ee§§, p. 133. 8"The existence of a Iaffer curve," writes Alan Blinder, "is not a result of economics at all, but rather a result of mathematics. We cannot doubt that there is a Laffer hill, i.e., there is a tax rate that maximizes tax receipts." [Alan S. Blinder, "Thoughts on the Laffer Curve," in - ' c ' ' , Laurence H. Meyer (ed.), Conference Proceedings, Federal Reserve Bank of St. Louis, 1981, p. 83.] See also Stephen Rousseas, W. (New York: M.E. Sharpe, Inc., 1982), p. 24. 9The new supply-siders refer to the underground economy as evidence of high marginal tax rates falling on the prohibitive range. Hence, tax cuts can lead to higher revenues since economic transactions can move from the underground to the legal economy. However, whatever the magnitude of the underground economy, Max Moszer argues, once illegal output reaches its maximum, and economic activity in total reaches its minimum, tax revenues start to rise again (i.e., the Laffer curve rises again). In a sense, Moszer doubts the magnitude of the prohibitive range to reach the 100 percent tax rate (as depicted by Laffer). Thus, the magnitude of the prohibitive range can be limited such that, not only tax cuts, but also tax increases can lead to an increase in revenues. [Max Moszer, "A Comment on the Laffer Model,” in supply-s1de Ecenem1ce, R. Fink (ed.)l p0 2060] 10Philip Mirowski claims that "the third point [corresponding to 100 percent tax rate] on the curve could not logically exist; and with it, the 'prohibitive range' vanishes from the graph. Even as a hypothetical thought experiment, the curve runs into severe conceptual difficulties." [Philip Mirowski, "What's wrong With the Laffer Curve?', Jeeznel 9f Ecenem1c Issues, vol. XVI, no. 3, September 1982, p. 820.] 11Mirowski argues that if the variable on the X-axis of the Laffer curve "is intended to represent some aggregate of rates, then the whole concept falls prey to problems of differential tax responses and their appropriate method of aggregation. Moreover, this problem is simply the tip of the iceberg, since in order to address it one must possess a reasonably well-articulated model of the interactions of the key sectors of the necroeconomy: 76 specification of what is exogenous and what is endogenous, the lines of causation and their identifying restrictions. All supply-side models are clear on this point: there is only one operational exogenous variable - the tax rate- and there is only one line of causality - government hindrance of the market mechanism." [Ibid., p. 822.] 12"The hypothesis that tax increases discourage work," writes Max Moszer, "has an implicit corollary. Occupations and professions that permit tax evasion would experience an influx of workers when taxes increase: these industries would be expected to expand. Underreporting of tips by waitresses, waiters, and taxi drivers are especially difficult to police. . .. . The effective tax rate had an upward trend. we would anticipate on the tax account an increase in the number of well-served restaurants and available taxis. Yet, during this time [the 19708], the traditional restaurant has given way to the fast-food operation. Taxis have become increasingly difficult to- find. 'These results are contrary to the theoretical presumption that tax rates are of significant importance in motivating the supply of resources." [Max Moszer, "A Comment on the Laffer Model," p. 220.] 13James M. Buchanan and Dwight R. Lee argue that one omitted variable is people's expectations about tax policy. These expectations, they add, are always changing, leading to a continuous shift in the short run Laffer curve. While the long run Laffer curve may be more stable, Buchanan and Lee maintain, the long run impact of a tax cut on tax revenues is ambiguous because it depends on one's definition of the long run. Thus, the critical question, they argue, is how long is the long run? "To the extent that we allow for all behavioral and institutional adjust- ment," they conclude, 'the period may be long indeed, perhaps decades. . . . The definitive empirical work remains to be done." [James M. Buchanan and Dwight R. Lee, "Where Are We on the Laffer Curve? Some Political Considerations,” in supply-side Ecegem1ce 1n ehe lagge, Conference Proceedings, Federal Reserve Bank of Atlanta and Emory University Law and Economics Center, Atlanta: Quorum Books, 1982, pp. 188-194.] 14The point of maximum revenue depends on the elasticities of factor supplies to tax cuts. If the elasticity of labor supply, for example, is relativeLy high, then the point of maximum revenue of the Laffer curve may come at a relatively low rate (as compared with the 50 percent tax rate). On the other hand, if labor supphy elasticity is relatively low (i.e., labor supply reaction to changes in after-tax income is weak), then the maximum 77 revenue point on the curve may come at a relatively high tax rate (as compared with the 50 percent tax rate). To that effect, Ronald A. Krieger writes that "most research in the U.S. casts doubt on the extreme supply-side view [that labor supply response is strong].' [R.A. Krieger, "Supply-Side Economics: An Introduction," in V1egpe1nhs, pp. 54-55.] 15The higher the elasticity, the lower the maximum revenue point on the Laffer curve [see note 14 above]. D. Fullerton empirically simulates the effect of different factor supply elasticities on the maximum revenue point. Using a general equilibrium taxation model, Fullerton concludes that if labor supply elasticity is 0.15, the maximum revenue point occurs at the 71.8 percent tax rate. If the labor supply elasticity is 4.0, however, Fullerton finds that the maximum revenue point occurs at the 4.8 percent tax rate. Fullerton believes the 0.15 and 4.0 to be the lowest and highest possible values for the labor supply elasticity, respectively. [Don Fullerton, "Can Tax Revenues Go Up When Tax Rates Go Down?", in The_5hpp1y;§1ge SQlQLiQfl: P- 140-] 16In fact, Jude Wanniski claims that the maximum revenue point occurs at the 25 percent tax rate. [Jude Wanniski, d - c ' ' nd Sgggeed. (New York: Basic Books, 1978), p. 260.] It seems that Wanniski is assuming a high elasticity of labor supply (as Fullerton's study suggests). 17Each possible value of factor supply elasticity determines a different maximum revenue point which, in turn, determines a different Laffer curve. Don Fullerton argues that while elasticities of the aggregate labor supply are ambiguous, these elasticities tend to be low. In fact, Fullerton summarizes major studies about labor supply elasticity in the U.S. to conclude that while ”there is a certain injustice to these authors in reporting their results in such a summary fashion . .. . the average is a .15 aggregate elasticity.“ [Fullerton, "Can Tax Revenues Go Up When Tax Rates Go Down?", in The shpply-51de solution. pp. 151—153.] 18Narrowly based taxes have a higher elasticity than broadly based ones because the substitution effect is higher for narrowly based taxes than for broadly based ones. 19Alan Blinder argues that ”the possibility of taxing beyond the Laffer point [maximum revenue point] is much more real for taxes whose bases are narrowly defined- eitr spac AS; neg: fooc pose of 1 all taxe pas imp] like broa ela: leas the 91.] Smit to has Joi & of ava eff: ela. tax: tenc Smaj miss Mic PE: Sup; this: the Pap, 94-5 abm dur inc eff. work the] SUP] 78 either in time, or in geographical space, or in commodity space - than it is for taxes that are broadly based. . . . A sales tax on Pastrami is much more likely to have a negative marginal revenue yield than a sales tax on all food, simply because of the much greater substitution possibilities on both the demand side and the supply side of the market for pastrami, as compared to the market for all food. . . . Can it be that some of our broadly-based taxes - like the personal and corporate income taxes - have passed the Laffer point? This seems to me highly implausible . . . the revenue maximizing tax rate is very likely to be so high as to be considered ridiculous for any broad-based tax. Only very narrowly based taxes, where elasticities in the neighborhood of 5 start to become at least believable, are likely to encounter the down side of the Laffer hill." [See Blinder in note 8 above, pp. 84- 91.] While the new supply-siders usually refer to Adam Smith arguing against high tax rates, Smith was referring to taxes (n1 consumption goods (which are usually narrow- based) and not income taxes. [Victor Canto, Douglas Joines, and Arthur Laffer, Eouhge§1ene ef sepply-S1de Egonem1e . (New York: Academic Press, 1983), p. 77.] 20By definition, the substitution effect is a function of the availability of substitutes. The higher the availability of substitutes, the higher the substitution effect. The higher the substitution effect, the higher the elasticity, given a certain income effect.' Since income taxes (from both labor and capital) are broadly based, they tend to have small substitution effects and, consequently, small elasticities. See note 17 above. 21Some studies suggest that SSE models have many misspecifications of key equations. S. Braun argues that Michael Evans gets a high response from labor supply and personal saving due to misspecifications of the labor supply and consumption equations in his model. These misspecifications, Braun adds, lead to an underestimate of the income effect. [Steven Braun, "Discussion of the Evans Paper," in The supply-Side Effecee 91 Economic Policy, pp. 94-98.] For a similar argument, see Fullerton in note 15 above, p. 144. 22A. Weniger and H. Robison refer to the fact that during the 19708 labor supply increased along with the increase in marginal tax rates as evidence of income effects outweighing the substitution effects. If people work to maintain a certain standard of living, they claim, then an increase in tax rates will lead to more labor supply (which was manifested by more wives entering the labOl Weni' Relig p. 79 subs overa time: actua and 1 Laffe misur of n than espe< may effe side: insi Clos Pric effe. Hick both foun Clea effe 825. effe and 0rd. 399: thai Hen< move (wh. 79 labor force and more people taking second jobs). [Anna ‘Weniger and Hank Robison, "Supply-Side Economics: A Religious Parable," Ecenem1c Fegum, vol. XII, Summer 1981, p. 79.] Similarly, Mirowski suggests that even if the substitution effect outweighs the income effect," the overall elasticity of labor supply would have to be sixteen times larger than existing estimates for there to be an actual contraction of tax revenues [after a tax increase],” and vice versa. [Philip Mirowski, "What's Wrong With the Laffer Curve?', Jeuznal of Ecenem1c Ieeues, p. 819.] 23Philip Mirowski writes: 'Laffer and company have misunderstood and/or misrepresented the theoretical content of neoclassical economics. This is nowhere more evident than when it comes to the issue of income effects, especially with reference to the idea that rises in wages may cause a slackening of effort because of the income effect: a possibility that is anathema to the supply- siders. Laffer brushes this serious qualification aside by insisting, 'it has been long recognized that within a closed general equilibrium system, a change in relative prices will not ordinarily entail any aggregate income effect.‘ He caps this assertion by citing a page from J.R. Hicks' classic, Velue end Capital. . . . If Laffer had bothered to read to the end of the book, he would have found this passage: Where my analysis seems to have been defective is that it did not take sufficient trouble with this income effect. (I was too much in love with the simplification which comes from assuming that income effects cancel out when they appear on both sides of the market.) . . . Instability through asymmetric income effects is, however, a perfectly general possibility, which runs through static, as well as dynamic, analysis. Clearly there is IN) 'general recognition' that income effects cancel." [See Mirowski in note 10 above, pp. 824- 825.] Recall that the new supply-siders assume the income effect to be a second-order effect which exists because of and not in spite of the substitution effect (the first- order effect): hence, as a first-order effect, the aggregate income effect must be zero. See part 2.3 of Chapter II above. Also note that Laffer's critics suggest that there is a backward bending supply curve of labor. Hence, cutting the marginal tax rate (which applies to additions to income at high brackets) would lead to a movement along the backward bending part of the curve (where the income effect dominates the substituthmm effec (ed.) of ma a li expec save. that consx Richa vol. 'Sav Econ perma peop. chan( behax incor 80 effect). See L. Klein in supply-s1de Ecehemiee, R. Fink (ed.), p. 250. 24Decisions to work and save are not only a function of marginal tax rates. If people work and save as part of (a life-time plan, for example, then the price level, expected inflation, and wealth affect decisions to work and save. If after the tax out people feel wealthier (assuming that they have wealth targets), for example, they might consume more and save less. See Richard A. Salmon and Richard Lotspeich, "Supply-Side Economics," Egghem1e_£e13m, vol. XII, Summer 1981, pp. 89- 92. See also R. Kaish, "Savings and Supply- -Side Economics," in $u pply- 51d e Egghem1ee, p. 399, where he argues that since the permanent-income-hypothesis of M. Friedman applies, then if people expect the tax cut to be permanent, they would change their consumption with little change in saving behavior (since saving is affected by temporary changes in income according to Friedman's hypothesis). 25Since the magnitudes of factor supply elasticities are ambiguous, then the magnitudes of the increases in labor supply and personal saving are also ambiguous. In fact, there is the possibility that a tax cut might lead to more inflation depending on the behavior of labor supply and personal saving. [For an interesting diagrammath: exposition of the above, see Edward Shapiro, "Supply-Side Economics: A Diagrammatic Exposition,"Neh1eehe_fieh1he1_efi W. vol 2. Spring 1981. p- 39.] 26While there are many factors contributing to the inflationary period of the 19708, and since our concern in this dissertation is not to study those factors, it will suffice to say that critics of SSE suggest that even if labor supply and personal saving can be considered among those factors, their role in combatting inflation is a minor one. See L. Klein, The Ecehem1ce 9f $22212 ehd Demend. (Baltimore, Maryland: The Johns Hopkins University Press, 1983): 9?- 4-13. See also part 3.5 below. 27See Alfred S. Eichner, ”Reagan's Doubtful Game Plan," ghellehge, vol. 24, no. 2, May-June 1981, pp. 21-23. 28Sidney Weintraub writes that "by some far-fetched wishful thinking on how savings will be generated, the SSE group generally advocates personal income tax cuts. . . . In utter disregard of data on the 0.9 average propensity to consume out of disposable income, the SSE rationalization is that tax cuts will be saved. Further, there is the stress on personal savings despite their relative unim at t savi “Key 122;. 1981 coo: 'Gro Fink unde Keyn Shap give grou wit] savi prof of I work 81 unimportance in gross savings. Finally, and most shocking at this late date after Keynes, the SSE 'analysts' have savings preceding investment. [Sidney Weintraub, "Keynesian Demand Serendipity in Supply-Side Economics," 8 , vol. IV, no. 2, Winter 1981-82, p. 188.] For R. Fink, saving and investment face coordination and not incentives problems. Richard Fink, "Growth and Market Processes," in supply-side Eeenom1ce, R Fink (ed.), p. 394. 29Edward Shapiro argues that SSE advocates assume no underutilization of the existing capital stock, and no Keynesian problem of investment demand deficiency. See E. Shapiro in note 25 above, p. 41. For A.S. Eichner, "the so—called 'capital shortage, given as the rationale for cutting taxes of upper income groups, is an illusion created by equating personal savings with total savings, and thereby ignoring the funds, or savings, generated by business firms themselves out of profits and depreciation allowances. . . There is confusion over what the principal determinant of business investment is. As a large number of studies have shown (Robert Eisner's is the most systematic body of work), it is the level of industry sales which exerts the decisive influence on investment. . .. . Our own estimate, based on the econometric model being constructed at the Center for Economic and Anthropogenic Research, is that for every one percent the economy expands above (or below) the average growth rate, corporate plant and equipment expenditures will rise (or fall) 1.9 percent above (or below) the growth trend of investment. . . The relatively low growth rates during the 19708 have acted, via what is termed the accelerator effect, to depress business investment." [See Eichner in note 27 above, pp. 23-25.] 30Thomas Supel suggests that if SSE were true, then lower inflation would generally tend to accompany higher productivity. To test this claim, Supel examines time series regressions of the logarithms of the consumer price index on the money stock and productivity for the U.S., Canada, Denmark, France, Germany, Japan, Sweden, and the U.K. over the period 1950-1973 to conclude that "none of the eight countries shows a statistically significant negative elasticity of price change with respect to an increase in productivity." i.e., in none of these countries has an increase in productivity been associated with a decrease in inflation. [Thomas M. Supel, "Supply- -Side Tax Cuts: Will They Reduce Inflation?", in y1e wpe1n he, pp. 163-165.] wel the two fac tiv ecc Mal pri ac) inf the PP. inc per dec in per dem Rea tax per Wei Eva XII Gil the Pro) 0f thi.‘ YOr! 82 Sidney Weintraub argues that "since Marshall if not well before, it has been elementary that supply prices, or the supply side of the price equation, is dominated by the two aspects: (1) the productivity of utilized productive factors, and (2) the prices of the productive factors. . . . Yet supply-roaders invariably concentrated on produc- tivity aspects with nary a reference to money wages. . . . This has been a strange pathological episode by economists, sloppy in the simplest of fundamentals. Marshall never lived, microeconomics texts were never printed, thought was suspended, as jejune economists achieved the political pinnacle. . . . It is in its inflation analysis, or the lack of it, that SSE betrays its theoretical bankruptcy." [See Weintraub in note 28 above, pp. 184-189.] 31Many critics suggest that even if productivity increases by 100 percent (from 1 percent in 1980 to 2 percent in 1984), for example, then this will lead to a decrease in inflation by only 2 percent (assuming no change in nominal wages). Hence, if inflation in 1980 was 11 percent, then to make a dent in inflation, the need for demand management is inevitable. Some critics argue that Reaganomics had to use a policy of tight money along with tax cuts to reduce inflation from 11 percent in 1980 to 4 percent in 1982. See Chapter IV below. See also Sidney Weintraub in note 28 above; and Esther Gesick, "A Critical Evaluation of Supply-Side Economics," Beeheh1e_£913m, vol. 32It is interesting at this point to quote George Gilder writing: ”The critics used an idiom of rejection that is becoming familiar in all the social sciences, as they eschew original reasoning and adopt the role of programming and interpreting their computers. . . . Nonetheless, the computers provide an all-purpose mode of refutation for any theory the experts dislike or did not think of first." [George Gilder, Weelth ehg Eoyerhy. (New York: Basic Books, 1981), p. 180.] 33The two mostly referred to tax cuts are the Coolidge-Mellon tax cut of 1920 and the Kennedy-Johnson tax cut of 1964. Also note that some supply-siders refer to major catastrophes in history and attribute each of them to some tax hike. See, for instance, Jude Wanniski, The flex 0 d . (New York: Basic Books, 1978): pp. 98- 260, where he attributes major incidents from the fall of the Roman Empire to the Great Depression to some tax hike. 34Note that while the new supply-siders believe in the dual nature of investment (in the sense that it affects b0 th. re in in 8e 0e inc 50 'Ta 50, wit the the and Ken lea inc on fig tax big. the ham eco Con act Spe Rob Has 81. EXp eCon ram in ' a‘it] more inc] l’eVI the red: tha {Ecc Prec tax 83 both aggregate demand and aggregate supply), they insist that the first-order effect of a tax rate cut is to change relative prices leading to an increase in saving, investment, and, consequently, aggregate supply. The increase in aggregate demand, they maintain, is only a second—level effect to the increase in real income that occurs after the increase in aggregate supply leading to an increase in bdth consumption and investment. See notes 59, 50, and 61 in Chapter II above. See also Jude wanniski, "Taxes, Revenues, and the Laffer Curve," Euh11e Thhegeet, 50, Winter 1978, pp. 3-16. Roberts writes: "Keynesians credit the 1964 tax cut with raising GNP $25 billion by mid-1965 and $30 billion by the end of the year. Another Keynesian, Edward Denison of the Brookings Institute, estimated the gap between actual and potential GNP to be only $12 billion - the size of the Kennedy tax cut. Obviously, a $12 billion gap does not leave enough room for a $30 billion expansion based on increased demand and unused capacity. Denison is an expert on estimating these gaps. If this estimate is a ballpark figure, the substantial expansion that followed the Kennedy tax out had to be based on a supply-side response to the higher after-tax rates of return to productive activities. Since almost all economists in the United States in the 19608 and 19703 were Keynesians, the Kennedy tax cuts have been studied from the demand side point of view. The economic boom that resulted has been interpreted as a consumption-led expansion caused by higher spending. In actual fact, after the tax cut went into effect, people spent a smaller percentage of their income." [Paul C. Roberts, u - 'd ' . (Cambridge, Massachusetts: Harvard University Press, 1984), pp. 76- 81.] 358. Starr McMullen argues that a careful look at the experiences during the 19208 and 19605 suggest that the economy was on the normal range and not on the prohibitive range of the Laffer curve. McMullen argues that the fall in the national debt during the 1921-29 period was "fully attributable to the fact that government expenditures fell more rapidly than the fall in tax revenues, "and not to an increase in revenues. Similarly, McMullen argues that I'tax revenues grew more from 1961-62 and from 1962-63 than in the period from 1963-64 immediately following the tax reductions. "What this suggests," McMullen claims, " is that the economy was already well on its way to economic recovery as tax revenues were rising even at high tax rates preceding the cuts." Finally, McMullen shows that "the largest increases in tax revenues during the 19605 occurred in 1968 and 1969, the Fur1 wer‘ tha SU9< rang [~1th Egg! ale SSE the pro int Hel Tho Che: yea mea eco int: bac cap: des; [8t int: We 196 potc eff] and bro its Sig] COn tax not! imp.- 9C0 Dot 198: inv inc Per; 8 84 the years when tax surcharges were implemented. . . . Furthermore, tax revenues fell sharply when tax surcharges were reduced 1J121970." Consequently, McMullen concludes that "the historical data for both the 19208 and 19608 suggest that the U.S. economy actually fell in the normal range of the Laffer curve during both periods." [B. Starr McMullen, "The Laffer Curve: Fact or Convenient Fantasy," Ecohem1c Eegum, vol. XII, Winter 1981-82, pp. 113-15.] See also Roberts in note 34 above. 36When compared with the Kennedy tax cut, the proposed SSE tax cut focuses on personal tax cuts as compared with the investment tax credit. Furthermore, SSE tax cut proposals focus only on physical capital. For an interesting analysis of the Kennedy tax cut, see Walter Heller, "Kennedy's Supply-Side Economics," in Yiegpe1hhe, Thomas J. Hailstones (ed.), pp. 39-46 (reprinted from Chellehge, May-June 1981), where he argues that "the first year was essentially a year of supply- and cost-side measures. ‘We did not use the catch phrase, 'supply-side economics', tun: that's exactly what it was: first, introduction of the investment credit, through this day the backbone of tax incentives for growth through business capital formation. . . . Second, the liberalization of tax depreciation guidelines. Third, the 'monetary twist', designed to make funds available for long-term investment. . . . Fourth, the bolstering of worker training and retraining programs. Fifth, the development and introduction of the wage-price guideposts. .-. . The shift to demand-side economics came in 1962 . . . we launched the offensive for a big tax cut in March of 1962. . .. . When an economy is operating far below its potential, as in the early 19608, a tax cut's demand-side effect boosts purchasing power and puts both idle machines and factories and idle workers back to work, thus broadening the tax base - not enough fully to pay for itself, but enough to cut the revenue 1088 very significantly." Note that, in retrospect, the personal tax cut was considered a "demand-side" approach while the investment tax credit was considered a ”supply-side" approach. Also note the different circumstances in which the tax cuts were implemented: Specifically, a period (the 19608) when the economy was operating (according to Heller) far below potential, along with little inflation (as compared with 1980). 37See ibid., where Heller argues that the increase in investment was due to the investment tax credit and the increase in consumption and not due to the increase in personal saving. For a similar analysis, see Bruce Kimzey, Beegehem1ee, 1983, pp. 31-34; and R. Kaish, "Savings and 85 Supply-Side Economics,“ in supply-s1de Bconem1ee, R. Fink (edo) I pp. 397-399. 38See Charles Garrison, "The 1964 Tax Cut: Supply- Side Economics or Demand Stimulus?"-, Jeugne]. e: Econom1c Iseuee, vol. XVII, no. 3, September 1983, pp. 681-695, where he interestingly compares the 1963-65 expansion with the 1976-78 expansion to conclude that while the former was initiated by a marginal tax rate cut and the latter was not, the composition of the two expansions does not differ. Garrison argues that the 1976-78 expansion was initiated by a decrease in the average tax rate which was accomplished by a tax rebate, a tax credit, and an increase in the standard deduction. Garrison adds that the 1963-65 expansion is considered by the "new" supply-siders to be a purely "supply-led" expansion. However, Garrison shows that the proportion of the increase in earned income accounted for by the top income class was even greater in the 1976-78 expansion than in the 1963-65 one. Moreover, the increase in investment in both periods was demand-led due to the increase in consumption. Finally, Garrison argues, the increase in personal saving was not due to incentives but due to the increase in income associated with the expansion in both periods. Hence, Garrison concludes that both expansions had the same composition associated with a demand-led expansion and that the "new" supply-siders exaggerate the primary role of high income groups in relation to the 1963-64 episode. Recall that the "new" supply-siders consider a tax rate cut to be superior to a tax rebate (or an average rate cut) because a marginal tax rate cut supposedly increases supply incentives while a tax rebate does not. See part 2.3 in Chapter II above. 39In fact, it is difficult to pinpoint the exact cause of the expansion after the 1964 tax cut since some studies show that the money supply increased both before and after the tax cutu Hence, those studies suggest that, in the 19808, there is a problem that did not occur in the 19608, specifically, the lack of liquidity to spur capital spending. See Alan C. Lerner, ”A Wall Street Perspective," in Shpply-s1de Beehem1e§ 1n the legge, Conference Proceedings, Federal Reserve Bank of Atlanta: Quorum Books, 1982, p. 93. See also James Barth, "The Reagan Program for Economic Recovery: Economic Rationale (A Primer on Supply-Side Economics),“ in y1egpe1nes, Thomas J. Hailstones (ed.), pp. 201-203. 40If the impact of the personal tax cut is to increase aggregate demand, as the critics of SSE believe, then inflation would increase. Recall that the "supply-side" 86 measure to increase growth in the 19608 was assumed to be the investment tax credit and not the personal tax rate out. See Heller in note 36 above. 41See William D. Nordhaus, “Policy Responses to the Productivity Slowdown," in The Dec 11n e 1h EKQQQQLiYiEY Qgegeh, Federal Reserve Bank of Boston, Conference Series No. 22, June 1980, where the author constructs an "average opinion“ (based (”1 a large number of studies) about the causes of stagflation in the 19708 to conclude that SSE can only explain 14 percent of the problem. 