Supply Side Economic In Us Economic Policy

Supply Side Economic in United States Economic Policy Namal Balasoooriya, Assistant Lecturer, Department of Economics, University of Kelaniya, Sri Lanka [email protected]

Introduction

Supply

side

economics

provided

the

The United States of America is a federal

political and theoretical foundation for a

constitutional republic with fifty states at 3.7

Remarkable number of tax cut in the United

million square miles and with 300 million

States. President George W Bush's proposal

people. USA (United States of America) is

to reduce taxes has reignited the economics

the third or fourth largest Country by total

debate in USA, Specifically, in his budget

area third largest by land area and

address before congress in February 2001;

population. Its national economy is the

President Bush cited the tax cuts of

world's largest with a nominal 2006 gross

president john F Kennedy and President

domestic product (GDP) of more than $ 13

Ronald Reagan to support his argument for

trillion.

tax relief. Forty years ago President natural

Kennedy and then twenty years ago

resources, a well developed infrastructure

President Ronald Reagan advocated and

and

to

introduced tax cut for there economic

International Monetary Fund, the USA GDP

policy. Interestingly, the Kennedy and

of more than $ 13 trillion constitutes 20 per

Reagan tax cuts were firmly rooted in

cent of the gross world product. Only the

supply side economics. As for the Bush tax

collective GDP of the European Union is

plan offers two fundamental supply side

greater. The USA is the largest importer of

ingredients are replacing the current five -

goods and second largest exporter. The

rate personal income tax structure of 15 per

private sector constitutes the bulk of the

cent, 28 per cent, 31 per cent, 36 per cent,

economy,

activity

and 39.6 per cent, with four lower rates of

accounting for 12.4 per cent of GDP,

10 per cent, 15 per cent, 25 per cent, and 33

Agriculture accounts for only 1 percent of

per cent and killing death taxes. (Raymond,

GDP but 60 per cent of the world's

2001)

USA

is

high

fueled

by

abundant

productivity.

with

According

government

agricultural production.

1

Supply side Economics

Supply - Side economic and detailed the

Supply side economics focuses basically on

supposed merits of low taxation and a gold

the marginal tax rate. The supply siders say

standard.

that high marginal tax rates decrease

In 1983 economist Victor Conto, a disciple

aggregate supply and lower marginal tax

of Aruthur Laffer, published the foundation

rates increase aggregate Supply that is the

of Supply - Side Economics. This theory

summaries idea of supply side economics.

focuses on the effects of marginal tax rates

This means that the goal of lowering the

on the incentive to work and save, which

marginal tax rate is to increase production

effect the growth of the Supply Side.

(Real GDP) According to say's law, if more

In the middle of the 1970s, Laffer developed

goods and services are produced, more

his famous Laffer curve is clearly accurate

goods and services will be bought, and it

at both extremes of taxation zero per cent

means "supply creates its own demand"

and

Supply side economics is a school of

government collects, no revenue. At one

macroeconomic thought which emphasizes

extreme, a 0 percent tax rate means the

the importance of tax cuts and business

government's revenue is of course zero. At

incentives in encouraging economic growth,

the other where there is a 100 percent tax

in the belief that businesses and individuals

rate, the government collects zero revenue

will use their tax savings to create new

because taxpayers have no incentive to work

business and expand old businesses, which

or earn. Some where between 0 per cent and

in

productivity,

100 per cent, therefore lays a tax percentage

employment and general wellbeing. While

rate that will maximize revenue, an idea

all macroeconomics involves both supply

central to the Supply Side Economics.

and

turn

will

demand,

increase

supply

side

economics

one

hundred

percent

where

the

Total tax revenue

emphasizes the importance of encouraging increases in supply. It was popularized in the 1970s by the ideas of Robert Mundell, Arthur Laffer and Jude Wanniski. The term was coined by Wanniski in 1975. In 1978 Wanniski published "the way the world

0

t*

tax rate

works" in which he laid the central thesis of

2

t*

represents the rate of taxation at which

revenue is generated.

