Budget & Tax

Who Is This Crazy Supply-Sider?

July 9, 2008

Daniel J. Mitchell

"Supply-side" economics is the simple notion that tax rates affect growth. One of the key observations made by supply-siders is that policy makers should pay close attention to the relationship between tax rates, taxable income, and tax revenue-particularly since higher tax rates can reduce incentives to earn and report taxable income, which therefore means there is not a linear relationship between tax rates and tax revenue. There is even a "Laffer Curve" which shows that excessive tax rates can lead to less revenue, though the main use of the Curve is to show that higher tax rates will collect more money, but not as much as predicted by the simplistic models used by revenue estimators.

The Beltway establishment routinely sneers at supply-side analysis, in part because some Republicans overstate the argument by claiming that every tax cut (even useless gimmicks such as rebates and credits) will generate more revenue. Properly understood, however, the Laffer Curve is a very useful tool for steering tax policy in the right direction-i.e., lower tax rates and reductions in the tax bias against saving and investment.

Interestingly, there was a prominent Democrat who understood the Laffer Curve, and he gave a speech about it years before Art Laffer came on the scene and popularized the concept. Watch the two-minute clip at http://youtube.com/watch?v=aEdXrfIMdiU and ask yourself if you can imagine Senator Obama giving this speech.

President Kennedy clearly understood that there is a relationship between tax rates, taxable income, and tax revenue. And while a bit of Keynesianism is detectable (the discredited notion that tax cuts boost the economy by putting money in people's pockets, which somehow overlooks the fact that government only gets the money to put in people's pockets by first taking it out of their pockets), it is worth noting that Kennedy's proposal was a pure supply-side mix of permanent tax-rate reductions.

Daniel J. Mitchell (Ph.D., George Mason University) is a senior fellow at the Cato Institute.