42For more details, see Hyman P. Minsky, "Pitfalls Due to Financial Fragility,” in n , Sidney Weintraub and Marvin Goodstein (eds.), (Philadelphia: University of Pennsylvania Press, 1983), pp. 114-118. 43In the sense that Keynes advocated a surplus during a boom and a deficit during a recession (or depression). See Irwin L. Kellner, 'Will it WOrk?", in y1eype1hhe, pp. 12- -l9, where he argues that deficits were the result of the Vietnam war and not Keynesian economics. For a similar argument. see Lawrence R. Klein. Wanna: ehd pemehd. (Baltimore, Maryland: The Johns Hopkins University Press, 1983), pp. 92-95. 44James Tobin writes: "All economics balances supplies and demands, ad nauseam of generations of students. Keynesian economics is no exception. Choosing up sides would be a laughable and harmless media diversion were it not taken so seriously." [James Tobin, 'Supply- Side Economics: What is it? Will it Work?", in y1eupe1h1e, p. 133. ] See also Klein in note 43 above, pp. 96- 108. 45Lawrence Klein argues that Keynes had an implicit concept of aggregate supply in inventory investment. "A part of I [investment]," Klein writes, ' is inventory investment. This component is not wholly demanded. At least some part of inventory investment represents an imbalance between supply and demand. Inventory investment then becomes a buffer between the two. Careful economic analysis would, therefore, recognize fully that many supply aspects enter the Keynesian system." [See Klein in note 43 above, p. 2.] 46Craig Elwell writes: ”For near-term issues dealing with the business cycle and the associated pucblems of inflation and unemployment, evidence made it tolerably clear that demand-side phenomena were the dominant 87 determining factors. For longer term issues such as labor supply, capital accumulation, and productivity growth, although the supply-side was clearly important, its behavior could still be represented accurateLy in a comparatively simple way." [Craig Elwell, "Supply-Side Economics: A General Perspective," in W solut1on, pp. 259-261.] 47See Charles thten and Isabel Sawhill (eds.), The 0 'cs. (Washington, D.C.: The Urban Institute Press, 1984): Pp. 2 and 3. 48Stephen Rousseas argues that "if 'change' has been for the worse, as supply-siders are convinced, then we can progress only by going backgrounds - by repealing the last half-century." [Stephen Rousseas, "The Poverty of Wealth," n c ' , vol. IV, no. 2, Winter 1981-82, p. 193.] "My own expositions of Keynes' thinking," writes S. Weintraub, ”have always inserted Aggregate supply in juxtaposition with Aggregate demand (1955, 1969). Lawrence Klein noted this in his presidential address to the AER (1979); his thoughtful paper, incidentally, probably originated the 'supply-side' vogue, maybe giving an unintended boost tn) the 'school' which took it to a frivolous joy ride.” [See Weintraub in note 28 above, p. 1860] 49Thomas Hazlett argues that the "new" supply-siders' confusion comes because they substitute for the equality of aggregate demand and aggregate supply, the notion that each specific supply equals its own demand at some specified ‘value. ine., that supply creates its own demand even on the micro level. Ur. Hazlett, "The Supply- Side' 8 Weak Side: An Austrian's Critique," in Shpply- 51d e Eeehem1cs, R. Fink (ado), P0 1000] 506. Gilder argues that "demand, like public opinion, does not exist in any very definite and identifiable way; it is a flux of hungers and sentiments which assume particular forms chiefly in response to the flow of supplies. . . . Preoccupation with demand fosters stagnation." [Gilder, "The Supply- Side," in en ppTy- 51d e Eeenemies. R. Fink (ed. ). p. 15 1 In another place, Gilder claims that "demand oriented businesses rarely create new goods, for there is no measurable demand for what is not already familiar. . . Without a flow of new products, the marketplace can be filled with stale items, produced with ever greater efficiency, continually redesigning in trivial ways, repackaged in brighter colors. . . . Jaws III will be 88 followed by IV and V: Cheerios become Sugar Cheerios." [Gilder, Weelhh end page: 2, p. 39.] Note that Gilder is not talking about the quantity demanded at equilibrium, but about the "demand' for unknown products. But once the good "exists", the price and quantity combination at equilibrium is determined by both supply and demand. In fact, whatever the innovation is, the quantity at equilibrium is a function of consumers' response. If demand is too low (or too high) then the quantity produced at equilibrium will be too low (or too high). Hence, Jaws III was produced because there was a high demand for Jaws II, and Jaws II was produced because there was a high demand for Jaws I, etc. . . . To a certain extent, Gilder misses the point that, in a capitalist society, it is the continuous efforts to satisfy the problematic wants of consumers that leads to innovation, i.e., producers are in a continuous process of “testing the market” for their new products. 51While one can identify and separate consumers of apples, for example, from producers of apples on the micro level, such a distinction is difficult to do on the macro level. The people determining the aggregate supply are the same people determining the aggregate demand. Hence, while the study of supply on the micro level can be done in separation from the study of demand (such as studying the maximizing behavior of apple producers and consumers), the study of aggregate supply of the whole economy (for all goods) cannot be done in separation from the study of aggregate demand. C. Elwell argues that "it is important to observe that neither of the pelicy actions [tax cuts] cited above is necessarily exclusively demand-side or supply-side in location of effects. . .. . Therefore, it is important to recognize that although their relative magnitudes and timing of occurrence may differ, both demand-side and supply-side effects are likely to be present in a given policy action.“ [See Elwell in note 46 above, p. 259.] Similarly, Hazlett doubts the possibility of separating demand from supply even on the micro level. Hazlett argues that supply is determined by Opportunity cost for inputs which is a function of consumer demands for final goods. See Hazlett in note 49 above, p. 99. 52See T. Hazlett in note 49 above, pp. 97-100. 53Hazlett argues that supply-curves are only demand curves read backwards. Ibid., p. 97. 89 54For Mirowski, l'when Laffer or Wanniski insist upon the tenability of Say's Law, they are claiming that the modern economy can never experience an internal coordination failure, thus ignoring the most profound economic insight of the twentieth century. . . . A clarion call to resurrect Say's Law in the face of these objections is a call to 'forget everything we ever knew.‘ It is nothing less than intellectual Luddism.‘ [See Mirowski in note 10 above, p. 826.] See also Wallace Peterson, Inceme, Empleyhene, end Econom1c 9:9! h, fifth edition. (New York: W.W. Norton and Co., 1984), p. 419. 55Mirowski argues that "supply-side theorists in a single chorus maintain that they are trying to revive Say's Law as a serious foundation of their analysis. They reject Keynes' liquidity preference and seem to believe in the total neutrality of money." [See Mirowski in note 10 above, p. 826.] 56W. Peterson asks: "Why do supply-side economists insist on the validity of Say's Law, particularly when no empirical evidence is produced to support this validity? . . . It is in part an article of faith, a belief in the beneficient workings of the market system.” [See Peterson in note 54 above, p. 419.] 57See ibid., p. 422-424; and P. Mirowski in note 54 above. 58"Sismondi, Malthus, Marx, and Keynes," writes Thomas Sowell, "each had his own alternative, which did not require him to deny that the market path of adjustment existed in theory or in practice, but only to assert that it was intolerable." [For more details on Keynes' reaction to Say's Law, see Thomas Sowell, Sey'e Lee. (Princeton, New Jersey: Princeton University Press, 1972), pp. 36-38.] 59Anna Weniger and Hank Robison write: "Possibly the most incredible perspective advanced in Gilder's book regards his view of the motive behind capitalist behavior. 'Capitalism begins with giving.’ This contradicts virtually all previous economic theorists. The power behind Adam Smith's invisible hand is self-interest." [Anna Weniger and Hank Robison, "Supply-Side Economics: A Religious Parable,” Ecehemig Eoguh, Summer 1981, p. 77.] For Gilder, "the essence of giving is not the absence of all expectation of return, but the lack of a predetermined return. Like gifts, capitalist investments are made without a predetermined return." [Gilder, Weeleh W. pp. 25-27.] 90 60See Hazlett in note 49 above, p. 111, where he argues that Gilder falls into what F.A. Hayek defines as the animistic fallacye ‘the attribution of a particular outcome to the intentional behavior of certain individuals rather than to the conclusion of the process. Recall that Gilder argues that "capitalist creativity is guided not by any invisible hand, but by the quite visible and aggressive hand of management and entrepreneurship." [G. Gilder, W. p. 37.1 61Weniger and Robison write: ”The view of history presented by Gilder is, in the natural law tradition, no history at all. Capitalism is seen to be as old as society itself. . .. . At some point in the past, however, capitalism operated in an essentially pure and unimprovable fomnu Modern liberalism has effected a contamination of this pure form. Well-intentioned government programs have fostered a 'slovenly and improvident way of life'. . . . The implied solution to the contemporary problems of moral and economic decay is to reverse history by removing the contamination, and thus returning to this paradise lost.” [See A. Weniger and H. Robison in note 59 above, p. 77.] 62Lester Thurow argues that "as a society we could choose to abolish our social welfare systems. . . . This is an ethical decision and not one ferced upon us by harsh economic imperatives. The supply-side arguments about savings merely demonstrate the principle that value judgements often run under the cover of economic analysis. Economic arguments are advanced - taxes or social welfare programs must be cut to raise savings - to achieve an objective that the advocates want to achieve - less welfare spending." [Thurow, Dengereus ghggente, p. 139.] According to R. Lekachman, "advanced economies are dominated by large institutions that prefer merger and collusion to competition. . . . Enterprises and industries in trouble routinely shuttle to Washington in pursuit of loan guarantees, quotas, trigger-price mechanisms, and similar shelters from the icy blast of competition. . . . At home, it is the trucking industry and the Teamsters Union, not unrepentant Keynesians, who oppose deregulation. It is the airlines who regret their earlier endorsement of deregulation." [Robert Lekachman, G£§§Q_i§_h&£_£fl239hl Beegehem1_§. (New York: Pantheon Books, 1982), p. 55.] Jameson and Philips argue that ”falling productivity cannot be blamed on government, unions, and the like: rather, it rests squarely with the U.S. corporation and the type of manager who makes his or her way into the upper echelons." [Kenneth Jameson and Joseph Philips, "Supply- Side Economics: A Skeptical View," Ecehemic Fogum, Summer 1981, p. 85.] 91 63W. Peterson and P. Estenson argue that "George Gilder, a leading supply-side devotee, writes that 'the essential thesis of Say's Law remains true: supply creates its own demand. There can be no such thing as a general glut of goods.‘ Indeed, if we have unemployed people, and unused factory capacity, capitalism couldn't be blamed, nor Say's Law abandoned. Instead, the blame lies with government. Government taxes and regulations stand between conditions of unemployment and stagnation, or full employment prosperity. . .. . According to the supply-side doctrine, the government can increase output three ways: by cutting social welfare programs, by deregulating the economy, and by redistributing the tax burden away from the wealthy and business.“ [Wallace Peterson and Paul Estenson, "The Recovery: Supply- -Side or Keynesian?", n ' , vol. 17, no. 4, Summer 1985, PP. 448 and 449.] Weniger and Robison write: "But the most tortured supply-side logic concerns the tax cuts that so blatantly reward the rich. By reducing the tax burden on the wealthy, it is argued, large amounts of savings and investment will ensue. . . . Growth, rapid and uncon- strained, is the vehicle by which everyone, rich and poor, benefit from supply-side economics. These prescriptions, advanced in the name of prosperity for all, mask the redistributional essence of the supply-side campaign." [See Weniger and Robison in note 59 above, p. 78.] 64Thurow writes: "Little correlation exists between the degree of government intervention and economic success - the Japanese economy being the most subject to government intervention, regulation, and manipulation." [Thurow, Dehge19g§_9311en;§, p. XV.] “We spend a smaller percentage of GNP on social programs than most [OECD] countries," writes Philip Klein. [Philip A. Klein, "Reagan's Economic Policies: An Institutionalist Assessment,'Jeu;ne1 of fi_ehem1e_1e§hee, vol. XVII, no. 2, June 1983, p. 467. ] 65For J. Petr, "one can persuasively argue that the expansion of government regulatory activity throughout the past thirty years is an adaptive evolutionary response to a plethora of 'externalities' spawned by increasingly complex production and distribution processes in the midst of a more populous community." [Jerry L. Petr, "Creationism versus Evolutionism in Economics,“ ou o c no 'c Teehee, vol. XVII, no. 2, p. 477.] 66Petr argues that "the growing share of government in our overall economic activity corresponds to our affluence- driven transformation from a goods economy to a services economy. We evolve in our consumption preferences; and 92 governments, as service providers, are 'beneficiaries' of expanded demands." [Ibid.] [After leaving the Reagan Administration, D. Stockman argued that ”the triumphant welfare state principle means a fundamental trade-off between capitalist prosperity and economic security. As a nation we have chosen to have less of the former in order to have more of the latter. . . . The abortive Reagan Revolution proved that the electorate wants a moderate social democracy to shield it from capitalism's rougher edges.” [David Stockman, "The Triumph of Politics," Negegeeh, April 28, 1986, p. 64.] 67William Grieder quotes Stockman saying: "The hard part of the supply-side tax cut is dropping the top rate from 70 to 50 percent - the rest of it is a secondary matter. The original argument was that the top bracket was too high, and that's having the most devastating effect on the economy. Then, the general argument was that, in order to make this palatable as a political matter, you had to ‘bring down all the brackets. But, I mean, Kemp-Roth was always a Trojan horse to bring down the top rate." [William Grieder, “The Education of David Stockman," in V1egpeihhe, p. 297. Reprinted from The At1ant1c monthly, Dec., 1981.] 68D. Levine argues that "the great attraction of both monetarist and supply-side economics (especially the latter) is that there is such a thing as a free lunch- i.e., that the Phillips curve trade-off need not be endured." [David A. Levine, "Monetarists versus Supply Siders," Pel1ex_3e11e1, Fall 1982, p. 4.] See also N. Ture in note 78 below. 69For Kimzey, "one could therefore argue that it was possible to cut taxes, raise spending, and still not increase the budget deficit. The Laffer curve was clearly a popular political concept.“ [Kimzey, Reegenom‘ce, p. 18.] 7oSamuelson writes: "Keynesian liberals like me testified before congressional committees that there was no cogent evidence in economic history, nor plausible presumption in sensible analytics, for the contentions of the radical-right supply-siders.” [Paul Samuelson, "Evaluating Reaganomics," ghellehge, Nov.-Dec. 1984, p. 6.] See also part 2.6 in Chapter II above. 71$ee ibid., p. 6, where Samuelson argues that "supply-side economics is not a new story; such Keynesian stalwarts as Robert Solow (estimator of econometric production functions) and Arthur Okun (of Okun's Law fame) 93 long worked this furrow. And a long list of scholars- including Simon Kuznets, Colin Clark, John Kendrick, Moses Abramovitz, Edward Denison, and Angus Maddison - have investigated what contribution capital formation (human and tangible) and technical innovation and development can make to a society's productivity. This standard supply-side economics deals with long and slow processes that shape a society's progress. Kemp-Laffer-Stockman supply-side economics is a different thing. Its authors prepared for the new President an initial document, declaring that he had inherited a crisis situation (a 'Dunkirk') due to governmental overregulation and disastrous overtaxation." 72The critics argue that tax cuts can lead to an increase in aggregate demand leading to more inflation. For example, Lyle Gramley maintains that "reductions in taxes on wages and salaries stimulate demand as well as supply . . .. the available evidence indicates that the increase in aggregate demand would be substantially larger than the increase in aggregate supply, possibly 5 or 10 times as large, or maybe more." [Lyle Gramley, 'Supply- Side Economics: Its Role in Curbing Inflation," in W: P- 147-1 73'Listen to the new prophets and all our problems will be solved. Forget the complexities of modern economics and institutions. Ignore OPEC, pay no attention to agricultural cycles and do not believe for a moment that oligopolistic labor markets or social mores will prevent us from reaching the promised land. JUSt follow the Golden Rule . . . ruduce the wedge [between the before- and after- tax incomes], and everything will be hunky-douy." [See Levine in note 68 above, p. 4.] 74For R. Keller, "our current macroeconomic problems reflect a breakdown of institutions . . . supply-side policies are ill-conceived. The policies fail to address fundamental questions, raised by comparative economic history and institutional analysis, about the trans- formation and evolution of the economic process. This neglect of an evolutionary and historical perspective increases the chance of severe dislocations and policy failure." [Robert Keller, ”Supply-Side Economics Policies During the Coolidge-Mellon Era. W. vol. XVI, no. 3, Sept. 1982, p. 786.] For a similar analysis, see Klein in note 64 above, p. 463. 75M. Lower distinguishes between pecuniary and industrial activities (a'la Veblen) to conclude that "the misallocation of aggregate investment cannot be corrected by 'throwing money at the problem.'" [Milton Lower, "The 94 Reindustrialization of America," Qeugnal of Ecenoh1c Ieeeee, vol. XVI, no. 2, June 1982, p. 633.] For a similar argument, see Keller in note 74 above. Similarly, W.M. Dugger argues that productivity and growth are a function of social and technological phenomena (a'la Veblen) and working rules and laws (a'la Commons), and not to pecuniary incentives. It is the changing institutional structure and the increasing ”opening up of participation to more and more, formerly excluded, potentially skillful human beings" that leads to growth, Dugger concludes. [William M. Dugger, "An Institutionalist Critique of President Reagan's Economic Program,“ Q1fi111, Sept. 1982, PP. 791-810.] For S. Rousseas, "there is no guarantee that investment, as a result of a greater after-tax business income, would increase. Bountiful corporate cash flows could well lead to corporate mergers instead of new investment.“ [Stephen Rousseas, The 2011t1ce1 Ecenomy e; W. p. 42.] 76"The prominent names here," writes Samuelson, "include Arthur Laffer, Congressman Jack Kemp, the old David Stockman, Paul Craig Roberts, Norman Ture, and still others. These supply-siders did not have very distin- guished academic credentials." [Paul Samuelson in note 70 above, p. 6.] Similarly, Thurow claims ”that the President's 'favorite' supply-side economist, George Gilder, had, after all, no formal training in economics." [Thurow, Qengezeus CBLLQDLfi: Po 124-] 77For Martin Feldstein, "it is important in any discussion of supply-side economics to distinguish between the traditional supply-side emphasis that characterized most economic policy analysis during the past 200 years from the new supply-side rhetoric [SSE] that came to the fore as the decade began." [Martin Feldstein, "Supply-Side Economics: Old Truths and New Claims," e ' n c 'c Bey1eg, Papers and Proceedings, vol. 76, no. 2, May 1986, p. 26.] See also note 70 above. 78The internal contradictions refer to the differences in opinion among the three groups of "supply-siders“ (see Chapter II above) in relation to monetary policy and the crowding out effect of deficits (to be discussed in Chapter IV below). See James Tobin, "Supply-Side Economics,” in Y1eupe1hte, p. 138, where he argues that "confidence that this scenario [cutting taxes along with tight money] will bring disinflation together with prosperity rather than recessirni and stagflation is borrowed from the other two counter-revolutions, monetarist and new classical." The 95 term "new classical" by Tobin refers to the rational expectations hypothesis since SSE advocates argue that as soon as taxes and money growth rates decrease, inflationary expectations would immediately decrease. For a depiction of such an argument, see P.C. Roberts, "Analyzing Supply- Side Economics," in y1egpe1h_§, p. 73. Similarly, Weintraub argues that "deference is paid to monetary policy or the calloused hope that the Fed will make the Marxian army of unemployed so abundant as to dampen money wage progression. Of course, the magnificent contradictirni in the simultaneous belief in monetary policy, Philips curve accompaniments, and a pmofession of an investment boom and Laffer curve GNP expansion is evaded and passed over by SSE advocates." [See Weintraub in note 28 above, p. 190.] Note that the new supply-siders seem to believe that no contradiction exists since it seems they implicitLy assume a vertical Phillips-curve both in the short and long runs. In fact, "one of the principal analytical outputs of the supply-side economics,“ N. Ture writes, ”is the rejection of the so-called 'Phillips-curve' relationship between inflation and unemployment. By the same token, it rejects the view that price-level stability can be purchased only at the cost of unacceptably high levels of unemployment or that acceptable growth in employment depends on pursuit of fiscal and monetary policies likely to spur inflation. There is no analytical basis for seeking a recession as a means of wringing inflation out of the system." [Norman Ture, "Implementation of Supply- -Side Policies,“ in Shpply- 51d e no ehem1c e in the 12§Q§p p. 230. ] CHAPTER IV CRITICS OP REAGANOHICS The experience since 1981 has not been kind to the claims of the new supply-side extremists that an across-the-board reduction in tax rates would spur unprecedented growth, reduce inflation painlessly, increase tax revenue, and stimulate a spectacular rise in personal saving. Each of those predictions has proven to be wrong. . . . The miraculous effects anticipated by some of the new supply-side enthusiasts were, alas, without substance. * - Martin Feldstein The true magnitude of the deficit should not have remained hidden so long. We hadn't been the victims of a sudden and unexpected economic earthquake. Instead, we had deceived ourselves nearly from the beginning and had subsequently covered up the forecast debate when it urgently needed airing. . . .. It had not been his [President Reagan's] fault. He had been misled by a crew of overzealous--and ultimately incompetent--advisers. The original budget plan I devised for him had been fatally flawed.** - David Stockman 5,1 laggedhghieh: There is plenty of evidence in the literature that Reaganomics (the name popularly given to President Reagan's economic program) was an attempt to apply SSE.1 In fact, time and time again, the two terms "Reaganomics" and "supply-side-economics' (SSE) are used interchangeably 96 97 (whether by proponents or opponents of Reaganomics) to refer to the same thing.2 Moreover, and since Reaganomics involved four major components, specifically, (l) reduc- tions in personal and business tax rates, (2) spending cuts to reduce government spending as a share of gross national product, (3) reductions in the burden of federal regu- lations, and (4) a commitment to stabilize money growth rates; both proponents and opponents suggest that it was a compromise to "please” the three groups of supply-siders (namely, the Lafferites, the monetarist supply-siders, and the balanced-budget supply-siders) leading to internal contradictions.3 Critics of Reaganomics argue that such a compromise application of SSE was a gamble with the U.S. economy and, thus, were skeptical of the assumed results of SSE (an untested theory in their opinion).4 In fact, their skepticism was mainly a reaction to the so-called “painless cure” to the problems of inflation and unemployment. That "painless" cure, critics of Reaganomics claim, promised a simultaneous decrease in inflation and unemployment along with a simultaneous increase in productivity, growth, and tax revenues.5 This was questionable, the critics insist, because the tax cut would either lead to an increase in inflation (by increasing aggregate demand), an increase in deficits (at least in the short run due to an assumed weak supply-side response), or both. Moreover, they add, 98 adhering to a policy of tight money growth can lead to less inflation but only at the cost of a recession (also in the short run), delaying the supply-side incentives (by increasing interest rates to crowd out private investment), or both.6 Given such criticisms, SSE advocates respond by insisting that the real test of their theory was to try it and see how well their program works.7 After the 1981-82 recession and the ensuing so-called recovery, however, some advocates of SSE lauded its accomplishments whereas other advocates admitted failure. This led critics of SSE to argue that it is not a coherent doctrine and that its enthusiasts are of many minds, conflicting at times as to both the fact and causes of success or failure.8 This chapter will study the ex-post explanations of both proponents and opponents of SSE as to why the recession and the ensuing recovery occurred. The chapter also will study both views in relation to the future impact of Reaganomics on the economy, and on SSE. - s ' n 'z ' o t e ccu rence t - s' d 's'n During the period 1981-82, the U.S. economy plunged into a deep recession. While inflation rates decreased, unemployment rates increased. In addition, real GNP growth, capacity utilization, business fixed investment, 99 and industrial production rates all decreased along with a simultaneous increase in federal budget deficits.9 Given the optimistic projections that were predicted by the Reagan administration, critics of Reaganomics were ready to argue: "we told you so," and to offer their explanations as to what happened.10 While some critics focused on fiscal policy through the tax rate cut as the main cause of the recession (via the crowding-out effect of increasing deficits), other critics focused on the policy of tight money as the main cause of the recession (by increasing interest rates). A third group of critics, however, argued that the combination of both loose fiscal policy (tax cuts) and tight monetary policy were contradictory and inconsistent and that such a contradiction was a reflection of the attempt of Reaganomics to compromise (or satisfy) the recommendations of the three groups of supply-siders (which are contradictory in their Opinion).11 Moreover, there were supply-siders (both inside and outside the administration) critical of the Reagan program, and who were also willing to offer their ex-post rationalizations and future recommendations. The Lafferites argued that the recession occurred due to two reasons: The first reason suggested that the Federal Reserve, by pursuing tight money, plunged the economy into .a recession, thereby delaying (or weakening) the supply- side incentives of tax rate cuts. Hence, some Lafferites 100 were recommending either an increase in the money supply or a return to the gold standard (since they believe it is the only policy best-suited to SSE). The second reason that was given by the Lafferites in relation to the recession argued that the tax cuts were "too little too late". In fact, some Lafferites blamed the balanced-budget supply- siders in the administration (specifically David Stockman) for delaying the future tax cuts (since the tax cuts were phased in over a period of three years). Moreover, the Lafferites argued that by attempting to balance the budget (by trying to delay future tax cuts and decreasing government civilian spending), the administration delayed the incentive effects and, thus, were calling for more (or faster application of) future tax cuts.12 The monetarist supply-siders (also both inside and outside the administration) critical of Reaganomics, in turn, argued that it was the huge deficits and not tight money that led to the recession (because they believed that a consistent policy of tight money would immediately lower both inflation and inflationary expectations a'la the rational expectations hypothesis). The deficits, they insisted, had an overwhelming crowding out effect by increasing interest rates.13 Finally, the balanced-budget supply-siders had their own explanation by claiming that, by adhering to its commitment of tight money and lower tax rates while at the 101 same time ignoring its commitment to balance the budget, the administration caused the recession by cutting taxes "too much too soon", and, thus, called for delaying the application of legislated future (after 1982) tax cuts, less government spending, or both.14 51 F1sce1 2911cy: Opponents of SSE critical of the Reagan program argue that by cutting tax rates and social spending, the administration assumed that supply-side incentives would be unleashed leading to higher labor supply and personal saving. These, in turn, would lead to higher output, productivity, and tax revenues. This did not occur, the critics claim, because of the following: First, the magnitude of the tax cut was ”too large? leading to an immediate increase in the deficit. The deficits, they add, were the main cause of the 1981-82 recession because of the crowding-out effect. This is the case, they argue, because, given a certain money supply, an increase in the deficit would increase the demand for credit leading to an increase in real interest rates which crowd out private investment and lower growth potential.15 Second, such critics maintain, Reaganomics assumed people were rational a'la the rational expectations hypothesis such that even if the deficits increased in the short run, the administration assumed people would expect 102 future interest rates to rise and, thus, would increase their savings. The expected increase in savings, such critics claim, was assumed by Reaganomics to be large enough (due to increased incentives following the tax cut) to cover the rising deficits. This scenario did not work, the critics argue, because the fast increase in the deficits created negative incentives in the economy (because people expected future higher taxes) thereby outweighing the positive incentives of the original tax cuts. Moreover, the critics maintain, the severity of the recession (which occurred due to crowding out in their opinion) led to a significant decrease in people's real incomes leading to a decrease in actual savings (i.e., the income effect of the recession outweighed the substitution or incentive effect of tax cuts.)16 Hence, critics of Reaganomics conclude, the 1981-82 recession proved (in their opinion) that the elasticity of personal savings with respect tn: tax rates was smaller than assumed by Reaganomics because the income effect outweighs the substitution effect (especially in a recession), and] because the inflationary expectations of higher deficits outweighed the incentive effects of lower tax rates both on savings and real growth.17 Third, the critics argue, the 1981-82 recession created negative incentives in the labor market outweighing the positive incentives of lower tax rates. Supply-side 103 incentives, the critics insist, simply do not work in a recession when unemployed resources exist. If employers are not hiring more workers, the critics argue, employment will not increase no matter what the size of the tax cut is. Similarly, the critics add, capital formation will not increase if capacity utilization rates are declining and plant shut-downs are increasing.18 Finally, the critics conclude, the administration overestimated the revenue response and underestimated the disincentives of rising deficits after the tax cut. Deficits, the critics insist, are nothing but "hidden" taxes, and hidden taxes have the same disincentive effects just as "visible" taxes. By cutting visible taxes and increasing deficits, the critics maintain, Reaganomics assumed that hidden taxes of rising deficits do not have the same disincentive effects as visible taxes. The 1981- 82 recession, the critics conclude, proved the contrary (i.e., that hidden taxes have the same disincentive effects as visible taxes.)19 In fact, David Stockman (a balanced-budget supply- sider and the Director of the Office of Management and Budget until 1984) admitted that deficits were having a devastating impact on the economy. With the increasing severity and duration of the recession, Stockman became more skeptical of the power and magnitude of the hitherto assumed supply-side incentives and was calling for more 104 spending cuts and/or higher (or delaying the implementation of cuts in) future taxes.20 In addition, Stockman admitted that the deficits were not totally unexpected (at least to himself) and that the administration's optimistic forecasts of declining deficits and rising revenues were a reflection of the Lafferites' views. ‘These views, he argued, were based on simple and primitive faith in the power of the Laffer curve. Stockman insisted that the Laffer effect can work, but only in a zero inflation economy and under the gold standard. Stockman concluded that by leaning more towards the Lafferites, the administration did not allow him to cut spending leading to huge deficits and the recession. This was the case, Stockman argued, because the administration accepted the Lafferites' views that the Laffer curve will miraculously take care of the rising deficits in due time.21 In a similar argument, some monetarist supply-siders (both inside and outside the administration) warned against the crowding out and/or the inflationary effects of rising deficits and were calling for lower spending and/or delaying future tax cuts.22 The Lafferites, however, had their own explanation of what happened: By delaying the tax cuts (phasing them in over three years instead of completely implementing them in 1981) and by decreasing the growth rate of the money supply, they argued, the 105 administration both delayed and weakened the supply-side incentives. This was done, the Lafferites claim, because the administration wanted to deliver on its promises to the monetarist and balanced-budget supply-siders. It was monetary policy and the delayed tax cuts, and not the deficits, they argue, that caused the recession. Deficits accompanied by lower tax rates, they add, neither crowd out investment nor are they inflationary (because high interest rates and price levels are largely a reflection of high marginal tax rates in their opinion). By focusing on the deficits, they insist, the balanced-budget supply-siders deflected attention away from the failure of monetary policy (which they blame for causing the recession).23 Moreover, the deficits increased, they add, not because of the tax cuts, but because of delaying the tax cuts (phasing them in over 3 years) and, thus, foregoing the increase in revenues that would have occurred had the tax cuts been immediately implemented (in 1981) and had the supply-side incentives been completely unleashed (i.e., the implemented tax cuts were “too little late”). In addition, they argue, deficits have a momentum of their own and their increase was, not a result of the modest tax cuts (in their opinion), but a result of previous bad policies and not a result of current policies. Even if there were no tax cuts, they maintain, deficits would have increased (since deficits are a reflection of increased government 106 spending). The difference now, they insist, is that such deficits are accompanied by lower tax rates (something preferable in their opinion because of lower disincentive effects).24 e1 uenetegy 2911cy and the Gold Stenda; : By slashing money growth rates to control inflation, critics of Reaganomics argue, the administration caused high credit, slack labor and industrial markets, and the 1981-82 recession.25 Optimism (inside the administration) that inflation will decrease with no (or little) increase in unemployment, the critics claim, was based on the assumption of rational expectations (which was borrowed from the rational expectations hypothesis in their opinion) such that pursuing a consistent policy of tight money would immediately decrease inflationary expectations and interest rates. Due to the speed at which money growth rates were cut, the critics claim, inflation decreased but interest rates increased. This occurred, the critics argue, because even if inflationary expectations decreased, the amount and speed of the decrease in money supply growth rates led to a severe recession, a decrease in total savings, and an increase in interest rates. Hence, they conclude, inflation decreased but only at the cost of a recession, thereby proving (in their opinion) the existence of the Phillips-curve trade-off (at least in the short run). The 107 decrease in the money supply, some critics insist, was very effective, very "painful", and very Keynesian (in the sense that inflation decreased due to a decrease in aggregate demand via the decrease in money supply and not due to an increase in aggregate supply).26 At the same time, and in relation to monetary policy, while some Lafferites were blaming tight money for the recession and were calling for either an increase in the money supply (to unleash the incentives that were stalled by tight money) and/or a return to the gold standard (because the Federal Reserve causes severe gyrations in the money supply in their opinion whereas the gold standard does not), monetarist supply-siders were defending the administration's monetary policy (in the sense that a recession in the short run was a necessary evil to wring inflation out of the system) and/or were blaming the tax cuts and the ensuing deficits of the Lafferites for 'the occurrence of the recession (in the sense that the tax cuts' incentive effects did not deliver) and should have been implemented only after inflation was under control.2‘7 The differences in opinion between the Lafferites (the "new" supply-siders) and the monetarist ("old") suppLy— siders in relation to the effectiveness of monetary policy is very much related to the issue of the call for the return to the gold standard. The Lafferites favor such a return because, in their opinion, the Federal Reserve has 108 complete monopoly over the money supply leading to either an undersupply of money and higher interest rates (the price of money) as happened in 1981-82, or to severe gyrations in the money supply, interest rates, and the price level due to the inability of the Federal Reserve (although a monopolist) to always control the money supply because the definition of the money supply is constantly changing when financial innovations (such as NOW accounts) occur. The gold standard, they insist, is the most suitable monetary policy to accompany SSE because, in such a system, the money supply is controlled, not by the Federal Reserve (a monopolist), but by the world supply of gold which is in complete harmony with their call for the return to “free" markets and "laissez-faire". The gold standard, they maintain, is the only assurance of long run stability in money supply, interest, and inflation rates. The historical evidence is clear, they claim, since inflation became a problem in the 19708 only after the U.S. abandoned the gold standard. Moreover, the 1981-82 recession, they insist, proved the failure of monetarism (in the sense that, as compared to monetarism, the gold standard may not necessitate a recession to control inflation).28 Critics of the gold standard, however, argue that, under such a system, shortages in gold supply can lead to less growth in the long run. In fact, by cancelling the 109 discretionary power of the Fed to increase the money supply during recessions, such critics argue, the gold standard can lead to severe recessions or depressions as happened in 1929. Moreover, some critics argue that the gold standard can lead to unstable price levels since it changes the value of money by linking it to the large costs of gold production.29 Moreover, and while the Lafferites view monetarism and SSE to be in complete disharmony (since, after all, monetarism is only the other side of Keynesianism), monetarist supply-siders believe that the policy of tight money was in complete harmony with the tax cuts and that the Fed does not necessarily lead to severe gyrations in interest rates as the Lafferites believe. After all, monetarist supply-siders insist, it was the tax cuts and the resulting deficits, and not the money supply, that caused high interest rates and the 1981-82 recession. Although the gold standard is similar to a fixed money growth rate rule, monetarist supply-siders prefer to keep the discretionary power in the hands of the Federal Reserve since the fixed growth rate of money would be determined by the Fed itself and not by the world supply of gold (in the sense that the gold standard would offer only one possible growth rate while the Fed can choose from a set of growth rate options according to the circumstances).30 Given the foregoing arguments and counter arguments as to what happened, critics of Reaganomics argue that the 110 whole program was internally inconsistent. This inconsistency, such critics claim, is best manifested by the collision of monetary and fiscal policies, to which we DOW turn. 91 Eiscel ahd Monehagy 2011c1e§ 1n 99111s1on: The attempt to cut taxes, balance the budget, and control the money supply to decrease inflation and have a simultaneous increase in tax revenues, productivity, and growth, critics of Reaganomics argue, was totally inconsistent if not impossible. The combination of easy fiscal policy and tight monetary policy, the critics argue, was both inconsistent and contradictory. What the government gave in tax cuts, they claim, was taken away by tight money (because the recessionary impact of tight money outweighed the assumed incentive effects of tax cuts).31 In addition, the critics maintain, because the adminis- tration wanted to decrease inflation as fast as possible, the expansionary effect of tax cuts (on aggregate demand) added a further burden on monetary policy leading to a deeper recession (i.e., given the tax cut, a specified amount of a decrease in the inflation rate had to be achieved by a larger decrease in the growth rate of the money supply than without the tax cut).32 In fact, the critics insist, the combination of tight money and rising deficits led to unexpectedly high interest rates and lower 111 GNP growth due to the existence of tight credit (i.e., the existence of loose fiscal policy prolonged the duration and increased the severity of the recessionary impact of tight monetary policy).33 The severity and duration of the recession, the critics add, in turn led to a further increase in the deficits (because unemployment insurance payments increased and tax revenues fell due to the fall in GNP growth) further compounding the problem of tight credit.34 Such inconsistencies were assumed away by the administration, critics of Reaganomics suggest, because the administration seemed to accept the neutrality of money (which was borrowed from Say's Law in their opinion) by assuming that if the Fed can control inflation (a monetary phenomenon a'la the monetarist supply-siders) by cutting money supply growth rates, and if the Treasury can increase real GNP growth (an "incentives'-related phenomenon a'la the Lafferites) by cutting tax rates, then inflation and GNP growth rates would simultaneously decrease and increase, respectively.35 This did not happen, the critics maintain, because there was no increase in aggregate supply while the aggregate demand sagged (due to tight credit) leading tn) the inflation-unemployment trade-off of 1981- 32.36 The administration adopted the combination of loose fiscal policy and tight monetary policy, critics of 112 Reaganomics suggest, for the following two reasons: First, the administration wanted to satisfy the three different groups of supply-siders (especially the Lafferite and monetarist supply-siders) by cutting both taxes and the 37 The second reason (which was mainly a money supply. reflection of the first one), was the so-called "Feldstein- twist" (or F-twist) which argued that previous policies of easy monetary policy and tight fiscal policy (in the form of high marginal tax rates) were leading to a misallocation of investment funds away from the corporate business sector to the housing sector because capital income originating in the corporate sector was taxed more than income attributed to owner-occupied housing in their opinion.38 By reversing the two policy roles, the critics suggest, the F-twist claimed that the resulting high interest rates would crowd out funds going to the housing sector because the housing sector was more sensitive to high interest rates than the corporate sector, thereby freeing more funds to go to business investment which would be further stimulated by the tax cuts.39 This was the case, the critics maintain, because Reaganomics assumed that both housing and business investment were financed by personal saving (if more funds were going to the housing industry, then less funds would 40 Saving and be available for other industries). investment did not increase (especially during 1981-82), the critics claim, because of the severity of the 113 recession. In fact, the critics conclude, the rich reacted to the tax cuts by mainly rearranging their portfolios (by moving a portion of their existing savings to the new tax— free status) rather than increasing their savings, and businesses reacted to the tax cuts by mainly increasing mergers (to increase their cash flow and diversify their investments) rather than increasing investment. During a period of tight credit and slack in total sales, the critics argue, businesses will not increase investment no matter how big the tax cut is, especially with the existence of a counteracting tight monetary policy. The assumed neutrality of money, some critics insist, does not hold.41 Other inconsistencies between monetary and fiscal policies, critics of Reaganomics claim, were not recognized by the administration until after the occurrence of the 1981-82 recession. In fact, they argue, one inconsistency was clearly obvious in the ”rosy-scenario" that was projected by the administration in 1981. That scenario, the critics claim, promised a simultaneous decrease in money supply growth rates, inflation, and interest rates, along with a simultaneous increase in productivity and growth. SuCh a scenario, the critics suggest, assumes a decrease in interest rates along with a simultaneous increase in real GNP growth (which can occur, they argue, only if the velocity of money increased by unprecedented 114 amounts given the promised decrease in money supply growth rates). Moreover, if velocity is supposed to be a rough measure of the demand for money relative to its supply, and if the interest rate represents the price of money, the critics insist, then how can an excess demand for money lead to a fall in its price (given the assumed increase in velocity)?42 Such an inconsistency between velocity and interest rate projections, opponents of Reaganomics argue, reflects a serious inconsistency between the monetarist and Lafferite supply-siders which was intensified by the occurrence of the 1981-82 recession. In fact, monetarist supply-siders had some doubts from the beginning that the projected surge in productivity and growth via the incentive effects would be as strong and as fast as was assumed by the Lafferites. This was the case, because some monetarist supply-siders realized that such a scenario would require an unprecedented surge in the growth rate of the velocity of money (given the promised decrease in money supply growth rates). Hence, and given such doubts, the Lafferites responded by suggesting that the velocity of money would in fact increase by unprecedented amounts because of the revolutionary nature of the tax cuts.43 After the 1981-82 recession, however, the Lafferites realized that there was no surge in productivity and growth and started blaming the other two groups of supply—siders 115 by insisting that the incentives were both weakened (by delaying the tax cuts) and overcome (by tight money) and were calling for the adoption of the gold standard. Similarly, and after the recession, however, the monetarist supply-siders had their own rationalization by arguing that their promises of a decrease in inflation along with a simultaneous decrease in interest rates were overcome by the rising deficits (which created the rising interest rates in their opinion). Finally, the balanced-budget supply-siders were in turn unhappy that the deficits were rising and were arguing that taxes should be out only when the budget was in balance. Such arguments and counter- arguments led critics of Reaganomics to conclude, once again, that Reaganomics was internally inconsistent.44 While disclaiming responsibility for the 1981-82 recession, critics of Reaganomics claim that SSE advocates (both inside and outside the administration) were at the same time arguing that SSE was responsible for the decline in inflation and the accompanying 1983 recovery. Such an argument, the critics add, is completely at odds with the facts for the following reasons: First, the critics argue that while inflation rates declined, it was due to the 1981-82 recession, the drop in oil and food prices (due to gluts in both markets), the decline in housing prices (due 116 to high mortgage rates), and the overvalued dollar (leading to lower import prices). There is little evidence, the critics insist, that inflation rates decreased because of the tax cuts. Productivity, labor supply, personal savings, and aggregate supply, they claim, all decreased after the tax cut leading to lower inflation at the cost of the 1981-82 recession. The argument that inflation decreased due to SSE, the critics conclude, does not hold.45 Second, critics of Reaganomics argue that the 1983 recovery occurred, not because of SSE, but because of Keynesian "demand-side" forces. In fact, after the 1981-82 recession, they claim, the administration's policies became Keynesian by default. This was the case, they maintain, because the administration increased money supply growth rates and increased government expenditures. The increase in the money supply, the critics suggest, allowed the expansionary demand-side forces of the original tax cuts (that were stalled by tight money in their opinion) and the rising deficits to take effect (due to the decrease in interest rates). Aggregate demand increased, they maintain, leading to an improvement in business confidence and business investment. Evidence clearly suggests, the critics conclude, that the recovery was led by an increase in both housing and consumption of durable goods (which are sensitive tn) lower interest rates). Hence, the recovery 117 occurred, they insist, due to reemployment of idle resources and not because of increased growth potential (or aggregate supply) as SSE advocates believe.46 Third, and although the recovery occurred, the critics maintain, it was far weaker than previous post-war recoveries, given the severity of the 1981-82 recession (previous records suggest that severe recessions tend to be followed by fast and strong recoveries).‘f7 In fact, had the recovery been supply-led as some Lafferites claim, the critics argue, one would have had a surge in productivity, savings, labor force participation, and smaller deficits. However, the critics claim that none of these occurred. While productivity did in fact increase, they maintain, it grew at a slower pace than during any other post-war recovery. Moreover, the personal savings rate continued to fall, they claim, while it should have (according to SSE) increased. In fact, the only part of total savings that increased during the recovery, the critics argue, came from business savings which increased because demand for their products and profits increased. In addition, labor force participation, the critics argue, continued to slow down since 1980. Finally, the critics conclude that deficits continued to rise while they should have decreased, had the recovery been supply-led (as the "new" supply-siders claim).48 118 In fact, some Lafferites were claiming that the recovery was "supply-led" since investment finally increased because of increased after-tax rewards and an increase in personal saving that were previously stalled by tight monetary policy and the delayed implementation of the legislated tax cuts.49 Monetarist supply-siders, however, were arguing that the recovery was neither "fiscal-led" as the Keynesians claim (in the sense that the tax cuts and the deficits finally had their "demand-side" effect by increasing consumption to increase demand) nor "supply-led" as the Lafferites claim (in the sense that the tax cuts worked to increase labor supply and personal saving to increase aggregate supply): rather, it was "money-led" (in the sense that, given the achievement of lower inflation rates, monetary policy allowed an increase in the money supply leading to an increase in nominal GNP in their opinion). The impact of the tax cuts on growth, monetarist supply-siders add, will only materialize in the future, to which we now turn.50 4.4 The Eugene Impect ef Reagehem1cs on the_EeenemY Critics of Reaganomics argue that, contrary to what some advocates of SSE expect, the future impact of the Reagan program will be less equity, efficiency, capital formation, and growth. This is the case, they claim, because Reaganomics has both economic and socioeconomic 119 costs that will be manifest only in the long run. First, the combination of lower social spending (especially on education and training) by government and a more regressive tax system (because the tax cuts benefit the rich more than the poor in their opinion), they argue, will lead to lower incentives and Opportunities for the poor to work more in the long run. Without opportunity, the critics insist, incentive is a cruel joke. Job training and education, they add, are especially targeted on low-income groups and provide them with an important escape route from poverty and unemployment. Reductions in such programs, the critics conclude, will only reduce their Opportunities.51 Second, critics of Reaganomics argue that the Reagan tax cuts may not necessarily increase the efficiency with which capital is allocated across its various uses. This is the case, they maintain, because the recent tax changes have not, (Hi the whole, reduced tax differentials among different assets and industries.52 Moreover, the decline in non-defense government expenditures on Research and Development (R a D) and in direct public investment in infrastructure and human capital, they claim, have greatly reduced the prospects for long run growth.53 Finally, the severity of the recent recession will lead to permanently higher unemployment and lost productivity. This is the case, they insist, because the recession caused a permanent drop in the capital stock below its potential.54 120 Last but not least, the critics question the idea that Reaganomics will lead to future improvements in real growth and lower inflation, given the unprecedented size of budget deficits. While short run inflation rates have declined, the large size of the deficits suggests to them that inflation will start rising in the future. This is the case, they insist, because lower inflation rates in the short run were only achieved by a severe recession and not by structural improvements in the economy towards long run stable growth rates.55 Deficits, they believe, will lead to a continuous process of crowding out generating permanently lower growth rates in the economy and higher inflation. This is ironic, the critics maintain, because, whereas the administration proposed to increase the (aggregate supply, the long run impact of the deficits will be a permanently lower aggregate supply and real growth via higher long run real interest rates.56 In addition, and even by following the most optimistic estimates, they argue, Reaganomics will have little improvements on long- term growth. Finally, and as a result of the rising structural deficits, they conclude, the economy would end up with slower growth, higher inflation, and, probably, higher