The Supply side Economic theory guided the

policies

of

the

administration

of

President Reagan. The Most significant Let

us examine the conclusions of supply

economic policies of his first term come

side economic theory using Aggregate

with the Economic Responsibility and Tax

Demand - Aggregate Supply graph. The

Act of 1981. There were two main

argument is that lowering marginal tax rates

provisions of this Low. First, and most

will cause a significant increase in supply.

important, was the lowering of the marginal

On the graph an increase in aggregate

tax rates. President Regan’s reasoning for

supply is shown as a shift to the right

this provision should be clear after the

GDP Deflator

discussion of the ideas of Supply- Side S1

economics. The Economic Recovery and tax Act was fully implemented by 1985

S2

E1

(Raymond, 2001)

P2 P1

E2

The tax rate schedules for a single person in 1980 and in 1985 are repeated below. Notice that the marginal tax rates are lower in 1985

0

Q1

Q2

than they were in 1980. Notice that the

Real GDP

highest marginal tax rate fell from 70 per Accounting to above graph, first the Real GDP rises from Q1 to Q2 this is a

cent to 50 per cent. Table 1: the tax rates schedules (1980, 1985) 1980

expansion.

During

an

expansion,

the

1985

Income $

Tax rate %

Income $

Tax rate

0-2300

0

0-2390

0%

2301 - 3400

14%

2391 - 3540

11%

3401 - 4400

16%

3541 - 4580

12%

4401 - 6500

18%

4581 - 6760

13%

6501 - 8500

19%

6761 - 8850

14%

8501 - 10800

21%

8851 - 11240

15%

Finally, if the Laffer curve assertion is

10801 - 12900

24%

11241 - 13430

16%

12901 - 15000

26%

13431 - 15610

18%

correct, tax revenues will also rise and the

15001 - 18200

30%

15611 - 18940

20%

18201 - 23500

34%

18941 - 24460

23%

budget deficit will be reduce or eliminated.

23501 - 28800

39%

24461 - 29970

26%

28801 - 34100

44%

29971 - 35490

30%

34101 - 41500

49%

35491 - 43190

34%

41501 - 55300

55%

43191 - 57550

38%

55301 - 81800

63%

57551 - 85130

42%

81801 - 108300

68%

85131 +

48%

up to 108301

70%

unemployment rate falls. All of this is good second the GDP deflator falls from P2 to P1. This is a deflation. Again this is good.

Supply

Side

Economic Policy

Economics

in

USA

50%

Sources: http://daphne.palomar.edu/llee

3

George W Bush became president in 2001. President Reagan proposed a more sweeping

A major part of his campaign had involved a

reform of the federal income tax low in

proposed reduction in marginal tax rates. In

1986. Again, his proposal was enacted into

May 2001, President Bush's Tax reduction

low. The main provision this low, as with

Proposal was enacted into low called the

the 1981 low, was to lower the marginal tax

"Economic

rates. The number of tax brackets was

Reconciliation Act of 2001", it created a

reduced the new tax rate schedule for a

new tax bracket of 10 per cent, effctive

single person in 1986 is repeated below.

January 1st of 2004. This was estimated to

Growth

and

Tax

Relief

lower tax payments by $300 for a single Table 2: Reduced tax rate schedule - 1986 Adjusted cross Income $

Marginal Tax rate

0 - 19450

15%

19451 - 47050

28%

47051 - 97620

33%

up to97621

28%

person and $ 600 for a married couple. This tax reduction was sent to people as checks in 2001. Table 4:The marginal tax rates for a single person for2002.

