Wednesday, October 24, 2007

Supply-side Economics as a Substitute for Smaller Government

The New Yorker's James Surowiecki (hat-tip Brendan Nyhan) makes some interesting points about supply-side economics:
The supply-side argument that, in the United States, tax-rate cuts pay for themselves—that, after cutting taxes, the government actually ends up with more revenue—has little or no support within the mainstream economic profession, and no hard empirical data to back it up.
Surowiecki suggests that:
...the absurd idea that tax cuts pay for themselves is based on an idea that is not at all absurd, which is that tax rates can have an impact on people’s behavior. Increase taxes too much, and people may work less (since they get to keep less of the income they earn) and invest less (since their gains will be taxed more heavily), and so the economy will grow more slowly. The opposite can happen if you cut taxes. (How much of an impact tax rates have—and how high taxes have to get before they have an impact—is a subject of much debate in economics, but it’s inarguable that they do matter.) What supply-siders have done is start with that reasonable idea and extrapolate it to unreasonable lengths.

They’re aided in that extrapolation by the simple fact that the American economy grows over time. As a result, even if you cut taxes the federal government will eventually take in more tax revenue than it once did. And that allows supply-siders to fashion a spurious syllogism: taxes were cut in 2001, government revenues are higher in 2007 than they were in 2001, therefore the tax cuts increased revenue. The comparison that really matters in analyzing the impact of the tax cuts, of course, is not between government revenue in 2001 and government revenue in 2007. It’s the comparison between actual tax revenue in 2007 and what tax revenue would have been in 2007 had there been no tax cuts in 2001. And studies that make these types of
comparisons—including one by Bush’s own Treasury Department that looked at the tax cuts’ impact on economic growth—find that government revenues would be greater had taxes not been cut. But that hasn’t stopped President Bush from claiming victory.

The above logic makes some sense to me. But regardless if one agrees with studies linked to above, I completely agree with Surowiecki's next point:
In one sense, of course, it’s odd that a Republican President should treat higher government revenues as a point of pride. Historically, after all, Republicans have been the party of small government and fiscal restraint. But, while Republicans still talk a good game about the need for spending discipline, in practice it matters far less to them than tax cutting. After all, if tax cuts pay for themselves, then there’s not much reason to worry about restraining government spending—we can afford it all. In fact, if government spending grows too big, you can cut taxes again to pay for it.
I enjoy a tax cut as much as the next guy but the fact is that there are no mainstream Republican politicians calling for smaller government at all. If I'm wrong about this please let me know.

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