taxes in the future.” This suggests, they add, that the tax cuts were adopted by Reaganomics for two reasons: :first, to redistribute income, and second, to decrease the size of government.58 The deficits, the 121 critics insist, were neither a mistake, nor unintentional, because Reaganomics assumed that the increasing deficits would put some pressure on Congress to decrease spending. However, spending proved to be harder politically to out than taxes, they maintain, leading to the present rising deficits.59 115 The Impece ef Beeganeh1ce on the ye11d1ty 9.1.553: Critics of SSE argue that Reaganomics proved the failure of SSE. This is the case, they claim, because SSE promised ”too much" and delivered "too little".60 SSE was not only discredited by recent events, some critics insist, it ironically proved the validity of Keynesian economics (against which SSE claimed to be a revolution).61 Not only .that, the critics also suggest that SSE ended up the ”enemy" of ”supply-side" economics itself.62 SSE manifested itself as an ideology with no coherent program, a jumble of confusion, leading to complete collision between SSE theory and practice. That confusion, they maintain, was clearly reflected by the collision of the three supply-side groups.63 Finally, the critics conclude that while SSE was more successful in the political arena (because, in their opinion, the American public is always ready for the notion of a tax cut), SSE advocates will blame the Fed, Congress, and the Reagan administration for the economic failure of their theory by arguing both that 122 Reaganomics was not a correct and/or complete application of SSE, and that it therefore does not constitute a valid "test" of that theory.64 In fact, while some monetarist and balanced—budget supply-siders were arguing that Reaganomics proved the failure of the Lafferite version of SSE (in the sense that Reaganomics was heavily skewed towards that version by completely believing in Laffer-curve miracles), some Lafferites were arguing, first, that Reaganomics does not constitute a valid test (at least Of their version) of SSE because it works only if the gold standard is established, and second, that the Reagan tax cuts were 'too little too late” leading to weakened incentives.65 Hence, it was "Reaganomics" and not SSE that failed because it was never 'properly implemented in the first place (due to political compromised. SSE cannot be proven right or wrong, they maintain, because in a democracy theories cannot be adequately tested.66 Monetarist and balanced-budget supply-siders, however, argued that Reaganomics failed because it was an unbalanced 67 By focusing only on (or extreme) “supply-side" program. tax cuts, Reaganomics rushed the process Of SSE too soon by cutting taxes ”too much too soon” leading to the resulting deficits and their problems. A more balanced "supply-side" approach, they suggest, would have allowed taxes to be out only after the budget was balanced (by cutting spending 123 a'la the balanced-budget supply-siders), or after the economy was already well on its way to non-inflationary economic growth (by following a stable money growth rate a'la the monetarist supply-siders).68 In fact, Martin Feldstein distinguishes between "traditional" supply-side economics, and the "new" supply- side economics (SSE). While he considers himself to be a ”traditional" supply-sider, Feldstein argues that the “new" supply-side rhetoric (SSE) gave fundamentally good policies (traditional supply-side policies which focus on long run growth) a bad name and led to quantitative mistakes that not only contributed to subsequent budget deficits but also made it more difficult to modify policy when those deficits became apparent. In addition, Feldstein claims that the ~experience since 1981 has not been kind to the claims of the new supply-side "extremists" (Lafferites). But it would be unfortunate, Feldstein adds, if this gave a bad reputation tn) the traditional supply-side policies (that the evolution of a nation's real income depends on its accumulation of physical and intellectual capital and on the quality and efforts of its workforce). Moreover, nothing about the experience since 1981, Feldstein insists, would cause us to doubt the time-honored conclusion of economists that tax rules influence economic behavior and that high marginal tax rates reduce incentives. These processes, Feldstein maintains, are long run processes. It 124 was the excessive claims that were made on their behalf, Feldstein concludes, that led to the failure of Reaganomics.69 Was "supply-side-economics' (SSE) a viable alternative to or a: revolution against Keynesian economics as it claimed? It all depends, in addition to one's conception of how the economy actually or ideally works, on one's definition of "supply-side" economics, the concept of a ”revolution", and the scope of "economics" itself, to which we now turn in Chapter V. 125 NQ£§§_§2_§DQE£EL_I¥ *Martin Feldstein, "Supply-Side Economics: Old Truths and New Claims," m ' n o c w, Papers and Proceedings, vol. 76, no. 2, May 1986, pp. 29-30. **David Stockman, "The Triumph of Politics," Newswee , April 28, 1986, pp. 56 and 58. See also David Stockman, The T11umph e: 2911h1cs; Why the Beagen Reve1ut1on £e11ed. (New York: Harper and Row, 1986). 1P.C. Roberts writes: "Jack Kemp was the first supply-side politician, and Ronald Reagan was the first Supply-side President." [Paul Craig Roberts, The Supply- S1ge Beyelut1e . bCambridge, Massachusetts: Harvard University Press, 1984), p. 1.] For Evans, "supply-side economics came of age on July 31, 1981, the day that Congress sent President Ronald Reagan an unprecedented five-year $749 billion tax cut." [Michael Evans, The Teuth hbeut supply-side Beehemie . (New York: Basic Books, 1983). P. 3.] For Palmer and Sawhill, "three aspects of the Reagan administration's economic and social policies are particularly noteworthy. The first is the experiment in supply-side policies that were Offered as a solution to the country's economic problems. The second is the shift in social philosophy as fundamental as was the New Deal. The third is the efforts of the administration to leave behind a more effective set of federal programs and policies than it inherited from its predecessors." [John Palmer and Isabel Sawhill, "Perspectives on the Reagan Experiment," in W. J. Palmer and I. Sawhill (eds.), (Washington, D.C.: The Urban Institute Press, 1982), P. 22.] 2For David Stockman, ”he [President Reagan] embraced the huge Kemp-Roth tax cut because it seemed to be vali- dated by an anecdote from his own personal history--the way high wartime taxes had prompted some movie-makers to quit after just four films each year." [David Stockman, "The Triumph of Politics," Negeeeeh, April 21, 1986, p. 40.] Similarly, B. Bartlett writes: ”As he pointed out many times during the presidential campaign, when he was an actor Hollywood was virtually a laboratory for supply-side economics. Reagan told an interviewer: When I was in the movies, I'd reach a point each year where after the second movie I'd be in the 90 percent tax bracket. SO I wouldn't make any more movies that year. And it wasn't just me, but Bogart and Gable and the others did the same. 126 We weren't the ones who were hurt. The people who worked the props and the people who worked the yard, they were the ones who were hurt. [Bruce Bartlett, Reegenemice; Supply-$1de Ecenem1es 1n Ace-1 11. (New York: Quill Books, updated edition, 1982), p. 212.] 3For a description of President Reagan's economic program, see eheg1ce'e new fieg1nn1ng: A REQQIQE fie; Ecoh- Om1c Beceyegy. (Washington: The White House, February 18, 1981); and also the "Economic Recovery Tax Act of 1981,” (Public Laws 97-34, 13 August 1981), vol. 95, pp. 172-356. For Paul C. Roberts, "the Reagan Administration's economic program consists of a fine balance between three different points of view, each with a dominant goal. There are the supply-siders inthe Treasury, who are primarily concerned with increasing the rate of real economic growth. There are the monetarists in the Treasury and on the Council Of Economic Advisers, who are primarily concerned with lowering the inflation rate as fast as possible. And there are the traditionalists at the Office of Management and Budget, who are primarily concerned with making good on their promise of a balanced budget by 1984." Note that Roberts (a Lafferite) does not refer to the other two groups as monetarist supply-siders and balanced- budget supply-siders, but as monetarists and tradition- alists. This is the case because Roberts blames the other two groups for both the recession of 1981-82 and the deficits by delaying the tax cuts. In fact, Roberts insists that the other two groups of supply-siders were not “true" supply-siders because they did not completely believe in the "power" of the tax cuts as the Lafferites do. Moreover, Roberts argues that because there were not enough Lafferites to staff the White House and the administration, President Reagan had to appoint non- Lafferites leading to a compromise program. See P.C. Roberts, “Will Reaganomics Unravel?" in yjeepe1nhe en sepely;§1ge_fieehem1ee, Thomas J. Hailstones (ed.), (Reston, Virginia: Reston Publishing Co., 1982), p. 234. 4"But the supply-side outlook has some passionate critics. President Reagan's own vice-president, George Bush, called it 'vodoo economics' when he was running against Mr. Reagan in last spring's primaries. Walter Heller, former chairman of the Council of Economic Advisers, says the theory is supported by only a 'few thimblefuls of questionable evidence'. Sen. Paul Tsogans, a Massachusetts Democrat, derides it as 'bumper-sticker economics'." [Robert Merry and Kenneth Bacon, "Supply-Side Economics and How It Became a Presidential Program," in W. p. 188.] 127 5Rousseas refers to the administration's projections in the President's February 1981 Economic Report to be as follows: inflation would decrease from 9.9 percent in 1981 to 6.0 percent in 1984. Unemployment would decrease from 7.8 percent in 1981 to 6.4 percent in 1984. The 91-day Treasury bill rate would decrease from 11.1 percent in 1981 to 7.0 percent in 1984. The fiscal year federal deficit would decrease from $55 billion in 1981 to become an actual surplus of $1 billion in 1984. The money supply (currency plus checking deposits) growth would decrease from 7.0 per- cent in 1981 to 4.0 percent in 1984. And real GNP growth would increase from 1.1 percent in 1981 to 4.5 percent in 1984. See stephen Rousseas, The_2elitieal_fieeeemx_ef_3ee: gehgm1ge. (New York: M.E. Sharpe, Inc., 1982), pp. 96-98. 6"The Reagan team thinks it can produce simultaneous economic growth and milder inflation, rather than trade one for the other as the Ford and Carter administrations tried to do.” [See Merry and Bacon in note 4 above, p. 187.] For Charles Hulten and Isabel Sawhill, ”The second basic presumption Of Reaganomics was that all the program's goals could be achieved simultaneously, and, according to some members of the administration, immediately. NO trade- Off between policy Objectives was seen to exist: inflation could be controlled without recession, and could thus be reduced without jeopardizing near-term economic growth; increased economic growth would generate enough additional revenue that the deep cut in tax rates would not lead to ‘larger budget deficits; and economic growth in the private sector would more than compensate those people who lost benefits from cutbacks in social welfare programs." [Charles Hulten and Isabel Sawhill, The Legeey ef Beegehemige. (Washington, D.C.: The Urban Institute Press, 1984), p. 1.] 7"Just a little more individual incentive (tax cuts) and the supply of effort and, therefore, of goods and services will increase dramatically. Productivity gains allegedly will be substantial. This makes up a very heady brew of assumptions. But supply-siders 'pragmatically' explain that the real test of their thought is not the validity of their assumptions. Instead, the test is how well their program works when implemented, and President Reagan is now providing us with that test. We have an economic methodologist's dream come true--a decisive test of a theory. Or do we?" [William Dugger, 'An Institionalist Critique Of President Reagan's Economic Program." J22real_£uLJflauuumu;_leeee§. vol. xvr, no. 3. September 1982, p. 796.] 128 8"The news media suggested that even though their case is weak, why not let the Reagan administration try it and see what happens? These attitudes display a disturbing anti-intellectualism. . . .. But more importantly, the problem is not that supply-side models have never been tested: the problem is that supply-side ideas have never been logically argued, and are therefore fundamentally incapable of ever being tested. I would like to suggest that supply-side economics is not a theory at all, but rather a concerted attempt to ignore or suppress much that has been learned about the macroeconomy in the last fifty years. It is upon these grounds that supply-side economics :must be rejected.” [Philip Mirowski, "What's Wrong With the Laffer Curve?", Johgnel e: Eeenom1c Ieehee, vol. XVI, no. 3, Sept. 1982, p. 823.] 9Summers shows the percentage changes in annual growth rates of crucial variables to be as fodlows: Real GNP rates decreased from 2.6% in 1981 to -1.9% in 1982, business fixed investment rates decreased from 5.2% in 1981 to -4.7% in 1982, industrial production rates decreased from 2.7% in 1981 to -8.2% in 1982, capacity utilization rates decreased from 90.4% in 1980 to 72.1% in 1982, civilian unemployment rates increased from 7.6% in 1981 to 9.7% in 1982, and the inflation rate (CPI) decreased from 10.4% in 1981 to 6.1% in 1982, while the federal budget deficit increased from $55 billion in 1981 to exceed the $100 billion mark in 1982. See Lawrence H. Summers, "The Long-Term Effects of Current Macroeconomic Policies," in Ih§_L§2§£Y: P- 132- Note that the administration's projections for some of the above variables as they appeared in the 1981 Egghem1§ o 'd were as follows: Real GNP growth rate for 1982 at 4.2% (the actual was -l.9%), the civilian unemployment rate for 1982 at 7.2% (the actual was 9.7%), the inflation rate in 1983 at 7.0% (the actual was 3.2%), and the fiscal year federal deficit for 1982 at $45 billion (the actual was $109 billion). See Stephen Rousseas, The 2911§1ce1 Beehemy ef Beegehom1cs, p. 97, Table of Reaganomics projections--reprinted from Econoh1c Regent 91 the 2:ee1§ent, Washington, D.C., February 1981. 10"Conventional conservative economists like Alan Greenspan, Herbert Stein, and Arthur Burns for once made common cause with the Solows, Modiglianis, and Tobins in warning against the rashness Of massive tax cuts before one knew what the economic conditions would be like in 1981-84. . . . Post-Keynesians like me testified before Congres- sional committees in early 1982 along the following lines: 1. We told you so, that Reaganomics wouldn't work out as promised. Events are right on target. 2. Since the 129 economy has already suffered the effects of the Reagan deficits on interest rates, let us at least get the program's benefits in employment. So enact the 1982 tax cuts, but reserve judgement about whether the 1983 cuts should go into effect.” [Paul Samuelson, "Evaluating Reaganomics," ghellehge, vol. 27, no. 5, November-December 1984, pp. 6 and 7.] See also Herbert Stein, "Some Supply- Side Propositions," a t u , March 19, 1986, p. 24, where he argues that the impact of SSE on inflation control will be little. 11See subparts A, B, and C below. 12See Paul Craig Roberts, e u - 'd v ut‘ n. (Cambridge, Massachusetts: Harvard university Press, 1984), pp. 1-5. 13See Stephen Rousseas, The £911t1ca1 Ecenemy ef W, pp. 80-82, where he quotes Beryl Sprinkel arguing against the Laffer curve. 14See Michael Evans, e u b u -s'd Egghem1he. (New York: Basic Books, 1983), p. 273. See also David Stockman, "The Triumph of Politics," Neweweek, April 28, 1986, p. 64. 15"It is now clear that important policy trade-offs did in fact exist, and that the main goals of Reaganomics could not be achieved either simultaneously or immediately. . . . Federal spending proved far harder to cut than taxes, and the resulting budget deficits are widely viewed as a drag on future economic growth. Unemployment soared to the highest rates since the 19308." [Hulten and Sawhill, The m: Po 20] For Klein, “empirical studies in the United States indicate that there are some supply-side effects, but that they are relatively small and stretched out over several years in achieving their full impact. Policy-makers in the Reagan administration have proceeded blindly, in the face of responsible professional warnings, to depend on this optimistic version of supply-side economics by enacting large cuts in marginal tax rates. . . . There was no surge of labor productivity, no sudden shift towards high savings, and no spurt in capital formation. The result has, ironically, been that a serious unexpected recession has been generated. . .. . The large deficits, the high interest rates, and the recession were predicted by the Keynesian-type models that were being criticized." [Lawrence Klein, 'c u nd a d. (Baltimore, Maryland: The Johns Hopkins University Press, 1983), p. 97.] 130 For I. Sawhill, 'it was supply-side theory that provided the stated rationale for the tax cut of 1981. The purpose Of the tax cut is to increase savings, investment, and work effort and to revive the economy's lagging rate of growth. Thus far, its major effect has been to produce unexpectedly large deficits." [Isabel Sawhill, "Economic Policy," in The Beegeh Expeg1mene, I. Sawhill and J. Palmer (eds.), (Washington, D.C.: The Urban Institute Press, 1982), p. 32.] 16See Rudolph S. Penner, "Political and Economic Impact of Deficits," in SuQQLy-s1de Ecenomics 1n hhe 12898, pp. 168-172. I. Sawhill and J. Palmer write: ”Thus far the consequences of the 1981-82 recession have far outweighed the impacts of the tax reductions. . .. . By mid-1982 civilian employment and real hourly earnings were no higher than they had been in 1980, and the unemployment rate had risen by more than two percentage points. After adjustment for inflation, median family income declined by 3.5 percent during 1981. And the incidence of poverty increased from 13.2 percent in 1980 to 14.0 percent in 1981, its highest level since 1967.” [Palmer and Sawhill (eds.), The_£eegeh WI Po 190] 17For Summers, ”the performance Of personal savings, has not, at least on cursory examination, borne out supply- side hopes. The behavior of the personal savings rate has attracted particular attention. During the second quarter of 1983 it declined to 3.9 percent, close to its historic low,“ as compared with 6.9 percent in 1976 and 5.3 percent in 1981. Note that the decline in savings reflects (in the view Of the critics of SSE) the fact that the income effect outweighed the substitution effect because of the recession. [See L. Summers in note 9 above, p. 196.] In relation to expectations, Ronald Johnson writes: "If taxpayers believe that today's tax cut will be followed by a tax increase in the future, then the effects of a permanent tax cut on real growth will depend on how long it takes for taxpayers to adjust their expectation. In the case where taxpayers expect marginal tax rates on productive activities to rise in the future, they may discount all or part of the relative price effect of the tax cut. This would result in initially a small impact on real growth of the tax cut." [Ronald Johnson, ”Supply-Side Economics: The Rise to Prominence," Rey1ew 9; Neck 2911e1ee1_fieehemy, vol. 12, no. 2, Winter 1983, p. 198.] 18"In 1982,“ writes Summers, "the unemployment rate reached double digit levels, far surpassing its previous peak of 8.9 percent during the 1975 recession. At the same 131 time, capacity utilization fell to its lowest level since the collection of the data began [after World War II]. . . . At the end of 1982, the real gross national product (GNP) was below its 1979 level. . . . The major aim of current policies, at least at the time of their inception, was to stimulate aggregate supply by Offering increased incentives to work, save, and invest . . . the supply-side program has clearly been a failure, relative to what was promised." [See Summers in note 9 above, pp. 181 and 195.] Wallace Peterson and Paul Estenson argue that after 1981, and as a.result of the Economic Recovery Tax Act of 1981, the labor force participation rate remained nearly constant, increasing by only 0.6 Of a percentage point during 1981-84. [Wallace Peterson and Paul Estenson, "The Recovery: Supply-Side or Keynesian?', Jougnel 9: post Keyhee1eh_£eehem1ee, Summer 1985. Pp. 451 and 452.] M. Evans (a balanced-budget supply-sider) writes: “Supply-Side economics works poorly or not at all under the constraints of slack resources. Lower tax rates simply will not improve the incentive to look for work if fewer jobs are available. Capital formation will not be stimulated no matter how generous the tax rates if operating rates are at 50 percent or less," and advises to cut taxes only when the budget was balanced. Evans blames the deficits for causing the recession by arguing that taxes were out "too much too soon" following the advice of the Lafferites. [Michael Evans, The Tguth About supp1y- s1ee Ecenom1ee, p. 273.] ' 19Congdon argues that deficits have three related hidden taxes. The first is called the crowding-out tax by increasing interest rates. The second is called the inflation tax which occurs due to increased gowernment spending. The third one is called the debt debasement tax which is an extension of the second such that the government deprives the private sector of resources because of the increased borrowing. Congdon argues that SSE advocates wrongly prefer hidden taxes than visible taxes since they assume that hidden taxes (or deficits) do not affect incentives. Congdon concludes that hidden taxes (deficits) have the same disincentive effects as visible taxes. [Tim Congdon, “What's Wrong With Supply-Side Economics," P011cy Bev1ew, Summer 1982, pp. 9-17.] 20"I discovered that to balance the budget we would need huge spending cuts too--more than $100 billion per year. The fabled revenue feedback of the Laffer curve had thus slid into the grave Of fiscal mythology forty days after the supply-side banner had been hoisted at the GOP convention. . . . 132 In 1982, we didn't get 5.2 percent real growth. Instead, the U.S. economy contracted by 1.5 percent. And inflation came down to 4.4 percent. Tax revenues were about $85 billion lower in the final reckoning than we had forecast." [See Stockman in note 2 above, pp. 44 and 52.] 21"The February 1981 economic forecast eventually became known as 'Rosy Scenario'. weidenbaum [Chairman of the Council of Economic Advisers then] wrote the specific numbers, but its underlying architecture was ultimately the work of a small band of ideologues. . . . Bookkeeping invention thus began its wondrous works. We invented the 'magic asterisk': If we couldn't find the savings 1J1 time-—and we couldn't--we would issue an IOU. We could call it 'future savings to be identified'. It was marvelously creative. A magic asterisk item would cost negative $30 billion . .. . $40 billion . .. . whatever it took to get a balanced budget in 1984 after we toted up all the individual budget cuts we'd actually approved." [Ibid., pp. 52 and 56.] For Stockman, "the whole California gang [the Lafferites] had taken it [the Laffer curve] literally (and primitively). They seemed to expect that once the supply- side tax cut was in effect, additional revenue would fall from the heavens." [See Stockman in note 14 above, p. 54.] 22See Rousseas in note 5 above, p. 79, where he quotes Sprinkel (a monetarist supply-sider in the administration) arguing against the crowding-out effects of rising deficits and warning against monetization of the debt. 23P.C. Roberts argues that the effort by the balanced- budget supply-siders to make the budget deficit the focus of economic policy deflected attention from the failure of monetary policy and endangered the President's tax program. In fact, Roberts blames both D. Stockman and M. Feldstein for the recession. Roberts, Waugh. p. 259.] For Alan Reynolds, "postponing the tax cuts and pursuing monetarism delayed our recovery and inflated the budget deficit. . . . Postponing effective tax cuts until 1983 was merely a disaster. The monetary version of demand-side 'Reaganomics' turned out to be much worse." Recall that the Lafferites refer to monetarism as the other side of Keynesian "demand-side" economics. [See Alan Reynolds, "How Supply-Side Triumphed," ghellehge, November- December, 1984, pp. 12 and 13.] 24Ibid., p. 18: ”Yeager believes it is 'grossly irresponsible' for supply-siders to question the mismeasurement of deficits, or to ask for evidence that 133 deficits necessarily raise either interest rates or inflation. The burden of proof, however, is on Yeager. . . . It is not that deficits 'don't matter', but that deficits of the magnitude recently experienced are less damaging than trying to squeeze equivalent taxes out of one year's output.” Note that Reynolds seems to believe that deficits (or hidden taxes) have no (or little) disincentive effects contrary to what Congdon argued in note 19 above. For a similar argument, See B. Bartlett Reegenoh1cs, pp. 217-219. 25Levine argues that "tight credit and slack labor and industrial markets have placed downward pressure on wages and profit margins. Very effective, very painful, and very Keynesian. By 'very Keynesian' I, of course, mean that inflation moderated for reasons that Keynes would have understood. Whether or not he would have approved is a separate question." Levine seems to be stressing the existence of the Phillips-curve trade-Off in the short-run, given the 1981-82 experience. See David A. Levine, "Monetarists Versus Supply-Siders,“ W, Fall 1982, p. 4. 26For Peterson and Estenson, 'the Federal Reserve, in its battle against inflation, slashed the annual average rate of growth in the money supply from 10.3 percent in January 1981 to -0.2 percent in October 1981 (Econem1c Repoge e: ehe Egee1dent, 1983, p. 233). The result was a recession devastating to both business and laborers." [See Peterson and Estenson in note 18 above, p. 447.] P. Davidson writes: "If the unions and management believe Reagan, Regan, and Stockman, it is claimed [by SSE advocates], then 'rational expectations' will prevail as everyone recognizes that everyone else will stop asking for inflationary wage and profit margin increases, and inflation will stop dead in its tracks without the punishing depression of Thatcherism." Note that Davidson refers to Mrs. Thatcher's economic program in England to be a similar and earlier version of "Reaganomics“ leading to lower inflation only at the cost of a recession in that country. See Paul Davidson, "Monetarism and Reaganomics," in Reegenom1e§ 1n the Stagglet1eh fieenemy, Sidney Weintraub and Marvin Goodstein (eds.), (Philadelphia: University of Pennsylvania Press, 1983), p. 96. For P.W. McCracken, inflationary expectations did not immediately decrease for two reasons: institutional rigidities (such as multiyear labor contracts), and strong expectations that the disinflationary program was not expected to persist, given the record for more than a decade of a growing gap between what government said and what it delivered. McCracken concludes that "momenmnn factors and the understandable assumption that once again 134 'Washington' would not persevere made it certain that there would be an interlude of slack in the economy on the way to a greater stability of costs and prices. The problem here was less an error Of diagnosis than that some blood, toil, tears, and sweat rhetoric would have been in order." [See Paul W. McCracken, "Reaganomics: A Midterm Examination," in Reegeneh1ee: heen1hg, Meehe, ehd Ends, Paul W. McCracken and John Kenneth Galbraith, The Charles Moskowitz Memorial Lectures, N.Y. University. (New York: The Free Press, 1983). PP. 67-70.] 