Sources: http://daphne.palomar.edu/llee

Notice

how

much

lower

the

highest

marginal tax rates were compared to the highest marginal tax rates of 1980. The reason for this change should be clear in

Adjusted Gross income $

Marginal Tax rate

0 - 6000

10%

6001 - 27950

15%

27951 - 67700

27%

67701 - 141250

30%

141251 - 307050

35%

up to 307050

38.6%

Source: http://daphne.palomar.edu/llee

1991, the 33 per cent marginal tax rate and the top 28 per cent marginal tax rate were

George W Bush Sought and Obtained

combined into are 31 per cent marginal tax

another congressional approval for tax cuts

rate. So for 1992 the tax rate schedule for

are the job creation and worker Assistance

single person looked as shown below.

Act of 2002 and the jobs and Growth tax

Table 3: Tax schedule for a single person - 1992

Relief Reconciliation Act of 2003. In 2003

Adjusted Gross Income $

Marginal tax rate

further changes to the tax low were posed

0 - 21,450

15%

21451 - 51900

28%

up to 51901

31%

Sources: http://daphne.palomar.edu/llee

under the influence of President Bush. So the marginal tax rates were reduced once again, as shown below. There were several other tax changes passed in the 2003 low.

4

Table 5 Tax schedule for 2003 for a single person Income $

Marginal tax rate

0 - 7000

0%

7001 - 28400

15%

28401 - 68800

25%

68801 - 143500

28%

143501 - 131950

33%

war 311950

35%

higher than they have been for this effect to operate. In fact, the lowering of marginal tax rates in 1981 and 1986 coincided with a large increase in federal government budget deficits. From having federal government budget deficits of about $ 60 billion in 1981, the USA experienced federal government budget deficits of more than $ 100 billion in

Source: http://daphne.palomar.edu/llee

1982 and then more than $ 200 billion in

Criticism of Supply Side Economics

1983. These federal government budget

via the USA Economic Policy

deficits stayed at very high levels, reaching a

Among economists, there is several criticism

peak of $ 290 billion in 1992.

of supply side Economics. The first one is a

A third important criticism involves the fact

view like that of supply side economics is

that the view of the supply. By doing so, it

very controversial. This criticism is that,

ignored the effects of decreases in marginal

even though the conclusions of supply side

tax rates on aggregate demand. Lowering

view validity the effect is exaggerated.

marginal tax rates may indeed increase the

Lowering marginal tax rates will likely

incentives for people to work and to save.

provide people with greater incentives to

But

work and to save. But these effects are likely

disposable

income.

This

to be very small and too small to create any

disposable

income

increases

significant

spending. Many economists argue that the

improvement

in

economic

doing

so

also

provides

greater

increase

in

costumer

behavior.

benefits of the decrease in the marginal tax

A second important criticism involves the

rates come more as a result of the effect on

Laffer curve. This curve argued that

consumer spending than on incentives to

lowering marginal tax rates would increase

produce.

production so much that tax revenues would

A last important criticism involves the

actually increase. The 1981 and 1986 tax

distributional

changes were justified by this argument. But

lowering the marginal tax rates. An across

subsequent

that

the board decrease in marginal tax rates

marginal tax rates would have to be much

provides great benefit to richer people are

research

has

shown

effect

of

the

policy

of

5

that to poor people. Richer people are those

GDP ratio increased from 26.1 pre cent in

in the highest tax brackets and are the people

1979 to 41.2 per cent in 1986.

who pay most of taxes. Poor people may pay

Considering

no federal income tax at all and therefore

administration Economic growth of USA is

would receive no benefit from the policy of

going up slowing that can be seen

lowering marginal tax rates.

comparing the data between averages of

Actually the 1980s tax cuts did not increase

economic indicates of 1949 - 2000 and 2001

the rate of growth of GDP and productivity,

- 2005

nor the investment and savings rates. The

Graph 1: Economic growth for the 2001 to 2005

unemployment rate went above 10 per cent

the

George

W

Bush

business cycle compared to the average for business cycles 1949 to 2000.

in 1982. The private saving rate continued to decline slowly in the 1980s. In the 1973 1980, private saving averaged 7.8 per cent of the economy, and dropped to 6.9 per cent in 1986 and 4.8 per cent in 1989. In other words, the saving rate was significantly lower after the 1981 tax cut than before it,

