Dan

Calabrese

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October 29, 2007

Supply-Side Economics: Jonathan Chait and His Liberal Lens Miss the Point

Jonathan Chait is a man on a mission. Target: Supply-side economics. Problem: He views supply-side theory through a liberal lens, which is why it’s not making sense to him.

Chait, a senior editor at The New Republic, has written a book titled “The Big Con: The True Story of How Washington Got Hoodwinked and Hijacked by Crackpot Economics,” along with various op-ed pieces roasting supply-side theory.

Chait’s argument focuses on the oft-stated belief of supply-siders that tax cuts pay for themselves by spurring economic growth – that taking smaller slices of a bigger pie still yields you more pie than bigger slices of a smaller pie. Mmm. Pie.

Much of the left is hailing Chait as a hero for “exposing the truth” about supply-side, but all Chait has really exposed is his own priority of government revenue, the higher the better, as the optimal objective of tax policy.

Chait’s primary retort against supply-side is that, while federal revenues did rise after the Reagan tax cuts of 1981 and the Bush tax cuts of 2003, they would have risen even more without the rate reductions, because economic growth moves in cycles and is not caused by tax cuts.

The resulting problem, he posits, is the rise in federal deficits, and here he faults conservatives for always proposing tax cuts without feeling the need to propose equivalent spending cuts, because, supply-siders say, tax cuts pay for themselves.

Chait is tied up in knots. Let’s untie him.

The primary reason supply-siders favor lower tax rates is indeed that higher marginal rates discourage investment and stunt economic growth. The private economy is healthier when both work and investment are more amply rewarded. Some taxes are more onerous than others. One of the worst is the capital gains tax, which punishes returns on investments, and often has the effect of taxing income a second time, because people invest what is leftover from their original after-tax income.

Punishing investment is one of the most efficient ways to kill economic growth. But taxing income is pretty bad, too, since it lessens the rewards available for actually being productive.

All this leads to the supply-side belief that lower marginal tax rates create a better environment for economic growth.

Chait is not sold, and insists that the higher federal revenues following the 1981 and 2003 tax cuts should not be compared to federal revenues in 1981 and 2003, but rather to what federal revenues would have been in the subsequent years had the rates remained higher.

This is the crux of Chait’s case against supply-side, and it is where he most misses the point. The objective of supply-side economics is not higher federal revenues, nor is it deficit reduction. The objective of supply-side economics is a growing private economy. Mr. Chait is hereby reminded that the government exists to serve the citizenry, not vice versa. If economic policy is helping to create a growing private economy, it has succeeded at its most important task.

Thus, if the economy was growing and federal revenues were rising – which it was and which they were – it doesn’t matter that, theoretically, federal revenues might have been even higher under an alternative scenario. Federal revenues were high enough in both cases to fund a level of governance required by the American people.

The problem is that Congress keeps giving us governance far in excess of what we need, and this is where Chait still needs to be untied. Tax policy and spending policy are two different things.

Enacting tax policies that spur economic growth does not relieve Congress of its obligation to spend responsibly, and neither in the 1980s nor today did Congress exercise responsibility in spending. If they spent like drunken sailors because they felt supply-side tax policies would cover the costs, shame on them, but that doesn’t prove anything about supply-side theory. It only proves that no level of revenue is sufficient when spending is out of control.

In fairness, neither Ronald Reagan nor George W. Bush chose to engage Congress in a knock-down-drag-out to truly get federal spending under control. But both did their parts with tax policies that were friendly to private-sector growth.

The taming of federal spending is a desperately needed undertaking. The president who forces Congress to do it will be a hero for the ages. But supply-side economics has done its job. It has promoted growth while bringing in enough revenue to allow the government to govern. Now the government just has to wean itself off all the other things it thinks it needs to do, and it might find itself in as healthy a condition as supply-side has helped make the private sector.

Then do you think Jonathan Chait will be happy?

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