27Martin Feldstein blames the Lafferites for promising "too ennui too soon" (in the sense that their supply-side incentives did not deliver as fast as they claimed they would), and defends the administration's monetary policy. Feldstein writes: "Unfortunately, though, as I indicated earlier, the nature of the administration's new economic strategy has been disguised and distorted by the extreme supply-side rhetoric. . . . Some of the administration spokesmen who actually believed the extreme supply-side theory predicted that the new policy would cause an immediate surge in economic growth and productivity and a rapid decline in the rate of inflation. It is abundantly clear that the economy's performance is not living up to these naive and euphoric forecasts. The economy slid into a recession. . . . It is important to judge the program by its long-term consequences and not by its failure to live up to the naive short term forecasts implied by the extreme supply-side theory.” [Martin Feldstein, "The Conceptual Foundations of Supply-Side Economics," in Shpply $1Qe Ecenem1c e 1e the lfifine, pp. 147-157.] Recall that, as a monetarist supply-sider (and Chairman of the Council of Economic Advisers until 1984), Feldstein believes that incentive effects are weak in the short run and take effect only in the long run leading to the need to cut money growth rates in the short run in order to control inflation. See Part 2.4 in Chapter II above. For a "Lafferite" critique of the Reagan monetary policy, see Paul Craig Roberts in note 22 above, pp. 292- 295, where he calls for the adoption of the gold standard. 28See Paul C Roberts. WW. pp- 292- 95; and J. Roberts, "The Gold Standard," in ' W W. R Fink (ed. ). pp. 433- 453. 29See J. Salerno, "The Gold Standard," in Shpply;fi1de BERRQMiQfi. PP- 455-485- 135 30See Beryl Sprinkel, "Reaganomics: The Monetary Component," in gueely-s1de Economics 1n the 12898, pp. 273- 280. 31For S. Weintraub, "SSE advocates can be judged as either fools or knaves, demanding a tighter money flow to repress the economy and tax measures to revive it, or an injunction to go slow and to go fast, simultaneously. The left arm of government was to be driven out Of sync with the right hand.” [Sidney weintraub, "Keynesian Demand Serendipity in Supply-Side Economics," Journal of post Keyhe§1eh Econem1cs, Winter 1981-82, p. 184.] 32"If there was a burst of new investment, given the Fed's adamant stance to damp down borrowing, the normal stimulating effect Of the corporate tax cuts could be aborted by an even tougher monetary response." [Ibid.] 33For Galbraith, "the recession has been made worse in the U.S. by the association Of a tight monetary policy with a relatively loose fiscal policy--what we may call the supply-side aberration. Loose fiscal policy puts an added burden on monetary policy, involves a greater competition for loanable funds, and leads to high interest rates." [See J.K. Galbraith in note 26 above, p. 38.] 3“S. Rousseas writes: "By mid 1981, the economy started to sag on its way to a full-blown recession. By year's end, the sag had become a steep decline in real output accompanied by high unemployment rates. The near- term impact on the deficit was not difficult to figure out. Roughly, the federal deficit increases by $30 billion for each percentage point rise in the unemployment rate--$25 billion for increased federal expenditures on unemployment insurance, food stamps, etc., and $5 billion in lost tax revenues." [See Rousseas in note 5 above, p. 106.] 35For James Tobin, "Reagan put one engine [the Fed] at one end of the train and a Stockman-Kemp engine at the other." [James Tobin, "The Supply-Side," in supely-flde Ecenem1cs, R. Fink (ed.). p. 337.] 36See Rousseas in note 5 above, p. 106,- and Alfred Eichner, "Reagan's Doubtful Game Plan," ghellehge, May-June 1981, p. 26. 37P.C. Roberts argues that because there were not enough Lafferites to staff the White House, President Reagan had to be conciliatory and appointed both monetarist and balanced-budget supply-siders, thereby leading to a compromise on policy objectives. See Roberts, The supply- W. pp. 3-5. 136 33Char1es Hulten and Isabel Sawhill show that, in fact, capital income originating in the corporate sector was taxed at 34.5 percent under the pre-l98l law, while income attributed to owner-occupied housing was taxed at a rate of 18.6 percent. See C. Hulten and I. Sawhill (eds.), TbeJMeuEuu p. 5. 39See Alan Blinder, "Reaganomics and Growth: The Message in the Models," in The_Legeey, p. 206. 40Recall that SSE advocates assume that business investment is financed by personal saving, while critics of SSE suggest that it is mostly financed by business saving and bank credit. See part 3.4 in Chapter 111 above. 41According to Eichner, Reaganomics assumes (via the neutrality of money) that increases in the money supply *were the cause of inflation in the 19708. This, Eichner adds, assumes that the money supply is exogenous and, thus, that it should be controlled by the Fed to control inflation. This is not the case, Eichner maintains, because the money supply is endogenous. The money supply increased during the 19708, he insists, because it was a symptom, and not a cause, of inflation. Slashing money supply growth rates, he concludes, will only lead to a "credit squeeze" accompanied by an economic downturn. See Alfred Eichner in note 36 above, p. 26. For an interesting study of business mergers, see "Business Disappoints Congress," Be§1hee§_fleeh, December 21, 1981, p. 36. 42For Rousseas, "If the real rate of economic growth is to be increased almost four-fold from 1981 to 1986 (from 1.1 to 4.2 percent) while we are sharply reducing the money supply growth rate (from 7 to 2 percent), then the growth rate of velocity, . . ., would have to increase from 4.0 in 1981 to 7.1 in 1986. Given a nominal 1981 GNP of $2,900 billion and a $430 billion money supply, the velocity of money (Y/M) would have to increase from 6.7 in 1981 to 9.1 in 1986 in order to finance the adminis-tration's projected real GNP growth rate of 4.2 percent at a 4.9 percent inflation rate. The problem is that the administration predicted a fall in the interest rate (9l-day TBs) from 11.1 percent in 1981 to 5.6 in 1986. It did so on the basis of a convenient belief--that interest rates 'are largely a mirror of price expectations'. . . . The problem is that the model implicitly assumes a falling rate of interest and a rising income velocity of money. This cannot be. Velocity . . . is supposed to be 'a rough measure of the demand for money relative to supply', with the interest rate representing the price of money. But then how can an excess demand for money lead to a fall in 137 its price? . .. . The administration's model was internally inconsistent.‘I [See Rousseas in note 5 above, p. 98.] 43To have an increase in real GNP growth while at the same time reducing the growth rate of the money supply, monetarist supply-siders suggest that velocity Of money would have to increase by unprecedented amounts. Historically, the monetarist supply-siders suggest, velocity growth rates average around 3.2 percent. With the Reagan scenario, they add, velocity growth rates would have to increase to 6.1 percent which is impossible in their Opinion. Hence, they doubt the assumed fast growth projected by the administration (which reflects the Lafferite view in their opinion). The Lafferites, in turn, argue that velocity will increase by unprecedented amounts given the revolutionary nature of the tax out. For an interesting depiction Of both views in relation to velocity growth rates, see M. Johnson, "Are Monetarism and Supply- Side Economics Compatible?', in Supp1y-s1de Ecenem1cs, pp. 405-414. 44Rousseas asks: "Where does Supply-Side Praxis come out in all this? It is clear that there is a lack of coherence in supply-side 'theory'. The classical supply- siders [Lafferites] are in fundamental disagreement with their monetarist brethren, and the Old Guard budget- balancers are undercutting both. Supply-side praxis is based on a garbled 'theory' which points in several directions at the same time." [See Rousseas in note 5 above, p. 115.] Rousseas then refers to the Greider article on Stockman's confessions in The htlaht1c Menthly, December 1981, pp. 27-54, where Stockman is quoted: "None of us really understands what's going on with all these numbers. . . . You've got so many different budgets out. . . . People are getting from A to B and it's not clear how they are getting there. . . . We didn't add up all the numbers. . . . We ended up with a list that I'd always been carrying of things to be done, rather than starting the other way and asking, what is the overall fiscal policy required to reach the target? . . . I've never believed that just cutting taxes alone will cause output and employment to expand. . . .. Some of the naive supply-siders just missed this whole dimension. . .. . You don't stop inflation without some kind of dislocation." [Reprinted in Thomas J. Hailstones (ed.), yiewpeinte, op. cit., pp. 294-299, and in William Greider, The Educat1en of hey1d Steckmeh end chet AM. (New York: E.P. Dutton, Inc., 1982).] See also D. Stockman, The Triumph Qt Bo11t1c . (New York: Harper 8 Row, 1986). 138 45Chimerine and Young write: ”There is no evidence to support the notion that increased supplies of commodities or finished goods have resulted from lower marginal tax rates, or that the tax cuts have been a major factor in reducing inflation because Of any change in the aggregate supply curve." [Lawrence Chimerine and Richard Young, "Economic Surprises and Messages of the 1890's, Ame11eeh Econem1c Rey1ew, vol. 76, no. 2, May 1986, p. 33. ] “Our work at The Urban Institute shows that nearly one-fifth of that drop occurred because the CPI index itself overstated inflation in 1980. . . . Then we estimated that more than one-third Of the drop in the CPI was due to favorable movements in volatile items such as food, energy, and import prices. Much of that drop would have occurred in any case, even without a severe recession. Finally, the remainder, or about half the drop in inflation, was due to the recession.“ [Isabel Sawhill, ‘ "Can We Salvage the 19808?', ghellehge, September-October, 1984, p. 20.] 46For Samuelson, "the massive reduction in nominal and real interest rates brought the residential construction business back to life. Durable goods like autos began to sell well again. IUi the standard textbook pattern, the Fed's easier-money program brought the 1981 Reagan recession to its end in November 1982. It was a consumer- led recovery. As usual, plant and equipment investment were lagging time series. . . . Looked at another way, the colossal budget deficit finally had its Keynesian 'stimulating effects once the high real interest rates occasioned by fear of future deficits were offset by easier Federal Reserve credit policy." [See Samuelson in note 10 above, p. 10.] See also Sawhill in note 41 above, p. 21. For Peterson and Estenson, "Both the recession and the recovery were the result of Keynesian and not supply-side factors. This was not the intent of the administration, but it is the way things turned out." Note that by "Key- nesian" factors Estenson and Peterson mean "demand-side" factors. See Peterson and Estenson in note 18 above, p. 461. 47'In February 1983," writes James K. Galbraith, "the administration forecasts were for real economic growth of 3.1 percent in 1983 (fourth-quarter over fourth-quarter), with most of that in the second half of the year. Actual growth has been much better: 2.6 percent in the first quarter and 9.6 percent in the second, and 7.7 percent in the third. . . . By the standards of past recoveries, however, this performance was not unusually strong. Five of the seven previous postwar recoveries saw higher average growth rates in the first three quarters Of expansion. . . 139 . Given, however, that the preceding recession was second in severity since 1949, one might have regarded even higher growth as normal, since deep recessions tend to generate rapid rebounds." [James K. Galbraith, "The Case for Rapid Growth,“ Challenge, March-April 1984, p. 11.] For Stockman, “what economic success there was had almost nothing to do with our original supply-side doctrine. Instead, Paul Volcker and the business cycle had brought inflation down and economic activity surging back. But there was nothing new, revolutionary or sustainable about this. . . . By the end of 1985, the economic expan- sion was three years Old and demonstrated no miracle. Real GNP growth had averaged 4.5 percent--an utterly unexcep- tional recovery by historical standards, and especially so in light of the extraordinary depth Of the 1981-82 recession." [See Stockman in note 14 above, p. 64.] "To assess the claims of the new supply-siders," Feldstein writes, ”it is useful to compare the actual growth of real GNP between 1981 and 1985 with the growth that the supply-siders initially projected. The record shows that real GNP increased 10.9 percent between 1981 and 1985, only slightly more than half Of the 19.1 percent predicted in the Reagan Administration's original economic plan. . . . During the first four quarters of the recovery, real GNP increased at about the average pace of the previous recoveries. Zni the second year Of the recovery, the rise in GNP exceeded the past norm. But now, eleven quarters after the recovery began, the cumulative rise in GNP has settled back to the middle of the range of past recoveries." [M. Feldstein, "Supply-Side Economics: Old Truths and New Claims," hme11eeh_fieehem1e_3eg1eg, vol. 76, no. 2, May 1986, pp. 29-30.] 48For Peterson and Estenson, "productivity grew at a pace slower than during any other postwar recovery. The average annual rate of productivity growth during the other postwar recoveries was 3.5 percent. Yet, in 1983 productivity increased by only 2.7 percent. . . . The savings rate also fell during both 1982 and 1983, to 6.2 percent of disposable income in 1982, and 5.0 percent in 1983. It should have gone the other way. . . . Savings and investment are related, though the line of causation is the reverse of the supply-side belief. Firms will save more because they wish to invest more in the future. Their desire to invest comes from their belief that demand exists for their product. . . .. The facts show that the key variables behaved more in accord with Keynesian than supply-side theory." [See Peterson and Estenson in note 18 above, p. 455.] 140 For Feldstein, "those who wish to believe that the cut in the tax rate stimulated a major increase in the number of people wanting to work will be disappointed by the data on labor force participation rates." [See Feldstein in note 47 above, p. 28.] 49For Alan Reynolds, "The Reagan expansion has been an investment boom of unprecedented proportions. How could investment flourish despite abundant unused capacity in 1983 and the Federal Reserve's outspoken efforts to slow the progress with interest rates that were four times the rate of inflation? The only coherent answer is that the after-tax reward for investment was so attractive that it justified borrowing at such high real interest rates. Accelerated depreciation and the investment tax credit are obvious reasons, but lower marginal tax rates on 'personal' income also raised the net return for unincorporated business and for individuals' dividends and capital gains. Clearly, reduced marginal tax rates on capital did induce more investment, and reduced tax rates on labor were favorable on both investment and employment.” [See Reynolds in note 23 above, p. 15.] P.C. Roberts writes: "The picture of the recovery presented by statistics on the gross national product is unambiguously clear. It is that of an investment led recovery. . .. . The GNP statistics are loaded with facts that vindicate the supply-siders and embarrass their critics." Recall that SSE advocates believe that the first-order effect of a tax rate cut is to increase investment leading to an increase in real GNP and later leading to an increase in consumption only as a second- order effect. [See Paul C. Roberts, "Consumption Should Not Get Credit for the Expansion," Business flegk, July 23, 1984, p. 16.] 50Martin Feldstein asks: "How much of the recovery has been due to the stimulus of increased supply that was provided by the new [Reagan] policies? I have already commented on the lack of evidence of an induced increase in the number of people wanting to work. But it would be equally wrong to view the recovery as the result of fiscal stimulus to demand as some traditional Keynesians have done. . . . In fact, the rise in nominal GNP since 1982 can be more fully explained by the traditional relationship to the lagged increase in money (M1)." (i.e., that changes in M1 cause changes in nominal GNP.) ”Only further research," Feldstein adds, "will resolve whether supply-side influences have contributed to the rise in real GNP since 1981. Let me emphasize that, to a traditional supply-sider like me, the positive but apparently modest supply-side effect is neither surprising 141 nor disappointing. Although we would expect some increase in work effort from the reduction in the highest marginal tax rates, past evidence all points to relatively small changes. The favorable effects of improved incentives for saving and investment can only be expected after a much longer period of time." Note that Feldstein's views are very close to those of the monetarist supply-siders. See Feldstein in note 47 above, p. 28. 51For Dugger, "the Reagan program will not revitalize American capitalism. Quite the reverse. After a brief fillip from tax cuts, the long-run effect of the Reagan program will be to thwart the immense development potential of the American people. This is because of the high socioeconomic costs of the Reagan program, costs often overlooked by economists. . . . The [tax] cuts are heavily skewed toward business and higher-income individuals. . . . Of the roughly $49 billion in nonmilitary budget cuts, a large portion of the cuts will fall on programs for the poor and disadvantaged. . . . A very large increase in inequality is underway and the long run social costs will be immense." [See William Dugger in note 7 above, pp. 796-802.] Lee Bawden and Frank Levy write: "Thus the largest relative declines in income resulting from the combined effects of the tax, AFDC [Aid to Families with Dependent Children], and Food Stamp changes are for working AFCD families with incomes just above the poverty level. Their aincomes after taxes and transfers decline by as much as $550, or 5.5 percent." [Lee Bawden and Frank Levy, "The Economic Well-being of Families and Individuals," in The Reegen Experiment, p. 480.] See also Robert Buchelle, ”Reaganomics and the Fairness Issue," ghellegge, September- October 1984, pp. 25-31. 52Don Fullerton and Yolanda Henderson write: "Our measure of the weighted deviation in the costs-of-capital across the economy remains unchanged from the 1980 law. In other words, despite the reduction in overall tax rates, there has been no apparent improvement in the efficiency with which capital is allocated across its various uses." [Don Fullerton and Yolanda Kodrzycki Henderson, "Incentive Effects of Taxes on Income from Capital: Alternative Policies in the 1980s," in The_Legeey, p. 80.] 53According to D.A. Nichols, "if the Reagan administration had wished to use budgetary spending deci- sions tn) enhance economic growth, it would have proposed increases in those areas thought to stimulate growth rates. These areas certainly include R & D, physical facilities, the environment, and human capital formation. . . . Indeed, 142 because outlays in these critical investment areas have, in general, been reduced, I must conclude that the prospects for economic growth have been hurt." [Donald A. Nichols, "Federal Spending Priorities and Long-Term Growth," in The Legeey, p. 173.] For a similar argument, see James Tobin, "The Supply-Side," in supply-side gcenemics, p. 344. S4Sawhill writes: "We have calculated that the 1981- 82 recession caused a cumulative loss of business investment ranging from $100 to $200 billion. That corresponds to a fall in the stock of capital of between 1 and 2.5 percent below what it would have been if the Adminis-tration had followed an alternative economic policy consisting of a less restrictive monetary policy, a tighter budget, and much smaller federal deficits.” [See I. Sawhill in note 45 above, p. 20.] For a similar estimate for the lost capital formation during the recession, see I. Sawhill and J. Palmer (eds.), The Beegen Becegd. (New York: Ballinger Publishing Co., 1983), pp. 97-103. 55"'Will the recovery lead to noninflationary growth that can be sustained over the long term? I think we are going to have to pay the piper for the big deficits later this decade, either in the form of higher inflation or lower growth." [See Sawhill in note 45 above, p. 21.] ”Although inflation rates are down," James K. Galbraith writes, ”it seems that there has not been a fundamental shift back to the noninflationary environment of the Fifties and Sixties." [See James Galbraith in note 47 above, p. 14.] 56For Michael Evans, "the staggering burden of high interest rates negates the tax cut of its essential benefits for the middle-class consumer who borrows to buy a house or other assets and cannot afford to save very much because such a large proportion of his income is gobbled up by mortgage rates. Thus the tax-cut induced deficits have robbed the middle class of any improvement in real disposable income by raising interest rates.“ [See M. Evans, The Tguhh Aheuh supply-side Ecenemics, p. 267.] For A.C. Lerner, ”If one takes the deficit and combines iJ:*with external corporate financing needs, and takes that as a percentage of gross savings flows, in 1965 this financing totaled about 12 percent of gross savings flows. . . . In 1970 this ratio rose to about 35 percent of gross savings flows. This year [1982] the deficit amd corporate external financial needs combined will be about 60 percent of gross savings flows. . . . It is a very serious trend. Why has the long-term market declined sharply in stature? Why are real rates of return so high now? . . . There will not be a significant increase in 143 business investment without a smoothly functioning financial market-~regardless of the incentives to save." [Alan C. Lerner, "A Wall Street Perspective," in shpply; Side Eeenomiee Tn hhe 1289s, p. 95.] For Chimerine and Young, "federal deficits, and the tax cuts that have largely caused them, have thus become counterproductive for economic growth—~their direct stimulus was being outweighed by the adverse effects of the excessively high interest and dollar exchange rates which they caused." [See Chimerine and Young in note 45 above, p. 33.] 57James Tobin writes: "The net result is a structural primary deficit of about 2 percent of GNP, which will rise to 3 percent in another four years. These are magnitudes unprecedented in peacetime. The word primary in that concept excludes debt-interest payments and related trans- actions: a primary deficit is what we would have if there were no outstanding debt. The word structural excludes cyclical components. . . 7. Specifically, the structural deficit is what existing budget programs, along with tax and entitlements legislation, would produce if the unemployment rate were 6 percent. . . . The net real interest rate cost of debt service exceeds the sustainable rate of growth of real GNP." [See J. Tobin, ”The Fiscal Revolution: Disturbing Prospects," We, January— February 1985, p. 14.] A. Blinder compares the simulation outcomes of three widely used models on growth, with and without the Reagan 'fiscal policy (i.e., by keeping monetary policy as it was before the Reagan program). The models used are the Data Resources quarterly macro model (DRI), the Wharton annual model (WEFA), and the MIT-Penn-SSRC quarterly model (MPS). Blinder concludes that while the DRI nwdel supports the most optimistic forecasts that "after nine years the Reagan program will give the U.S. economy almost 5 percent more capital, over 2 percent more GNP, and no higher prices than it otherwise would have had," and the MPS model supports the most pessimistic forecasts that "after seven years of Reaganomics, the country winds up with a price level 2 percent higher and real GNP 5 percent lower," on balance, "there is one important area of agreement among the models. Even the most optimistic assessment of the effect of Reaganomics on real growth (by the DRI model) says that the effect is small. Why resist the obvious conclusion?” [See A. Blinder in note 39 above, pp. 199-221.] "Yet how can economic growth remain high and inflation low for the long run," Stockman asks, "when the adminis- tration's de facto policy is to consume two-thirds of the nation's net private savings to fund the federal deficit? The clock is thus ticking away inexorably toward another 144 bout of inflationary excess. If we stay the course we are on now, the decade will end with a worse hyperinflation than the one with which it began.” [See Stockman in note 14 above, p. 64.] 58"Reaganomics picks and Chooses from among the competing schools in order to justify its goal of redistributing wealth in favor of the wealthy. Its ultimate objective is redistribution whether or not it leads to growth." [See Rousseas in note 5 above, p. 120.] "The rise of government in democratic societies, historically, has been in response to the excesses of private economic power. And it has been the intermediation of government that has, however imperfectly, legitimated the system and kept it in a precarious balance. And it is this precarious balance that Reaganomics now threatens to undo in the name of a rampant form of capitalism.“ [Ibid., p. 143. ] See also James Tobin, "Supply-Side Economics," in Ynmuxubts.rh 138. 59For Daniel Patrick Moynihan, "the unprecedented triple-digit deficits beginning in President Reagan's second year in office were deliberately created to force a great reduction in the size and activities of the federal government. . . . Asked about our deficits by an Austrian magazine, von Hayek said in 1985 that he regretted them, but added: . . one of Reagan' s advisers told me why the President has permitted [the deficits] to happen, which makes the matter partly excusable: Reagan thinks it is impossible to persuade Congress that expenditures must be reduced unless one creates deficits so large that absolutely everyone becomes convinced that no more money can be spent. The disaster [recession] was not deliberate; the deficits were. The deficits were meant to spur action, but didn't, thereby resulting in disaster. We now have David Stockman's memoirs, The Triumph efi Eelieies: Whv the Eeasan.£exelutien_fiailed. which I believe confirm the theory." [See Daniel Patrick Moynihan, "Political Aids," The New Bepublie, May 26, 1986, p. 17.] Robert Samuelson, however, argues that Reaganomics was not necessarily a "revolution" against government. Samuel- son writes: 'If Reagan had sought a 'revolution', he might have declared that government, for all its good intentions, could not guarantee prosperity. Therefore, it should not try. Instead, he argued that his vague economic program (variously labeled 'Reaganomics' or ‘supply-side economics') would restore good times. Far from disavowing government responsibility, Reagan embraced ita To shrink 145 government significantly, Reagan might have proposed eliminating the pillars of the welfare state, Social Secur— ity and Medicare. Reagan never went so far, and although Stockman may have harbored such notions, neither did he. The basic idea that government should protect the poor and elderly remained. Reagan changed the details of major programs and proposed eliminating some minor programs. But even with his tax cut, the tax burden is still at the average of the 19708." [Robert Samuelson, "The Imaginary Revolution," The N9! Bepuhlic, May 26, 1986, p. 32.] 60See Rousseas in note 5 above, p. 95. 61P. Samuelson asks: "Should we economists be pleased that for once, at least, our mainstream theories have seemed to be about right? Yes, perhaps." Note that by "mainstream" Samuelson means "Keynesian“. See Paul Samuelson in note 10 above, p. 11. 62For von Furstenberg and Green, ”supply-side politics [SSE], by piling up problems of austerity for tomorrow in return for short-lived boosts to domestic absorption today, would have revealed itself the enemy of supply-side economics. The latter's major contribution was to have been to shift emphasis in policy-making from short-term expedients to minding the economic base." [George von Furstenberg and R. Jeffrey Green, "Supply-Side Modeling from Bits and Pieces," Amegicen Economic Eeyieg, May 1986, p. 41.] ‘ 63According to M. Lower, "the dashing of supply-side dreams within the Reagan administration leaves it with an ideology and no program to address the central questions of economic policy in the 19803." [Milton Lower, "The Reindustrialization of America," Jegrhel e: Ecenemic Leehee, vol. XVI, no. 2, June 1982, p. 630.] See also Rousseas in note 5 above, pp. 95-142; and W. Dugger in note 7 above, p. 796. 