Source: Bureau of Economic Analysis USA, 2008

The labor force are at an average rate of 1.6 per cent over the 1982 - 89 period, about

While the Economy has grown under the

the same as during the previous four years,

Bush administration, growth was below

Overall labor productivity grew rapidly

average in comparison to the average for

before 1973 and less rapidly since then. In

business cycles between 1949 and 2000

the entire period after 1973, the annual

Overall real GDP has grown at an average

growth rate of productivity has been very

annual rate of 2.5 per cent (Bureau of

close to 1.1 percent. It average around 1.1

Economic Analysis, 2008) Between 2001

percent also in the 1980s, Budget deficits

and 2005, GDP growth was clocked at 2.8

that were equal to 40b $ in 1979 (-1.7 per

per cent, 17.6 per cent below the average of

cent of GDP) and 74b $ in 1980 (-2.7 per

3.4 per cent while GDI (Gross Domestic

cent of GDP) increased to 221b $ by 1986

Income) growth was 36 per cent below

(5.2 per cent of GDP), The public debt to

average. The number of jobs created grew by only 6.5 per cent, 28.5 per cent below the

6

growth rate of 9.1 per cent. The growth in

developed his famous Laffer curve. Under

average salaries was less than half as usual;

presidents Ragan and Bush, fiscal policy

1.2

was based largely on the views of supply

per

cent

versus

2.7

per

cent,

respectively. While growth in consumer

side economists.

spending was 72 per cent faster than growth in income, it too has "failed to keep pace

References

with the... average of previous cycles." Only

Alan

investment residential real - estate soared,

Turbulence, Penguin Press.

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Age

of

growing 26 per cent faster than average. Boskin Michael J. (1987) Reagan and the US Economy. The Successes, Failures, and Unfinished Agenda, ICEG

(Price L, 2005)

Conclusion Supply side economics focuses basically on the marginal tax rate. High marginal tax rates decrease aggregate supply and lower

Bureau of economic Analysis (2008),Gross Domestic Product: Percent change from pervious period.

marginal tax rates in order to increase aggregate supply. This means that the goal of lowering the marginal tax rate is to increase

production

(Real

GDP)

by

Chait, J.(2007), Feast of the Wingnuts: How

economic

crackpots

devoured

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Daniel J. Mitchell(1996),The Historical Lessons of Lower Tax Rates, The Heritage Foundation.

inflation is prevailing in the late 1970s and early 1980s. the views of the monetarist economist

gained

prominence

much

monitory policy was made with their views

Department of Labor US (2008), Labor Force

Statistics

from

the

current

Population Survey,

in mind meanwhile the most formal part of the Supply Side Economist's argument is associated with an economist named Arther

John Maynard Keynes(1972),The Collected Writings

of

john

Maynard

Keynes

Laffer in the middle of the 1970s, Laffer

7

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Price, L. & Ratner, D. (2005), Economy

Press.

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Join

Economic

Committee

(2006),

Research Report.

Raymond J. Keating(2001),Understanding Supply-SideEconomics:The

Principles,

Laffer. A. (2004), The Laffer curve, Past

the Policies, and the Future, Small

Present and Future, Heritage Foundation.

Business Survival Committee, Washington.

Niskanen W.A. (1988) Reaganomics: An

Tobin J. (1992) Voodoo Curse, Harvard

Insider's Account of the Policies and the People, Oxford University Press, Oxford.

International Review. http://daphne.palomar.edu/llee/101Chapter1 9-.pdf

Price, L. (2005), The Boom That Wasn’t: The economy has little to show for $860 billion in tax cuts.

http://www.nytimes.com/2005/08/31/busine ss/31wannisk.html

Jude

Wanniski,

69,

Journalist Who Coined the Term 'Supply Side Economics,' Dies http://www.wikipiedia. com.

8