64"In its tax cut udracles the strident SSE rhetoric gulled a public always ready to hear of salvation by a tax cut. Faith comes naturally in a country founded on a tax rebellion and now suffering from stagnating productivity and wretched inflation. Under the price seige it is particularly easy to believe that we will be better served if the government shared as a less avid partner in our income. The ground is always fertile for SSE demagoguery, especially under inflationary anguish and real income frustrations." [See Weintraub in note 31 above, p. 182.] For Tim Congdon, ”the supply—siders know well enough that the gold standard will not be restored. In 146 consequence, when their program--of which the centerpiece has always been the boost to the supply side from lower taxes--does not work, they will be able to say that the Administration's refusal to link the dollar to gold was responsible for failure, not the inadequacy of the econ- omy's response to tax cuts. . . . But it should be obvious that the appeal to the gold standard is tangential to the debate. . . . The case for or against tax cuts is logically separate." [See Congdon in note 19 above, p. 14.] According to P. Mirowski, "No one will accept the Reagan tax program as a deliberate test of the Laffer curve. By December 1981, in the face of rapidly escalating unemployment and ballooning deficit projections, Arthur Laffer was attempting to disassociate himself from the impending debacle by insisting that Reagan's tax cuts had not gone far enough." [See Mirowski in note 8 above, p. 823.] See also Thomas Hazlett, "An Austrian's Critique,” 65For A. Reynolds, "The Years 1981 and 1982 provided no test of either the tax or monetary proposals of supply- side economics. Tax rates were not reduced in those years, but were instead increased. . . . What we experienced in 1981-82 was a massive failure of demand-side economics." [See A. Reynolds in note 23 above, p. 14.] Similarly, Hale argues that Reaganomics was not bold enough and that the tax cuts were too little too late. Hale writes: "It would be a pity if its economic program »[Reaganomics] failed because it was not bold enough to replace an expensive but inadequate program of tax relief with a more far reaching program of structural tax reform that fundamentally altered the impact of taxation on work, savings, and investment." [David Hale, "Rescuing Reaganomics," Policy Beylew, Spring 1982, p. 68.] In fact, G. Gilder, J. Kemp and J. Wanniski argue that SSE was not properly implemented because Reaganomics gave little tax cuts to individuals and more tax cuts to corporations (the reverse of what they believe should be done). See Rousseas in note 5 above, p. 94. "Investment tax credits and rapid depreciation allowances--although better than no tax cuts at all--tend to favor the recreation of current capital stock rather than the creation of new forms of capital and modes of production." [Gilder, W. p. 243.] 66Paul Craig Roberts argues that Reaganomics had to be a compromise between the 3 supply-side groups because Lafferites were too small to staff the White House and the administration. Roberts writes: "Although the President campaigned as a supply-sider, the coterie of supply—siders was too small to staff a Reagan Administration. . . . The 147 Reagan Revolution was loaded down with policymakers who believe that tax cuts are a reward to be given out after the economy has been revitalized by other policies. . . . They do not see tax cuts as a means of a stronger economy. . . . No supply-siders penetrated the White House compound. . . . Margaret Thatcher had also been conciliatory, and in a spirit of cooperation and unity she too appointed a team that did not share her faith in her policies. . . . Ideas never go far without people to carry them." This is the case because Roberts thinks that only Lafferites are "true; supply-siders. [Roberts, The fin pply- Sid e Reyelgtleh, pp. and 5.] Note that what Roberts calls 'supply- -siderss above, the present writer calls the Lafferites. 67Michael Evans (a balanced-budget supply-sider) argues that Reaganomics failed because it promised too much too soon and because it was an unbalanced SSE approach by not cutting spending and balancing the budget. See Evans, u - c , pp. 273- 77. David Stockman writes: ”I think the history of the last five years totally invalidates the Kemp version of supply-side economics, which is that there are no hard choices, no trade-offs, no pain, that all we have to do is cut taxes and talk about a gold standard and the economy will be perfect. That's irresponsible nonsense." [See Stockman in note 2 above, p. 58.] Recall that Kemp was identified as a "Lafferite“, while Stockman was identified as a "balanced-budget supply- sider' (at least when he was in the Reagan administration). 68Lerner argues that tax cuts should have been implemented only after spending was cut and the budget was balanced. See Alan Lerner in note 56 above, p. 89. For a similar argument, see W. P. Gramm, "Supply-Side Aspects of Government Spending," in an pply- side Beehemlc e 1h the lfiflfle, pp. 257-262. According to Michael Evans, "the Reagan tax cut was also hampered by its association with the so-called Laffer- curve, which apparently violated the first maxim of economics, namely that there is no free lunch. It was not enough to argue that the tax cut would stimulate the economy, reduce unemployment, and raise productivity. The Laffer curve stated baldly that in addition the budget could be balanced by cutting taxes," with which Evans disagrees. Moreover, Evans advises to "cut government spending first, delaying tax cuts until the budget is balanced.“ [See Evans in note 67 above, p. 108.] For a monetarist supply-side view, see Feldstein in note 69 below, and David Raboy, ”Norman B. Ture on Supply- Side Economics," in‘yiegpei_h§, p. 65. 148 69M. Feldstein writes: ”These policies [Reaganomics] were a major step in the direction recommended by supply- side economists of both the new and old varieties. What distinguished the new supply-siders from the traditional supply-siders as the 19808 began was not the policies they advocated, but the claims that they made for those poli- cies. The traditional supply-siders (although I dislike labels, I consider myself one of that group) were content to claim that the pursuit of such tax, spending, and mone- tary policies would, over the long run, lead to increased real incomes and a higher standard of living. . . . The 'new' supply-siders were more extravagant in their claims. They projected rapid growth, dramatic increases in tax revenue, a sharp rise in saving, and a relatively painless reduction in inflation. . . . Probably no single individual made all of these c1aims--at least not at the same time. And anyone who feels the need to defend his name can argue that the administration's 1981 economic program was not enacted exactly as proposed. Nevertheless, I have no doubt that the loose talk of the supply-side extremists gave fundamentally good policies a bad name and led to quantitative mistakes that not only contributed to subsequent budget deficits, but also made it more difficult to modify policy when those deficits became apparent." Note that those whom Feldstein calls the "new" supply- siders are here designated the "Lafferites". [See Feldstein in note 47 above, p. 27.] McCracken writes: "Unfortunately this concern about a real problem (stagflation) metamorphosed into preoccupation - with a highly vernacularized form of supply-side economics, and what should have been a major accomplishment has been a disappointment. This issue came into focus as an implementation of the Laffer curve . . . the nation cannot escape asking if Reaganomics is a success or a failure, and that is the question posed here. The answer, of course, is 'Both'. There are some items on the minus side and some on the plus side. . . . In all probability history will record that the most serious short-fall of the Administration's economic program was in the interrelated matter of budget policy and its interpretation of supply-side economics. . . . There is now danger that the failure of this popularized or verna- cularized supply-side theory, which never had a strong theoretical and empirical foundation, may erode support for some changes in policy needed to strengthen the basic capability of the economy. . . . There are, however, some major entries on the plus side. Reaganomics has made a contribution to steadier monetary policy.” [See McCracken in note 26 above, pp. 82- 91.] CHAPTER V CONCLUSION It may be granted that, even in its purest form, economic theory has implications for policy and in that sense makes political propaganda of one kind or another. This element of propaganda is inherent in the subject and, even when a thinker studiously maintains a sense of Olympian detach- ment, philosophical and political preferences enter at the very beginning of the analysis in the formation of, as Schumpeter would have it, his "vision": the preanalytical act of selecting certain features of reality for examination. The problem is not that of denying the presence of propaganda but that of separating the scientific ideas from the ideology in which they are inevitably embedded and to submit these ideas to scientific tests of validity. . . . The task of the historian of economic thought is to show how definite pme-conceptions lead to definite kinds of analysis and then to ask whether the analysis stands up when freed from its ideological foundation.* - Mark Blaug Economics cannot be a precise science of calculable effects. Its nature is to be the subject-matter of critical imagination, a subject-matter suited to an essentially literary expression, like history itself. It is a truth so obvious as to be banal that science exists only in the minds of men. Insight into the thing in being of which we form a part, whether we attend to its non-human or its human aspect, cannot consist in a knowledge of its nature or meaning in any ultimate, absolute 149 150 sense. All we can seek is consistency, coherence, order. In the sciences (so-called) of men and their affairs, the investigator may be said to impose rather than discover the orderliness which constitutes knowledge.** - G.L.S. Shackle n duc ' n: This chapter has the following objectives: First, to argue that the development of SSE has been more in consonance with the relativist than with the absolutist approach to the history of economic thought. Second, to study the significance of the rise of SEE in relation to both the status of the economist as "technician" and the identity of economics as a science. Third, to identify the origins of SSE (especially its ideolOQY), how it developed, why it was chosen for policy in Reaganomics, and how the whole SSE episode relates to the problem of ideology vs. technique, and its significance to the present state of economics. Finally, to study the "revolutionary“ claim and the place of SSE in the discipline from both the absolutist and relativist points of view. 5,2 Abeeluhlem gs. Belatiylsm: The development of SSE has been more in consonance ‘with the relativist than with the absolutist approach to the history of economic thought. To defend such an argument, this chapter will consider Mark Blaug as a 151 representative of the absolutist and G.L.S. Shackle as a representative of the relativist, although the complete views of each combine the two. Mark Blaug believes that ideology and analysis, or normative and positive economics, can substantially be separated. For Blaug, such a separation permits the historian of economic thought to "study whether the analysis stands up when freed from its ideological foundation.” This, in turn, leads the historian of thought to "determine whether the analysis contributes or adds to the development of economic science by submitting the analysis to scientific tests of validity.” These scientific tests are determined by the analytical tools or standards of modern economic theory which, according to Blaug, have been continuously improved and augmented throughout the historical progress of economic theory. Blaug's approach to the development of economic thought produces the absolutist who, "looking down from present heights at the errors of the ancients, cannot help but conclude that truth is largely concentrated in the marginal increment to economic knowledge."1 1G.L.S. Shackle, however, believes that ”ideology and analysis cannot be so easily separated." Shackle insists that "economic science exists only in the minds of men," and that the investigator (economist) is said to "impose rather than discover the orderliness which constitutes 152 knowledge." Shackle's approach to the development of economic ideas produces the relativist who believes that "there is no inevitable advance from less to greater certainty; there is no ruthless tracking down of truth, which once unbared, shall be truth to all times." Hence, "insight into the thing in being of which we form a part, cannot consist in a knowledge of its nature or meaning in any ultimate, absolute sense." Moreover, Shackle claims that: Theoretical advance can spring only from theoretical crisis: either internal crisis, as when, for example, the analytically indispensable‘ assumption of perfect competition is recognized to conflict with the notion of economies of large scale . .. . or external crisis, as when the established theory of value seems to declare general heavy unemployment impossible, in self- destructive contradiction of the facts. Given the above, the present writer will argue (a'la the relativist) that the rise of SSE in the discipline reflects a continuing search for the identity of a field that has been separated from philosophy only within the last two-hundred years. Hence, this chapter will draw an analogy between the 19705 and 19303 to argue that during times of ”economic crisis", the status of the economist as technician (a'la Blaug) is usually jeopardized. This, in turn, provides an opportunity, not only for the development of new theories cu: revolutions (against existing orthodoxies), but also for the development of theories or ideologies that search for ideological rather than 153 technical solutions. The development of SSE, industrial policy, and possibly religious fundamentalism in the 1980s (to mention only a few) as reactions to the "failure" of demand-management to control stagflation in the 19705, reflects the existence of such a crisis or opportunity. The role of the economist as technician holds as long as economists find successful solutions to existing economic problems. Once the technician "fails", ideological solutions are called for. Moreover, with the increasing role of government in modern capitalism, the ideological nature of the economic debate is apt to become more visible and, probably, more heated. This continuing shift from technique to ideology and back again reflects a continuing search for the identity of the field. Whether the current situation may or may not be called an "identity crisis", such a situation is not the first and, probably, not the last.3 Given the ideological nature of SSE, the purpose of this dissertation has not been to reach the "final word" on whether it was a revolution or a temporary fad, a theory or an ideology (if such a distinction can really be made a'la Blaug), or better or worse than Keynesian economics (in terms of analysis and actual achievements). Rather, it has been to study the origins of SSE (especially its ideology), how it developed, why it was chosen for policy in Reaganomics, why it was rejected by its critics, and how 154 the whole SSE episode relates to the ideology vs. technique problem and its significance to the present state of economics, to which we now turn. ' n‘ 'c c 'se W: In 1967, G.L.S. Shackle argued that the occurrence of the Great Depression in the 19305 brought an end to the Age of Tranquility (1870-1910) of the neoclassical general equilibrium theory. That Age of Tranquility originally existed, Shackle added, because the neoclassical theory seemed (at least to its builders) to be a satisfactory explanation of macro processes. So long as we have a satisfying conceptual structure, Shackle argued, a model or a taxonomy which provides for the filing of all facts in a scheme of order, we are absolved from the tiresome labor of thought. It was the occurrence of widespread unemployment in the 19303 that ended that Age of Tranquility, Shackle concluded, because of its contradiction with existing theory. That age of Tranquility was replaced by the Age of Turmoil leading to theoretical crisis and, consequently, to theoretical advance: the Keynesian revolution.4 If the term ”the Great Depression of the 19308" above is replaced by the term "the stagflation of the 19705“, then an analogy can be drawn between the two periods. Since the development of Keynes' theory, and with the help of World War II, the New Deal, the Neoclassical-Keynesian 155 synthesis, and the tax cuts of the 19608, another “age of tranquility" seemed to be emerging. Economists presented an image of complete control over the performance of the economy. The economist was viewed by both the public and the politicians as a technician, a mechanic, as it were, who mastered macroeconomic processes.5 This image was further enhanced by the development of econometrics and the increased mathematization of economic theory. This was another age of tranquility and, in the words of Shackle, of setting of minds at rest. It was an age of positivism (a'la Blaug). Economists left their normative questions on the back burner.6 But, the stagflation of the 19703 seemed to shatter that sense of tranquility bringing with it another "age of turmoil”. Economists were, not only taken by surprise, but also embarrassed. The policy role of the economist was jeopardized.7 While the technicians went back to their models to study where they "failed" (since the status of economists seemed positively correlated with their ability to predict), both the people and the politicians were willing to listen to answers from someone other than practitioners of the Neoclassical-Keynesian synthesis. This was an opportunity, not for technicians, but for 'pamphleteers' and "ideologues". This was a time that witnessed the rise of religious fundamentalism, supply- side economics (SSE) on the Right, and industrial policy on 156 the Left. It is interesting that such a period brought with it completely opposing explanations and remedies. While the advocates of SSE were calling for less government intervention in the economy to unleash their "supply-side" incentives, their industrial policy brethren were complaining of the lack of it. But why was SSE the one that was chosen for policy in the 19805? It was because of its propaganda and rhetoric, its superior salesmanship, and its luck. In a democratic capitalist society, arguments in favor of lower taxes, lower regulation, and less government are bound to be very popular. [With accelerating inflation rates, people were shifting (due to bracket creep) to higher nominal income brackets and, consequently, paying higher taxes (an unfavorable outcome especially during inflation). People felt that they were being "robbed” by both inflation and the government. SSE advocates realized such frustration and sought tn: capitalize on the notion of a tax cut promising (amid severe professional skepticism) a world with rua‘trade-offs. ‘Hence, many people were willing to vote in favor of Reaganomics (or SSE) in the belief that higher taxes were a major cause of their existing economic malaise (witness the fate of candidate Walter Mondale in 1984 when he proposed to raise taxes if elected President). Moreover, SSE advocates realized the political and ideological nature of economic theory especially in 157 relation to the role of government in the economy. Existing economic theory, they argued, was "rationalizing" the increasing role of government intervention, a major cause of stagnation in their opinion. Given the lack of confidence in technical solutions, they delivered an ideological solution. Although they had other implicit objectives (such as their call for an increased focus on the "morality” of capitalism), they explicitly demanded that the government should withdraw from the economy.8 To make their argument persuasive (especially to the public), they did not write in the language of the "technician". After all, they were not writing for economists, but for the layman in the street and, especially, the politician.9 In fact, it was this non-technical approach to economic problems that was heavily criticized by the technicians. The acceptance of SSE, its critics shouted, would lead to anti-intellectualism and intellectual luddism. It was an ideology, the technicians added, reflecting their belief in the easy separation between ideology and analysis (a'la Blaug). When freed from its ideological content, the technicians seemed to conclude, nothing else remains. It was an ideology without substance. This was the worst criticism of an economic theory from the technician‘s point of view. After all, the technicians were trained in the age of tranquility, the age of technique, the age of positivism. Ideology was their 158 "black sheep", not to be mentioned, not to be disturbed.10 SSE advocates sensed such a "weakness", and that was where they "attacked". They were not calling only for technical solutions. Rather, their theory was largely ideology. This was the time to awaken the black sheep, to open the technician's "black box", to expose his ideology. The continuing acceptance of an increased role for government (especially in the form of income redistribu- tions in favor of the poor) among the technicians, SSE advocates argued, was leading the U.S. capitalist system to converge towards socialism. In their opinion, demand-side economics was another name for socialism, while supply- side economics was another name for capitalism. Socialist economies are less productive than capitalist ones, they insisted, because of their focus and emphasis on demand- side economics in the form of government intervention and redistributions of income. Both so-called "liberal" and "conservative" economists were contributing to such a continuing convergence, they claimed, because of their endorsement of previous redistributions in favor of the poor. Liberals were socialists, they insisted, and conservatives were not conservative enough and were being "spoiled" by the liberals.11 The focus on demand-side economics rather than supply- side economics among the technicians, they added, was a major contributing factor to the movement towards 159 stagflation and, consequently, socialism. The socialist economy, in the words of George Gilder, proceeds from a "rational" definition of needs or demands to a prescription of planned supplies. In a socialist economy, one does not supply until the demands have already been determined and specified. Rationality rules, Gilder adds, and it rules out the awesome uncertainties and commensurate acts of faith that are indispensable to an expanding and innovative system. Capitalist production, Gilber insists, "entails faith--in one's neighbors, in one's society, and in the compensatory logic of the cosmos. Search and you shall find, give and you will be given unto, supply creates its own demand." It was the continuing acceptance of the welfare state among the technicians that was leading to stagflation. The welfare state was providing too much security at the expense of risk. Without risk, SSE advocates maintain, capitalism does not work.12 By ignoring this psychological aspect of capitalism, SSE advocates suggest, economists have contributed to the decline of the system by focusing on technique. It is psychological forces, they insist, that above all else shape the performance of the economy. Material progress, they maintain, is "inimical to scientific economics: it cannot be explained or foreseen in mechanistic or mathematical terms." After all, they concluded, ”the technician or the expert looking at a thing goes on seeing 160 less and less of that thing." Wealth and poverty, they add, are subjects "too vast and vital to be left to economists alone.“ Economists presented a dismal science, a world full of trade-offs, a zero-sum society.13 SSE advocates promised to change all that. They promised a world of no trade-offs, a world of free enterprise, a world of prosperity for all, a positive-sum society. Take government out of people's lives and everything would be fine. Government was "evil". It was a giant that grew more “hungry" every day. Cut taxes, regulation, and intervention, and prosperity would ensue via unleashed incentives. People are very sensitive to both psychological (risk) and monetary incentives, they argued, and the welfare state was negatively affecting such incentives. Increased taxes and redistributions of income in favor of the poor have both demoralized and sapped the vitality of the "supply-side", the rich, the entrepre— neurs.14’ This was their ideological ”vision" of how the world works and, to the dismay of the technician, they were getting a hearing, at least from policy-makers. d d ks: A. 553 §§ ldeelogy: Almost all economic theory begins with a "vision" of how the world works. Furthermore, almost all economic theory can be characterized as "supply-side” economics: 161 Almost all visions reflect the economist's opinion or simplification of reality in the form of behavioral assumptions and a-priori assumptions about the sources of growth and prosperity, that is, the supply-side. Whether the source of growth or prosperity was defined as bullion (a'la the mercantilists), agriculture or land (a'la the physiocrats), division of labor and the extent of the market (a'la Smith), or effective demand (a'la Keynes), that source of growth constituted, in effect, their supply- side. For SSE, however, the source of growth was not necessarily a technical tax cut for the rich and less welfare for the poor. Growth resided in uncertainty, in risk, in the belief in future reward, in "faith". That faith was being continuously eroded by the welfare state. Both the businesses and people were continuously "spoiled" by the welfare state to the point where they became totally dependent on it.15 Since the New Deal, they argued, the role of government became a provider of insurance against uncertainty and risk without which capitalism cannot work. Modern capitalism was approaching a point of complete dependence on government: socialism. Growth cannot proceed in an environment of certainty. People work hard, innovate, and entrepreneur only in response to risk and opportunity, both psychological factors. The welfare state broke that psychological link between effort and reward: 162 the essence of growth. Moreover, SSE was offering a different kind of capitalism. The essence of capitalism was run: "self-interest” (a'la Smith), but "altruism" and "love". Capitalism, George Gilder argues, begins with giving without even knowing of the reward. It was the technicians, the economists, focusing on self—interest that led to the continuing decline of capitalism. The current situation resembles that of mercantilism, Gilder adds, not because of a current emphasis on bullion: rather, because of the assumption of self-interest, of "beggar thy neighbor."16 In addition, the assumption that the current form of capitalism is that of a "mature" one, Gilder claims, has led economists, the technicians, to ignore the essential role of the entrepreneur and the rich. The assumption that entrepreneurs only existed in an "early" phase of capitalism, Gilder maintains, has led to a.wrong focus on corporations as the source of growth, as the supply-side.17 Furthermore, the assumption that wealth of the few entails poverty of the many, he claims, was leading to redistri— butions that "demoralize" the rich, the entrepreneurs, his supply-side. These were the risk—takers. These were altruistic givers, and for that, they were to be compensated. In a world of uncertainty about the future, the entrepreneur does not seek insurance from government, 163 as the corporation does in demand-side economics (or socialism), but form a ”higher morality", from God.18 Hence, high marginal tax rates and government interventions aimed at relieving future uncertainty for the corporation (in the form of assuring a stable future effective demand), negatively affect the incentives of the individual investor, the capitalist, the entrepreneur, the small businesses. In contrast with the large corporation, the entrepreneur "loves" his/her innovation, develops it, and carries it to its fullest regardless of future uncertainties. He has faith, faith in future rewards, faith in the system, faith in God. The corporation, however, does not undertake a new idea, an innovatnnu unless future demand is assured and measurable. It seeks security and faith in a "lower morality", as it were, in governmenti If the individual investors, the entrepre- neurs, the rich, are the sources of growth, then their material and psychological well-being should be looked after. Growth would ensue and the benefits would "trickle-down" to reach everyone, even the government. Wealth of the few entails wealth of the many.19 In fact, although SSE advocates were calling for less regulation of businesses (which affects both big and small ones), it was a secondary argument to the call for less taxes for the rich. The deregulation argument was simply a reflection of their call for less government in general. Individual 164 incentives prosper only in a free environment. Laissez- faire was their champion. The age of laissez-faire and individual entrepreneurs was not necessarily an early phase of capitalism, it was the only phase.20 Similarly, poor people were poor, not because of the rich, but because they were "demoralized" by the welfare state. Generous welfare programs by the state were leading to dependency of the poor on the rich leading to lowered incentives to work, higher unemployment, and dissolution of families. The creation of female-headed families by welfare programs, Gilder argues, was contributing to both family poverty and lower growth. This was the case, Gilder claims, because without the future responsibility of raising kids, males will not work. It was the nuclear family, Gilder insists, that was the source of the indus- trial revolution of the eighteenth century. The three pillars of growth, Gilder concludes, are motivation for hard work, marriage, and faith in a higher morality.21 To the dismay of technicians, wealth and poverty were both being explained by ideological rather than technical factors. ck nc 'n : The above arguments reflect the preanalytical ideological vision of George Gilder, the so-called "spiritual-leader" of SSE. But, once that vision was 165 translated by its advocates into economic or technical propositions, confusion arose. This was the case for two reasons: First, the term "supply-side economics" was not a completely self-describing term, too wide to be identified, leading to diverse explanations as to what it is. In fact, almost all economic theory (including demand-side economics) is "supply-side economics“. This is manifest in the economist's continuing search for the sources of growth and prosperity. Second, the lack of a prominent figure (such as Keynes for Keynesian economics and Friedman for monetary economics) who could provide an authoritarian coherent and specific statement or "model" of its economic propositions was a source of confusion and controversy in the discipline as to what it economically means. In fact, while some of its advocates (and critics) suggested that SSE was a return to Classical macroeconomic theory in the form of Say's Law, other economists suggested that it was an application of Neoclassical microeconomic theory to government taxation. In addition, while some economists saw in it a call to balance the budget, others saw in it a call to adopt monetarism in the form of stable money growth rates and the gold standard. Finally, while some economists saw in it a call to adopt supply-side management policies, others, ironically, saw in it nothing but a call to stimulate the economy via a tax cut and higher deficits (or demand-side management). 166 SSE was a theory pointing in many directions. It was a "phantom", a "mirage“ in a desert, as it were, where every individual economist saw it in a place and a form that fits his/her vision. It was just like the mirage of water in a desert appearing to different "thirsty” people in different forms and places. For one viewer, it was a river. For another, it was a lake. For a third, it was an ocean. For a fourth, it was Niagara Falls. Economists were so confused as to what form it took. In fact, it had no form, like water. It can only take the form of the cup, jar, or bottle that holds it. Its ideological nature enabled it to point in many directions at the same time. It had psychological, sociological, political, philosophi- cal, religious, and economic implications. This is not a new characteristic of economic theory. Both absolutists (a'la Blaug) and relativists (a'la Shackle) agree that economic theory starts with a preanalytical ideological vision. The problem with SSE, however, was that its ideology and analysis were difficult to separate and/or identify (as Blaug would like them to be). Moreover, economists trained in the Neoclassical- Keynesian era, the age of tranquility, were taken by surprise. They were trained to look at the economy from behind the technician's eyeglasses. Once their eyeglasses were removed (by the rise of SSE), as it were, the technicians were caught unprepared. This was a different 167 ball game, a different playground, a different environment that needed a different kind of eyeglasses, maybe sunglasses. Inu the meantime, while economists, the technicians, were searching to find their sunglasses, SSE was well on its way to becoming adopted for policy. In fact, arguments and counter-arguments about SSE within the economics discipline did not occur before the 1980 election, Terry Plum found; rather, it was well after its adoption, specifically, during the 1981-82 recession and the rising deficits.22 'c nt d d : Once the "technicians" found their sunglasses, the debate over SSE intensified. However, while arguments in favor or against SSE appeared to be technical, they were just a reflection of the economist's “language". Technical arguments were at times not convincing on both sides, not only because of substantive technical differences, but also because such technical differences were, at bottom, ideological. As a matter of fact, technical differences between Keynesians and SSE advocates in relation to personal and business savings were not necessarily technical arguments as to how much each part attributed to business investment and, thus, whether it was viable to cut taxes in favor of the rich to increase personal saving to increase business 168 investment. Rather, this was a reflection of a fundamental ideological difference over the sources of prosperity and growth. For the SSE advocate, it was the individual, not the corporation, that was the source of growth and prosperity. The vitality of the rich to take risks, innovate, and invest, was sapped by the lack of a free environment. The entrepreneur was being continuously demoralized by the welfare state. For the Keynesians, however, the importance of business saving and investment was a reflection of his vision of the supply-side which was composed mainly of large corporations, not individuals, not the rich. Corporations were the sources of growth and prosperity, and corporations cannot work in an uncertain environment. Corporations invest, not because they are risk-takers, altruistic givers without even knowing the return (as the rich or the entrepreneurs are for the SSE advocate); rather, they invest only in relation to expectations about future demand. That future demand was a function of the well-being of the consumer, the average citizen, not the rich. The average citizen was the power behind future demand. For the Keynesian, incentives for continued growth were not a function of a risky environment, but of a climate of future certainty, prosperity, and full employ- ment. Incentives for businesses to invest were not a function of monetary reward in the form of lower taxes and 169 faith in the systemic future, but of psychological certainty about future rewand. This was contrary to the entrepreneur of the SSE advocate, who invests on the basis of present monetary reward and faith in the systemic future. For the Keynesian, uncertainty about the future 'was bad not good. That uncertainty can only be eased by the help of--SSE-ridiculed--'lower morality": government's assurance of future demand in the form of deficits, and/or increased well-being of the average citizen, the consumer, in the form of redistributions in favor of the poor and full employment. Ironically, the attack of some of the advocates of SSE on Reaganomics was in relation to the importance of the individual investor, the capitalist. The tax cut on individual investors, the rich, some advocates of SSE argued, were "too little too late", and the tax cuts on corporations were more than they would have sanctioned. It was the individual investor and not the corporation, they insisted, that was the source of growth.23 Furthermore, differences between SSE advocates and Keynesians over the impact of tax cuts on the economy and the interpretation of why the 1964 tax cut worked were not simply a reflection of technical differences over whether the substitution effect outweighs the income effect (or vice versa). Rather, these were reflections of a fundamental difference over how the economy works. For the SSE advocate, the substitution effect was not only a 170 technical substitution effect in relation to changes in relative prices. It was also a psychological nonmeasurable incentive for the entrepreneur. Once the entrepreneur realizes the dismantling of the welfare state and its cuddling of the corporation at his expense, he would regain his freedom, his faith in the future and in the return to his kind of capitalism, the laissez-faire kind, the only true kind. These were the so-called Laffer curve miracles that the critics could not see. These were not technical measurable effects of tax cuts on elasticities of factor supplies. (N1 the contrary, these were psychological forces, nonmeasurable, and can only be seen by the faith- ful. The reference to substitution effects, income effects, and factor supply elasticities by the SSE advocate were only terms of "last-resort" used to convince the technical economist in terms of his/her own language. In fact, the controversy over the Laffer curve, its shape, and its point of maximum revenue was, for the SSE advocate, unnecessary. The Laffer curve was not a technical relationship, but an ideological one. The SSE advocate was convinced by its argument, not in relation to actual measurements of current tax rates and where they fall on the curve. Rather, he was confident that tax rates were on the prohibitive range. The presence of the under- ground economy, tax evasion, and stagflation, were convincing arguments in favor of tax cuts. Tax cuts would 171 lead to the so-called Laffer curve miracles, not only because of measurable effects of tax cuts on factor supplies, but because tax cuts were a signal to the entrepreneur of the dismantling of the welfare state and the coming of a free environment. Similarly, technical differences over whether the tax cuts and the accompanying cuts in welfare for the poor would lead to a higher supply of labor were tangential to ideological beliefs. The SSE advocate was not convinced by technical arguments that the elasticity of labor supply was too low to lead to the surge in labor supply that he expected. The poor would finally realize that the dismantling of the welfare state and its social welfare programs was for their own benefit. The atmosphere of uncertainty and risk that they would be thrown into would lead them to work harder, leading them to an upward mobility and an escape from poverty. After all, in an atmosphere of risk and uncertainty, the poor would, like the rich, seek insurance from a higher morality rather than from government. In fact, Gilder insists that social history proves that upward mobility of poor people was achieved, not by social programs (which break the link between effort and reward crucial to long run upward mobility), but by "hard work, the nuclear family, and faith."24 172 Hence, while the critics of SSE, the technicians, were talking about one thing, the advocates of SSE were talking about something else» In fact, while the technicians sat down to tinker with their tools and measure the Laffer curve, the advocates of SSE were confident that it was there. One can only feel it, they argued, rather than measure it. Only Jack Kemp, Jude Wanniski, and Arthur Laffer, Gilder argues, were capable of feeling the truth behind the Laffer curve. With all their "sophisticated techniques", Gilder adds, economists were incapable of comprehending the truth behind the Laffer curve. In fact, for the SSE advocate, the truth behind the Laffer curve was just like the truth behind the statement of a witness in front of a jury in court. His statement can only be taken on faith as the truth. It cannot be proven, it cannot be measured. Economists see what they want to see, writes G.L.S. Shackle, not necessarily what there is. And that was exactly what SSE advocates did.25 Differences over how the economy works were manifest not only between advocates of SSE and the Keynesians and their sympathizers, however, but also between SSE advocates (the "new" supply-siders) and the so-called "traditional" or ”old" supply-siders especially in relation to monetary policy and deficits. Such differences did not necessarily reflect technical differences over whether increases in the money supply or deficits would, or would not, lead to more 173 inflation in the short run. Rather, these were the reflection of different visions, ideologies, of how the world works. The final decision of the advocates of SSE on the need for the gold standard was not necessarily made on technical grounds, but on ideological ones. Although the impact of monetarism (the adherence to a fixed money grwoth rate rule) was technically similar in process and in result to the gold standard in controlling inflation, SSE advocates chose the latter because it contributed to the free environment for which they were calling for. After all, even if monetarism works, they argued, the Fed was a monopolist and was still part of the government, a part of demand-side economics that they were reacting against. The gold standard would not only achieve monetary stability, SSE advocates concluded, it was an assurance of a free environment since the money supply, inflation, and interest rates, would not be controlled by the Fed but by the forces of the market and the world supply of gold. After all, they argued, the money supply was a mathematical or technical concept that meant less than it seems, and for that, the Fed was incapable of effectively controlling it. The monetarist supply-siders, however, preferred to control the money supply via the Fed rather than the gold standard because they did not believe in the dismantling of the government's discretionary powers, at least in relation to 174 monetary policy. They were not revolutionaries. The new supply-siders were.26 Similarly, differences between SSE advocates and the balanced-budget supply-siders were not necessarily a reflection of technical differences over their impact on inflation, but a reflection of different visions of how the economy works. SSE advocates looked at deficits only in relation to the free environment they were trying to achieve. Deficits, they argued, were a reflection of policies of yesteryears. The long run impact of lower taxes, less regulation, and less government intervention, they maintained, would lead to the complete elimination of deficits“ That was the case because when a free environment exists, the increased growth that results from unleashed incentives of the individual investors, the capitalists, the rich, would increase the tax base to increase tax revenues and eliminate the deficits. Although such an argument seems to suggest a conflict between policy activism (in the sense that they believe in the power of tax cuts to stimulate growth and that they were trying to maximize the government's tax revenues) and the policy of laissez-faire explicit in the return to Say's Law, such a conflict did not exist in the minds of SSE advocates. This was the case because lower taxes were only a short run policy tx: reverse previous demand—side policies of over- regulation and overtaxation that crippled their supply- 175 side. Once the marginal tax rate reaches its ultimate level (50 percent for Laffer, and 25 percent for Wanniski), deficits would be replaced by surpluses, and policy activism would no longer be necessary. In fact, for the SSE advocate, the short run adjustment period was assumed to be unimportant, or so short as to not exist. Both the balanced-budget and monetarist supply-siders were not convinced that this will be the case in the short run. They were, after all, technicians who needed proof. The new supply-siders, however, were not. They were faithful. They always referred to the Laffer curve miracles. And as Stockman suggested, as soon as taxes were cut, the new supply-siders believed that "revenues would fall from the heavens."27 In fact, while the balanced-budget supply-siders saw a direct relationship between deficits and tax rates, they did not envision the tremendous surge in entrepreneurship that the advocates of SSE were talking about, especially in the short run. They could not agree with the sequence of events of the SSE advocate: lower taxes, higher growth, lower deficits. Their sequence was completely the reverse: lower deficits, higher growth (due to lower inflationary expectations), lower taxes. Such differences were clearly manifest after the 1981-82 recession. The balanced-budget supply—siders argued that the recession existed because taxes were lowered "too much too fast". The advocates of 176 SSE, however, argued that the recession existed because taxes were lowered "too little too late" and, thus, hindered the unleashing of the monetary and psychological incentives of their entrepreneurs, the capitalists, the rich. Moreover, the balanced-budget supply-siders believed that some supply—side incentives existed, and that the individual investors--the capitalists, the rich--had an important impact on growth. Such a role, however, was not so important as to abandon their faith in the role of the corporation in the supply side and, thus, the importance of future uncertainty in relation to inflationary expectations that were caused by high deficits. For the balanced-budget supply-sider, deficits were bad regardless of the level of tax rates (contrary to the SSE advocate who believes that only deficits that co-exist with high tax rates are bad).28 Finally, and in relation to the so—called 1983 recovery and the accompanying decline in inflation rates, technical differences were, once again, at bottom, ideological. Some monetarist supply—siders were happy because they believed these were the results of stable money growth rates and a decline in inflationary expectations. Some Keynesians were happy because these were the results of the demand—side effects of the tax cuts and the deficits. Some SSE advocates were happy because they believed the deficits would disappear in the long run 177 as long as tax rates remained low. Other SSE advocates were disappointed, however, because progress towards their free environment was slowed or hampered, especially by the neglect of the gold standard in Reaganomics. Some balanced-budget supply-siders were unhappy because they viewed the short run improvement in performance to be unsustainable in the long run as long as the deficits remained high. Finally, other economists were unhappy because they believed that the redistribution in favor of the rich, welfare cuts, and rising deficits of Reaganomics wouLd have a tremendous negative long run impact on the economy.29 It is clear that the same economic reality can generate different visions of how the world works. This is the case because first, economic reality is so complex and interdependent that it can present itself differently to different viewers or investigators. And second, because seemingly positive or analytical arguments are constantly mixed with normative ones. Economists are constantly crossing that fine line, which they drew for themselves, between positive and normative analyses, between ”truth" and "ideology", between "what is" and "what should be". In the words of G.L.S. Shackle, the investigator (economist) "imposes rather than discovers the omderliness that constitutes knowledge." This condition, ironically, is inherent in the subject—matter itself: the subject—matter 178 of men and their affairs, the subject-matter of "political economy".30 e m'c d ' ' c n m : Was SSE adopted in Reaganomics? Yes, at least in spirit if not in detail. In fact, time and time again the two terms "SSE" and "Reaganomics” are used interchangeably by both proponents and opponents of SSE to refer to the same thing: President Reagan's economic program. Was it effective? Not completely, given the wide discrepancy between its promises and its outcomes (especially since its promises were viewed by technical economists to be exaggerated). Was it a viable alternative to Keynesian or demand-side economics as it claimed it would be? It depends on whose view one accepts. For a Keynesian, SSE was not a viable alternative to Keynesian economics. This is the case, a Keynesian might argue, because SSE does not fit the facts better than Keynesian economics. The occurrence of the 1981-82 recession, the rising deficits, and the so—called 1983 ”recovery", all can be explained by Keynesian demand-side variables. .A monetarist supply-sider, however, can argue that SSE was a viable alternative to Keynesian economics because of the decline in inflation and the existence of lower tax rates and lowered inflationary expectations. A. balanced-budget supply-sider can argue that it was not, 179 because of the tremendous increase in deficits. Finally, an SSE advocate can argue that it was a viable alternative after all: whatever the size of the deficits, marginal tax rates were lowered (although not enough), and that will lead to higher incentives in the long run.31 Thus, one's evaluation of SSE depends, not only on one's own model or vision of how the world works, but also on one's economic priorities. If inflation is the foremost priority, then a monetarist supply-sider can argue that SSE was successful (although its impact on inflation control is debatable). If deficits are one's foremost priority, then a balanced-budget supply-sider can argue that it was a failure. If full-employment and pro-poor income redistri- bution are one's priorities, then a Keynesian can argue that it was a failure. Finally, if lower tax rates and higher incentives for the rich and a free environment are one's priorities, then an SSE advocate can argue that it was a partial success (because he would have liked to see the gold standard adopted and the welfare state dismantled). The presence of such different views or visions is not, however, a sign of weakness, but a sign of strength. In a democratic society, differences in opinion, especially in relation to political economy (the subject-matter of men and their affairs), are inevitable. Policy choice in such a society is made from among the existing competing 180 theories. The "final“ choice (both of the public and the politicians) is made on the basis of which theory persuades most, its consonance with their ideology or vision, and luck. Reaganomics, and almost all its preceding economic programs, were the outcome of a free democratic election (hence enters persuasion). Furthermore, theory choice is made on the basis of the harmony of that theory with the policymaker's own vision of how the world works (or should work for that matter).32 Thus, a certain element of ideology is embedded in the process. Consequently, the role of the economist is not only to illuminate but also to persuade, and persuasion necessitates the use of its language: rhetoric and propaganda. Hence, political economy requires the use of persuasion, including reference to not only what does exist but also what should exist. "We believe in mutual persuasion," writes McCloskey (quoting Wayne Booth), "we live from conference to conference." To that effect, SSE had its own kind of propaganda and persuasion. It exaggerated most of what it can deliver, promised a world of no trade-offs, and brightened the image of the dismal science. Its advocates were salesmen par excellence who, in the words of Thorstein Veblen, promise everything and deliver nothing.33 They mastered the art of persuasion and rhetoric, thereby taking the technicians by surprise. But once a certain theory is 181 adopted for policy, can one falsify or discard such a theory on the basis of its performance? The answer to this question is very much related to the nature of the field itself: the subject-matter of men and their affairs, the subject-matter of political economy. Although economics has developed a set of tools or testing techniques in the form of econometric models, both economists and politicians who follow a certain theory can always discard that part or that result of a certain model or theory that does not conform to their own vision of how the world works. In fact, when presented with econometric models that do not support the claims of their theory, SSE advocates discarded such models as "an all-purpose mode of refutation for any theory the experts dislike or did not think of first." After all, they were not technicians, but ideologues. To them, technical arguments were secondary.34 In addition, there is the difficulty of discarding a certain theory on the basis of its performance because of the impossibility of having controlled experiments. Even though a certain theory may be actually applied in the economy, the outcome of such an application may not always be close to what was predicted by that theory. The actual result that materializes in the economy is the result, not only of a certain policy action, but of many interrelated variables, both exogenous and endogenous to the applied theory that contribute to that outcome. An argument that a 182 certain theory failed by referring to a single application can always be met by counter-arguments that claim that the theory was not actually or totally applied. In fact, after the Reagan application, SSE advocates argued that Reaganomics may have failed because it was not a complete application of SSE by simply referring to the need for the gold standard. This is not to suggest the irrelevance of econometric models: rather, to argue that it is not always easy to separate the scientific ideas from the ideology in which they were inevitably embedded (as Blaug believes). In fact, Blaug himself admits that: The great difficulty of testing economic theories, whether ancient or modern, is not so much the impossibility of making controlled experiments and thus disproving theories once and for all but rather that, lacking suitable laboratory conditions, economists (and for that matter all social scientists) cannot agree on definite empirical criteria for falsifying a hypothesis. WOrse than that, they frequentLy disagree about the fundamental character of a theory. . . . An element of judgement inevitably enters into their evaluation. Similarly, Donald McCloskey argues that economists do not have an "official rhetoric of what they find persuasive."35 Hence, given the ideological nature of economic theory in general, and of SSE in particular, a major part of the controversy over SSE in the discipline was that its critics, the technicians, were trying to "falsify" it on technical rather than ideological grounds, an impossible 183 task according to Blaug. "Normative theories", Blaug writes, "can never be evaluated by empirical tests."36 0 o a o u ' n nd‘t c efi the $33 in the Qisclpllhe: SSE was defined by its advocates to be an argument in favor of less taxes, less regulation, and less government intervention to solve the problem of stagflation that occurred during the 19705. That argument was economically rationalized by the help of two propositions, namely, the Laffer curve and Say's Law. The Laffer curve represented their microeconomic observations: that tax rates affect supply-side incentives. The interpretation of Say's Law merely as supply creates its own demand, however, represented their macroeconomic observations: that inflation can better be handled from their supply-side by improving the well-being of the individual investor, the capitalist, the rich, rather than from the demand-side (a'la Keynesian economics) which focused on the well-being of the individual consumer, the average citizen, at the expense of their supply-side. While SSE advocates considered their approach to be revolutionary, their critics, however, argued that such supply-side incentives would have an effect on inflation and unemployment smaller than they expected. In terms of the Neoclassical-Keynesian paradigm, some critics argued, such ”supply-side" (actually microeconomic) effects were 184 nothing new om revolutionary. The SSE argument, the critics added, refers to the substitution effect outweighing the income effect, especially in relation to marginal tax rate cuts. While such a case was theoretical- ly possible, the critics maintained, empirical results were ambiguous. While the SSE advocates did not, of course, see the need for a technical proof of their argument, due to their faith, the critics, however, were still technicians after all and demanded such proof. Iui fact, both so-called liberal and conservative economists “or technicians) were skeptical about the assumed SSE miracles, especially in the short run. Some "traditional" supply-siders (or conservative economists) accepted some of the claims of the new supply-siders, at least in theory, and were willing to support their policy recommendations for the 1980s. But, after the Reagan experiment, such traditional supply-siders argued that the new supply-side economics (SSE) was not in complete harmony with their vision of the supply-side. This led to defections from the Reagan administration (the cases of Martin Feldstein, David Stockman, and Murray Weidenbaum being noteworthy), and to observations that SSE was mainly a rhetorical and political propaganda to redistribute income in favor of the rich, as Stockman suggested in The Atlantis in 1931.37 185 In fact, differences between the "old" and the "new” supply-siders were fundamental. The best representation of such differences was related to the rate of growth of the velocity of money leading to the implementation of contradictory fiscal and monetary policies within Reaganomics. Given the projected rates of growth of real GNP, money supply, and inflation rates by the administra- tion, monetarist supply-siders suggested that these were impossible given their historical technical estimates of the growth rate of velocity. If real GNP growth is to increase and money supply and inflation rates are to decrease as predicted by Reaganomics, they argued, then velocity growth rates were supposed to exceed their historical average, an impossible task in their opinion. Furthermore, given the predicted decline in real interest rates by Reaganomics, they maintained, velocity was supposed to decrease, implying a contradiction.38 The new supply-siders did not, of course, take such technical observations seriously. After all, they had faith in their argument because of their belief in the revolutionary aspect of their theory. In fact, it seems that what they meant by a revolution was not that SSE was only a revolution against economic theory, but also a revolution against the welfare state and its immoralityu Hence, technical observations were not credible because they were based on a different kind of an 186 environment. Once their free environment exists, a new set of technical observations would emerge supporting, of course, their claims. In fact, time and time again, SSE advocates insisted that previous technical observations were not convincing in their opinion because they were based on different circumstances and policies.39 Furthermore, differences between the old and new supply-siders in relation to the short run adjustment period reflected a fundamental difference over how the world works. The world of no trade-offs presented by the new supply-siders was, in the opinion of the old (traditional) supply-siders, a utopia, a gimmick, a propaganda (as Feldstein and Stockman suggested). To the old supply-siders, economics was still a dismal science. Supply-side incentives were only long run processes that are slow and weak in the short run. Hence, some demand- management techniques (cutting the money supply and/or deficits) were necessary, at least in the short run, especially since a tax rate cut would increase both demand- side and supply-side effects of the economy. The tax cut would increase both consumption and investment expenditures in the short run, thereby, increasing the aggregate demand and, hence, requiring some demand-management in order to control inflation in the short run. The supply-side effects, however, would come in the long run (as Feldstein suggested) due to increased growth potential via supply- 187 side incentives and higher capital stock. With all its revolutionary claim, SSE did not break out from the Neoclassical-Keynesian paradigm. And in terms of that paradigm, it faced heavy criticisms leading to its abandonment even by conservative economists who initially supported it (perhaps because they saw in it something that was not there, as in the mirage analogy). The old supply- siders were not revolutionaries, they would not abandon the welfare state. They were only suggesting a balance between demand-side management and supply-side management.40 So, where does SSE stand in the economics discipline? According to the absolutist approach to the development of economic ideas (a'la Blaug in epigraph above), the task of the historian of economic thought is to ask whether a certain analysis (or hypothesis) stands up when freed from its ideological foundation. This, in turn, leads the historian of thought to determine whether the analysis contributes or adds to the development of economic science by submitting the "analysis" to scientific tests of validity which are determined by the analytical tools of modern economic theory (the Neoclassical-Keynesian paradigm in analysis should not obscure the role of persuasion, in contrast to verification: acceptance and rejection are more a function of consonance with a particular paradigm and its preconceptions than of technical positivist methodology.” [See Samuels in note 3 above, p. 5.] See also Blaug in note 1 above. 36See Blaug in note 1 above, p. 7. 37See William Greider, "The Education of David Stockman," The Ahlehtic uohhhly, December 1981, pp. 27-54, where Greider quotes Stockman saying: "Kemp-Roth was always a Trojan horse to bring down the top rate." 38See section 4.2C in Chapter IV above. 39See 1L. Johnson, "Are Supply-Side Economics and Monetarism Compatible?", in Supply-side Econemies, R. Fink (ed.), p. 410, where he argues that the ”new" supply-siders believe that velocity will increase by unprecedented amounts because their fiscal stimulus is considered unprecedented in history so that the historical value of velocity does not capture the "new" effects of their policy. 208 40For Stockman, "some of the naive supply-siders just missed this whole dimension. . . . You don't stop inflation without some kind of dislocation. . . . the supply-siders have gone too far. They created this non-political view of the economy, where you are going to have big changes and abrupt turns, and their happy vision of this world of growth and no inflation with no pain." [See Stockman in note 37 above.] According to Martin Feldstein, "the experience since 1981 has not been kind to the claims of the new supply-side extremists that an across-the-board reduction in tax rates would spur unprecedented growth, reduce inflation painlessly, increase tax revenue, and stimulate a spectacular rise in personal saving. . .. . The miraculous effects anticipated by some of the new supply-side enthusiasts were, alas, without substance." [Martin Feldstein, "Supply- -Side Economics: Old Truths and New Claims," W. Papers and Proceedings. vol. 76, no. 2, May 1986, pp. 29- 30. ] 41For more details, see Blaug in note 1 above, pp. 713-724. See also John Worral and Gregory Currie (eds. ), ‘ 1‘ 10d. 00 o C CF‘: C1 'VOO-S _- Lakehe . (New York: Cambridge University Press, 1978). 42In fact, James Tobin argues that: "Since 1965 three counter-revolutions swept through the economics profession. . . . One was Monetarism. . . . A second and related Counter-revolution was the so-called New Classical Macroeconomics, based on the elegant and appealing theory of rational expectations. . . . The third is Supply-Side Economics. Though the three counter-revolutions differ, they have in common conservative messages popular in today's political climate: Government interventions, however well-intentioned, do harm, not good. . . . Supply-Side Economics, currently the most popular counter-revolution, is also the most amorphous. Without a Keynes or Friedman or Lucas, it lacks a sacred text expounding its theoretical foundations. It is more spirit, attitude, and ideology than coherent doctrine, and its enthusiasts are of many minds.” [See James Tobin, "Supply— Side Economics: What Is It? Will It Work?", in yiewpointe W Thomas J. Hailstones (ed.) (Reston, Virginia: Reston Publishing Co., 1982), p. 133.] 43For Mirowski, "a clarion call to resurrect Say's Law in the face of these objections is a call to 'forget everything we ever knew.‘ It is nothing less than intellectual luddism.” [Philip Mirowski, “What's Wrong With the Laffer Curve?", Jehgnal efi Economic issues, vol., XVI, no. 3, September 1982, p. 826.] 209 44"The prominent names here include Arthur Laffer, Congressman J. Kemp, the old David Stockman, Paul Craig Roberts, Norman Ture, and still others. These supply- siders did not have very distinguished credentials.” [See Paul Samuelson, "Evaluating Reaganomics,” Qhellehge, vol. 27, no. 5, November-December, 1984, pp. 6-7.] 45For Gilder, "Wealth and poverty are the prime concerns of economics, but they are subjects too vast and vital to be left to economists alone. . . . This book is in part an essay on the limitations of contemporary economics in analyzing the sources of creativity and progress in all economies. . . . This book sprang from an earlier work of mine, yieihle heh, an essentially sociological venture that undertook to understand poverty by studying the poor. . .. . I learned much from these researches about the devastating impact of the programs of liberalism on the poor. . . . So Weelhh_ehg Peyeghy began with the title 'The Pursuit of Poverty' and ended as an analysis of the roots of economic growth.” [See Gilder in note 11 above, p. ix.] 46See Blaug in note 1 above, p. 273. 47Ibid., p. 3. See also Shackle in note 2 above; and W.C. Mitchell, Lecguge Nehee eh Typee ef Ecehgmic Theery. (New York: August M. Kelley, 1949), vol. I, pp. 1-7.] 48See Sections 2.4 and 2.5 in Chapter II above. 49For J. Watkins, "studying the history of economic thought shows that the origin of economic ideas is closely associated with solving practical problems. . . . Adam Smith's invisible-hand doctrine was an attack on the burdensome government regulations which stifled trade and impeded prosperity. In particular, David Ricardo's corn model and his theory of international trade were an attack on the corn laws which taxed the importation of corn. . . . The purpose of John Maynard Keynes' general theory was to explain, for the purpose of resolving, the great depression of the 19305. In a similar fashion, supply-side economics is promoted as capable of solving what Keynesianism cannot: stagflation. . . . The problem with supply-side economics is not that it is based on a faith in ideas--as all theories are to some extent--but rather it is based on a faith in anachronistic ideas. Supply-side economics is nothing more than the resurrection of the theory of laissez-faire. . . . The theory of laissez-faire was born in the latter part of the eighteenth century, matured in the nineteenth century, and 210 died in the early part of the twentieth. It was created in response to conditions in which government intervention hindered production. Changing conditions, however, necessitate acquiring new ideas and dispensing with old ones. Societies, like individuals, must give up their old ways as they mature." [John P. Watkins, "Religious Parable: A Comment," Ecehemie Fegum, vol. XII, Winter 1981-82, p. 119.] 50For Samuelson, "a Hamlet-like student, poised in neutral equilibrium between eclectic post-Keynesianism, monetarism, and rational expectationism, would have to be pushed in the direction of post-Keynesianism by the brute factual experiences of the 19805. That is my message. That is my finding. Economics is not an exact science, so II cannot prove the correctness of this result in the way that one proves the Pythagorean Theorem or confirms the constancy of the speed of light. . . . When I say that post-Keynesianism has received some vindications from experience, I am also saying that some of the standard hypotheses of neoclassical microeconomics have been borne out by experience. Thus, good sense supply-side economics would expect that tax reductions which reduce the wedge between pre-tax and post-tax returns might well strengthen investment demand, ceteris paribus. . . . Should we economists be pleased that for once, at least, our mainstream theories have seemed to be about right? Yes, perhaps. But I remind myself that science is most exciting when new findings are being made. There is still plenty of excitement--too much excitement, some citizens would say--in the world of political economy.” [Paul Samuelson, "Evaluating Reaganomics,” Chellenge, November-December 1984, p. 11.] 51See note 40 above. 52For Stockman, "Some will be tempted to read into the failure of the Reagan Revolution more than is warranted. It represents the triumph of politics over a particular doctrine of economic governance and that is all. It does not mean American democracy is fatally flawed: special interest groups do wield great power, but their influence is deeply rooted in local popular support. However, the triumphant welfare state principle means a fundamental trade-off between capitalist prosperity and economic security. As a nation we have chosen to have less of the former in order to have more of the latter. . . . Viewed in this light, our political system functions fairly well to balance and calibrate the requisites bf capitalism with social democracy's quest for stability and security. . . . ‘l 8 211 The abortive Reagan Revolution proved that the electorate wants a moderate social democracy to shield it from capitalism's rougher edges. Recognition of this in the Oval Office is all that stands between a toderable economic future and one fraught with unprecedented perils." [See Stockman in note 27 above, p. 64.] 53See Shackle in note 2 above. BIBLIOGRAPHY Adams, John, "Financial Subinfeudation and the Penchant for Real Investment," Jehzhel e: flcehemic lseues, vol. 17, no. 2, June 1983, PP. 485—494. Alexander, Robert J., ”Contributions of the Galbraith 'Technostructure' to the Growing Crisis of the U.S. Economy," JQUIDQI efi Ecehomie lesues, vol. 17, no. 2, June 1983, pp. 495-502. Anderson, Paul A., "A Rational Expectations Approach to 'Supply-Side' Economics,” aueineee Ecenemice, vol. 16, no. 2, March 1981, pp. 3-6. Bartlett, Bruce R., n 'c - u - 'd c n m'c Actie . (New York: Quill Books, 1982). , "America' s New Ideology: 'Industrial Policy' with Neo-K Joining Supply- -Side Economics,” c n o n c d aetiology, vol. 44, no. 1, January 1985, pp. 1-7. - and Roth, Timothy P. (eds.), The -- ' supply-side solhtion. (Catham, New Jersey: Catham House Publishers, Inc., 1983). Blaug, Mark, Ecenemie IbEQEY ih Bettespeet. (Cambridge, New York: (Cambridge university Press, 3rd edition, 1978). . W. (New York: Cambridge University Press, 1980). Block, Walter, "Who Speaks for the Free Market: Monetarists or Supply- -Siders?", Pelicy Reyiey, vol. 24, Spring 1983. PP. 9- 12. Blum, David, ”The Laffer Curve: A Social History," The New Republic, August 19, 1978, pp. 24-25. Bosanquet, Nicholas, After the New Right. (London: Heiremann, 1983). Boskin, Michael J., "Some Issues in 'Supply- -Side' Economics," u n o n n m , vol. 14, Spring 1981, pp. 201-220. Bosworth, Barry, Tex lheentiyes end Ecenemic c-tewth. (Washington, D.C.: Brookings Institution, 1984). 212 213 Breit, William; and Ransom, Rogers L., The Academic scgibblete. (New York: The Dryden Press, revised edition, 1982). pp. 7-16 and 246-251. Bronfenbrenner, Martin; Sichel, Werner: and Gardner, Wayland, Econemi e. (Boston: Houghton Mifflin Co., Brookes, Warren T., The Ecenemy in Mind. (New York: Universe Books, 1982). Buchanan, James M.: and wegner, Richard E. (eds.), Eieeel ' ' ' ' ' 'on . (Leiden, Boston: Martinus Nijhoff, 1978). Buchelle, Robert, "Reaganomics and the Fairness Issue," ghellehge, vol. 27, no. 4, September-October 1984, pp. 25-31. "Reaganomics: Effect on Savings,“ Bueineee Week, March 8, 1982, pp. 60-62. Cagan, Phillip, "Monetarists Versus Supply-Siders," Polity Reyiey, vol. 22, Fall 1982, p. 3. Canto, Victor A.: Joines, Douglas H.: and Laffer, Arthur B., Foundatiens of Sn pply- Siee Eeehemiee. (New York: Academic Press, 1983). Chimerine, Lawrence; and Young, Richard M., "Economic Surprises and Messages of the 1980's," Amezicen Ecenemie Review, Papers and Proceedings, vol. 76, no. 2, May 1986, pp. 31-36. Congdon, Tim, ”What's Wrong With Supply-Side Economics?", Egllgy_3eyiey, vol. 21, Summer 1982, pp. 9-17. , ”Monetarists versus Supply-Siders," Policy Reyiey, vol. 22, Fall 1982, p. 14. , "Who Speaks for the Free Market: Monetarists or Supply-Siders?", Policy geviey, vol. 24, Spring 1983, p. 16. Cozzi, Terenzio, 'La 'Supply-Side Economics'," Riyiste di Politice Economice, vol. 72, no. 6, June 1982, pp. 583-613. Danziger, Sheldon; and Haveman, Robert, "The Reagan Budget: A Sharp Break with the Past," ghellenge, vol. 24, no. 2, May-June 1981, pp. 5-13. 214 Dugger, William M., 'An Institionalist Critique of President Reagan's Economic Program," 1211M Eeehemic Issues, vol. 16, no. 3, September 1982, p. 791-814. Eichner, Alfred 8., "Why Economics Is Not Yet a Science," Journel efi Econemic lesues, vol. 17, no. 2, June 1983, pp. 507-510. , “Reagan's Doubtful Game Plan," ghellehge, vol. 24, no. 2, May-June 1981, pp. 19-27. Evans, Michael K., u u - 'd c n m'c . (New York: Basic Books, 1983). Federal Reserve Bank of Atlanta, and Emory University Law and Economics Center. W 12395, Conference Proceedings (Westport, Connecticut: Quorum Books, 1982). Feldstein, Martin, "Supply-Side Economics: Old Truths and New Claims," Amezieeh Econemic Beyiew, Papers and Proceedings, vol. 76, no. 2, May 1986. Pp. 26-30. Fink, Richard H. (ed.), Supply-Sige ECQaniQ§i A inticel Appheieel. (Frederick, Maryland: Alethia Books, 1982). Flanagan, Robert J., "Wage Concessions and Long-Term Union Wage Flexibility," BIQQKiUQS Repete eh Egghemic Aetiyity, vol. 1, 1984, pp. 183- 216. Flassbeck, Heiner, “What Is Supply-Side Economics?", gonjunkthtpolitl , vol. 28, no. 2-3, 1982, pp. 75-138. Friedman, Milton, "Painless Revenue," Neweyee_, April 5, 1982, p. 63. Galbraith, James K., ”The Case for Rapid Growth," ghellehge, vol. 27, no. 1, March-April 1984, pp. 10- 14. Galbraith, John Kenneth, and McCracken, Paul W., 3e egen emieeg heehihg, heehe, and Ehge, The Charles Moskowitz Memorial Lectures, College of Business and Public Administration, New York University. (New York: The Free Press, 1983). Garrison, Charles B., "The 1964 Tax Cut: Supply-Side Economics or Demand Stimulus?” W Teehee, vol. 17, no. 3, September 1983, pp. 681-696. 215 Gesick, Esther, "A Critical Evaluation of Supply- -Side Economics," Egghemie_£ethm, vol. 12, no. 2, Winter 1981-82, pp. 103-111. Gilder, George, nd t . (New York: Basic Books, 1981). Goode, Stephen, 0 'cs a ' c no 'c o . (New York: F. Watts, 1982). Green, Jeffery R.; and von Furstenberg, George M., ”Supply- Side Modeling from Bits and Pieces," e c m c Review, Papers and Proceedings, vol. 76, no. 2, May 1986, pp. 37-42. Greenhut, M.L.; and Stewart, Charles T., Ptom Beeic ' 'c - ' c ' . (Lanham, Maryland: University Press of America, 1983). Greider, William, The Edueetien of David Steckmen and che; Ametieehe. (New York: E.P. Dutton, Inc., 1982). _, "The Education of David Stockman," htlentic Monthly, December 1981, pp. 27-54. Hafer, R.W., "Monetarists Versus Supply-Siders,” Policy Peyiey, vol. 22, Fall 1982, pp. 8-12. Hailstones, Thomas J. (ed.), ' 'nt‘ n u - 'd Pcenemie . (Reston, Virginia: Reston Publishing Co., 1982). Hale, David, "Rescuing Reaganomics," Pelicy Peviey, vol. 20, Spring 1982, pp. 57-69. Harberger, Arnold C., "Comment on Papers by Boskin and Piggott and Whalley," u a c , vol. 14, Spring 1981, pp. 221-229. Heller, Walter W., "Kennedy's Supply-Side Economics," challehge, vol. 24, no. 2, May-June 1981, pp. 14-18. , “The Kemp-Roth-Laffer Free Lunch," Well W1. 12 July 1978- Jameson, Kenneth P.; and Philips Joseph, "Supply-Side Economics: 1\ Skeptical View," Pcenemic Petum, vol. 12, no. 1, Summer 1981, pp. 81-88. 216 Johnson, Ronald, 'Supply- -Side Economics: The Rise to Prominence.“ WWW. vol. 12, no. 2, Winter 1983, pp. 189- 202. Johnson, William R., 'The Effect of a Negative Income Tax on Risk-Taking in the Labor Market," Eeehgmig_lhghiyy, vol. 18, no. 3, July 1980, pp. 395-407. Kaufman, Henry, "Reaganomics: Why Isn't Wall Street Convinced?", Challenge, vol. 24, no. 4, September- Keller, Robert R., "Supply-Side Economic Policies During the Coolidge-Mellon Bra." J2urnal_2f_fisonomis_lssuss. vol. 16, no. 3, September 1982, pp. 773-790. Kimzey, Bruce, Reegengmice. (St. Paul, Minnesota: West Publishing Co., 1983). Kinsley, Michael, 'Alms for the Rich," uey_Rephhlig, August 1978. PP. 19-26. Klamer, Arjo, o s ' n w' co ' . (Totowa, New Jersey: Rowman and Allanheld, 1984). Klein, Lawrence, con ' d d. (Baltimore, Maryland: The Johns Hopkins University Press, 1983). Klein, P.An,. "Reagan's Economic Policies: An Institutionalist Assessment," ou n o co 'c Teehee, vol. 17, no. 2, June 1983, pp. 463-474. Kukkonen, Pertti, 'Supply- -Side Economics in Finland, Ken neghtglgudellin eh Aikekghek igje, vol. 78, no. 5, 1982. pp. 227- 250. Layard, R.: and Nickell, S.J., "Marginal Employment Subsidies Again: A Brief Response to Whitley and Wilson,” Egghemig_gggthel, vol. 93, no. 372, December 1983. PP. 881-882. Lekachman, Robert, d ot nou - ea om'cs. (New York: Pantheon Books, 1982). Levine, David A., "Monetarists vs. Supply-Siders," Policy My V01. 22' Fall 1982' pp. 3-5. Lomax, David, 'Supply- -Side Economics: The British Experience," t ank Peyiey, August 1982, pp. 2-15. 217 Lower, Milton D., "The Reindustrialization of America," Jouthel oi Rcohgmip lesues, vol. 16, no. 2, June 1982, pp. 629-635. . Lux, Kenneth: and Lutz, Mark A. “Creative vs. Mechanical Evolutionism: A Commentary,“ u ' lesuee, vol. 17, no. 4, December 1983, pp. 1113-1117. Marshall, Ray, "Comments on the Institutionalist View of ReaganomiCS.' J2urnal_2f_£sopomig_lssuss. vol. 17. no. 2, June 1983, pp. 503-506. McDaniel, Bruce A.: and Silvia, John E., “Economic Stabilization, Supply-Side Economics, and the Social Economist." Eerisn_2f_fiosial_£sonomx. vol. 41. no. 2. October 1983, pp. 109-123. McMullen, B. Starr "The Laffer Curve: Fact or Convenient Fantasy," Peppemig_figtgm, vol. 12, no. 2, Winter 1981- 82' pp. 113-16. Meyer, Laurence H. (ed.), The sgpply-side Rfifiepte of chhgmic Pgligy, Proceedings of the 1980 Economic Policy Conference. (St. Louis: Federal Reserve Bank of St. Louis and the Center for the Study of American Business, Washington University, 1981). Mirowski, Philip, "What's Wrong With the. Laffer Curve?", Jghthgl gfi chhpmic lssuee, vol. 16, no. 3, Sept. Moynihan, Daniel Patrick, "Political Aids," The New Republic, May 26, 1986, pp. 16-18. Nagarajan, K.V., 'Ibn Khaldun and 'Supply-Side Economics': A Note." Journa1_of_Rost_KeYnesian_Esonomiss. vol. 15. no. 1, Fall 1982, pp. 117-119. Pechman, Joseph: and Aaron, Henry (eds.), Hey Taxee Affect Ecengmig Reheyigg. (Washington, D.C.: Brookings Institution, 1981). Penner, Rudolph G., "Discussion of the Papers by Piggott and whalley." lourndl_of_Monerdrx_Esopomiss. vol. 14. Spring 1981, pp. 231-235. ' Peterson, Wallace, lncgme, Emplgymeht, end Economic gggyth, Fifth Edition. (New York: W.W. Norton and Co., 1984). 218 ; and Estenson, Paul S., 'The Recovery: Supply-Side or Keynesian?', u n o ' Eeghgmipe, vol. 7, no. 4, Summer 1985, pp. 447-462. Petr, Jerry L., "Economic Evolution and Economic Policy: Is Reaganomics a Sustainable Force?", Joughel pf cono 'c s u , vol. 16, no. 4, December 1982, pp. 1005-1012. , "Creative vs. Mechanical Evolutionism: )1 Commentary." W. vol 17. no. 4, December 1983. pp. 1118-1120. , ”Creationism vs. Evolutionism in Economics: Societal Consequences of Economic Doctrine," Jgppmel oi Rcohgmic leepee, vol. 17, no. 2, June 1983, pp. 475-483. Plum, Terry, "Bibliographic Sources as Data: Quantifying the Spread of Economic Ideas,“ History of Economics Society Conference, June 1986. Raboy, David (ed.), 'n - 'd c n (Washington, D.C.: Institute for Research on the Economics of Taxation, 1982). ’ , ”Who Speaks for the Free Market: Monetarists or Supply- -Siders?", Pglicy Reyiey, vol. 24, Spring 1983, pp. 3-16. Ranson, David, "Monetarists Versus Supply-Siders,“ Pglicy Reyiew, vol. 22, Fall 1982, pp. 12-13. Reynolds, Alan, "Monetarists Versus Supply-Siders," Pplicy Review, vol. 22, Fall 1982, pp. 15-17. ______________ . "Who Speaks for the Free Market: Monetarists or Supply- -Siders?", Policy Reyiey, vol. 24, Spring 1983. pp. 16- 18. , 'How Supply-Side Triumphed,” ghellehge, vol. 27, no. 5, November-December, 1984, pp. 12-18. Roberts, Paul Craig, "A Guide to Understanding the Supply- Siders," Pueineee Week, 22 December 1980, pp. 76-78. T u - 'd u ' . (Cambridge, Massachusetts: Harvard University Press, 1984). 219 Roll, Eric, A Ristggy oi Econgmic Thgught. (Homewood: Irwin, 4th edition, revised and enlarged, 1974). Rosen, Harvey 3., "What Is Labor Supply and Do Taxes Affect It?", Ametic eh Ecengmip Re yiew, vol. 2, May 1980, pp. 171-176. Rousseas, Stephen, "The Poverty of Wealth,“ Journel of Post Keynesian Rcongmics, vol. 4, no. 2, Winter 1981-82, pp. 192-213. 0 ' 'c co 0 e nomic . (New York: M. E. Sharpe, Inc., 1982). Ruane, Frances P., "Government Financial and Tax Incentives and Industrial Employment," lzish Ranking Reyiew, June 1983. pp. 20-28. Salmon, Richard; and Lotspeich, Richard, 'Supply- -Side Economics: Personal Income Tax and the Aggregate Supply of Labor.'Eg.enoii1eJ:erim. vol. 12. no. 1. Summer 1981, pp. 89- -93. Samuels, Warren J., "The Current State of Economics,” Rephemip_Rptpm, vol. 12, Winter 1981-82, pp. 1-8. Samuelson, Paul A., "Republican Game Plans,“ Newsweek, February 16, 1981, p. 69. , "Evaluating Reaganomics," Challenge, vol. 27, no. 5, November-December, 1984, pp. 4-11. __________________ , "Succumbing to Keynesianism," Challenge, vol. 27, no. 6, January-February 1985, pp. 4-11 0 Samuelson, Robert J., ”The Imaginary Revolution," The New M, May 26' 1986' pp. 30-35. Sawhill, Isabel V., "Can We Salvage the 19805?', Chellehge, vol. 27, no. 4, September-October 1984, pp. 18-24. : and Palmer, John L. (eds.), The Reegeh Expetiment. (Washington, D.C.: The Urban Institute Press, 1982). ; and Palmer, John L. (eds.), The Reegen Recgtd. (New York: Ballinger Publishing Co., 1984). 220 : and Hulten, Charles R. (eds.), The Legeey_pfi_Reegehgmiee. (Washington, D.C.: The Urban Institute Press, 1984). shackle. G.L.S.. W (Cambridge. New York: Cambridge University Press, 1967). Shapiro, Edward, "Supply-Side Economics: A Diagrammatic Exposition,” b k u na c n m'cs d Rgeiheee, vol. 2, Spring 1981, p. 37-46. Shapiro, Perry; and Sonstelie, Jon, 'Did Proposition 13 Slay Leviathan?', 'c c n 'c ' , vol. 72, no. 2, May 1982, pp. 184-190. Sowell, Thomas, ' a - n ' 'c ' . (Princeton, New Jersey: Princeton University Press, 1972). Sprinkel, Beryl W., "Reaganomics Is Working," a en , vol. 25, no. 3, July-August 1982, pp. 51-53. Stein, Herbert, ”The Decline of the Budget-Balancing Doctrine or How the Good Guys Finally Lost," in James Buchanan and Richard Wagner (eds.), Piecel n 'b' 't 'n ' ' c c . (Boston: Martinus Nijhoff, 1978). PP. 35-53. , “Some 'Supply-Side' Propositions," The_Nell atteet QQUIDQI. March 19, 1980, p. 24. Stockman, David, The Tziu mph gt Politics: Nhy the Re egan Reyglgtigp_zeileg. (New York: Harper and Row, 1986). , "The Triumph of Politics," Newsweek, April 21, 1986, pp. 40-59. , 'The Triumph of Politics," Neyeyeeh, April 28, 1986, pp. 50-64. Stubbelbine, William C.: and Willet, Thomas D. (eds.) Reegehomics: A Migtegm Repozt. (San Francisco, California: ICS Press, 1983). Thurow, Lester, "Reaganomics," u nw‘ tsc , vol. 37, no. 4, December 1982, pp. 407-415. _______ , o e - T a of c m’c . (New York: Vintage Books, 1983). 221 Tobin, James, “The Fiscal Revolution: Disturbing Prospects," Chellehge, vol. 27, no. 6, January- February 1985, pp. 12-16. Ture, Norman, T Fu u <'v t en ' n5. (Washington, D.C.: American Enterprise Institute, 1976). Volcker, Paul A., ”Statement to the U.S. Senate Committee on Banking, Housing, and Urban Affairs," Fedetgl Reeetye_Rglletih, vol. 69, October 1983, pp. 757-769. Wanniski, Jude, d k - cono ' s ngl ehd succeed. (New York: Basic Books, 1978). Watkins, John P., "Religious Parable: A Comment,” nghpmNQ, Pppgm, vol. 12, no. 2, Winter 1981-82, p. 117-122. Weintraub, Sidney, "Keynesian Demand Serendipity in Supply- Side Economics," u na 0 st 5' n c m' , vol. 4, no. 2, Winter 1981-82, p. 181-191. ; and Goodstein, Marvin (eds.), Reagen- gmics ih the stegfletioh Egghgmy. (Philadelphia: University of Pennsylvania Press, 1983). Weniger, Anna; and Robison, Hank, "Supply-Side Economics: A Religious Parable," chhgmic Eotum, vol. 12, no. 1, Summer 1981, pp. 75-80. Whitley, J.D.; and Wilson, R.A., "The Macroeconomic Merits of a Marginal Employment Subsidy," c o 'c , vol. 93, no. 372, December 1983, pp. 662,680. Winter, Ralph, "Business Leaders Begin to Express Skepticism about Reaganomics," The_flell_§t;eet lghthgl, 29 January, 1982. Yeager, Leland B., "Monetarists Versus Supply-siders," Peligy_Reyiey, vol. 22, Fall 1982, pp. 5-8. Zinam, Oleg, "A Note on Reaganomics," t ri'c c no 1: Jggphel, vol. 4, December 1982, p. 98. M'CIHIIIGIVW WI Mi '{TIIIVIWIB'TIT 3 1193 03175 7572