You Know You’re Winning When Your Opponents Are Forced to Rely on Supply-Side Fantasies

Posted in: Politics

When they are not lying about climate change or health care or voter fraud or terrorism or guns or immigrants or reproductive rights, Donald Trump and the Republican Party love to lie about economic policy, especially taxes.

Are tax cuts—especially tax cuts for corporations and the extremely rich—the answer to all of our economic ills? The answer is still a resounding no, but the Trump/Republican axis refuses to allow reality to get in the way of a convenient story.

There is admittedly a Groundhog Day-like feeling here, because it was not even two months ago that I went over this already familiar ground in a Verdict column: “The Church of the Perpetual Supply-Side Miracle.”

Even so, recent developments call for a quick return to the Republicans’ budgetary fantasyland, and it is again necessary to remind ourselves just how nonexistent is the case for the Republicans’ hyper-regressive tax policy.

Indeed, the Trump Administration has ramped up its commitment to supply-side economic dishonesty, even though the theory and evidence in support of supply-side policies have never been weaker.

The Trump Administration’s Embrace of Imaginary Budgeting

In the midst of the string of mind-bending news stories that break almost daily—Trump’s disastrous recent foreign trip, his withdrawal of the United States from the Paris Climate Accord, the Comey and Sessions hearings regarding Trump’s impeachable actions, as well as natural disasters and mass shootings—it is easy to lose track of the storyline about economic policy.

But the news on that score from Trumpland is all bad, and the extent of the dishonesty is breathtaking. For example, when the White House’s economic team announced its budgetary forecasts last month, it said that it would fulfill Republicans’ dreams of repealing the estate tax, but it then included $330 billion of revenue from the estate tax in its ten-year budget forecast.

Similarly, the Administration was caught double-counting a two trillion dollar revenue surge that was supposed to flow from supply-side magic. They claimed that they could cut two trillion dollars of taxes that would then lead to an equal amount of increased revenues, but then they failed to account for the initial revenue loss in their forecasts.

At best, this is somewhat like saying, “You have to spend money to make money,” but then forgetting about the money that you had to spend, turning it into, “You make money by making money.”

In short, the Trump people are brazenly lying. That is no surprise, although their double-talk is always amusing. For example, Trump’s budget director, Mick Mulvaney, defended the dishonest accounting by saying that the Administration “did [the double count] on purpose” and that “there’s other places where we were probably overly conservative in our accounting. We stand by the numbers.”

But these craven lies threaten to distract us from the ridiculous initial claim that the tax cuts were going to generate two trillion dollars of increased tax revenue for the government.

That is the supply-side fantasy, and Trump has jumped on the Republican bandwagon to use it to justify his regressive tax cuts. It is still completely unsupported by theory or evidence.

Even the Weaker Version of Supply-Side Economics Is Completely Indefensible (in a Reality-Based Argument)

There are actually two versions of what is commonly called supply-side economics. The strong version is the Laffer Curve, which says that tax cuts fully pay for themselves, whereas the weak version (aka Trickle-Down Economics) simply says that cutting tax for businesses and rich people will increase growth and thus partly offset tax-cut-induced revenue losses.

The Trump people have fully embraced the strong version (multiplied by two, as I noted above), which is amazing, because it is difficult to find even conservative economists who believe such nonsense. But Republicans have always loved to embrace convenient fantasies, so reality is not a barrier to their preferred political views.

Moreover, even the weaker version of supply-side economics has become impossible to justify. In fact, the overwhelming weight of economic evidence shows that Republican-style tax cuts do not increase economic growth.

This is not, moreover, a matter of warring ideological camps of economists reading the evidence in different ways. A recent article in The New York Times quoted two prominent conservative economists saying the same thing that liberal economists say.

Alan Viard, who has advised Republican candidates and works at a prominent right-wing think tank, concluded that “[t]ax policy is clearly not some overwhelmingly powerful tool that affects growth.”

Similarly, Douglas Holtz-Eakin, who advised John McCain’s presidential campaign and is the former director of the Congressional Budget Office, rejected cutting tax rates and instead argued for investment incentives, infrastructure spending, and “retraining that improves workers’ skills and increases the proportion of prime-age Americans who are employed.”

Only the first of those ideas is a tax policy, by the way, and it is essential to note that it is not a simple tax rate cut. That is, it could be fully consistent with high tax rates—indeed, the higher are tax rates, the more effective targeted tax incentives can be.

The “This Happened, Then That Happened” School of Justifying Republicans’ Tax Cut Proposals

But true believers in supply-side fantasies are unfazed by all of this. Their defenses of the faith are essentially a matter of selective misreadings of specific episodes in economic history.

For example, as I noted in another column in April, motivated Republicans will often invoke the tax cuts early in Ronald Reagan’s first term as evidence that tax cuts increase growth. Sometimes, they will also mention tax cuts signed by John F. Kennedy as proof that supply-side tax cuts work. (See, Democrats? Your own hero was a supply-sider!)

Again, it is essential to remember that supply-side economics is actually not simply a claim that “tax cuts lead to growth.” That claim, in fact, is fully consistent with demand-side economics. For example, the growth that we saw after the first round of Reagan tax cuts was a result of those tax cuts being spent by people in the throes of what was then the deepest recession of the post-World War II era.

Even that is a gross simplification, as I will explain below, but the most that one can say about the effects of tax cuts on the economy in the early 1980s is that growth was somewhat higher for a couple of years, as increased spending helped the economy return to its longer-term growth path. That long-term path itself, however, was not affected by the Reagan tax cuts.

More generally, the invocation of the Kennedy and Reagan (and other minor examples of) tax cuts is a fascinatingly persistent example of a logical error that says that one event in time caused something to happen later, leaving aside all other factors.

This kind of illogic is actually quite common. “I wore my lucky socks, and then I got an A on an exam.” “I prayed, and my team won a playoff game.”

Of course, the difference with supply-side fantasists is that they claim to have a theory, a cause-and-effect story that says that tax cuts cause people and businesses to become so excited that they are willing to work harder and engage in more innovation in order to get richer. And when a tax cut at Time A is followed by higher GDP at Time B, that might seem to be validation of the theory.

The problem is that this is an easy game to play on either side. Devoted supply-siders invoke Kennedy and Reagan. Everyone else can counter with the tax increases signed by the first George Bush as well as the further tax increases signed early in Bill Clinton’s first term, which supply-siders said would kill the economy but in fact were followed by a record-setting era of prosperity.

Similarly, the two sets of tax cuts in George W. Bush’s first term were followed by incredibly weak growth even before the Great Recession nearly destroyed the world economy.

By contrast, the tax increases passed in the Obama years—in particular, the taxes on high-income people that were part of the Affordable Care Act, and which Trump and the Republicans are now trying desperately to repeal—were followed not by economic catastrophe but by consistent (if frustratingly slow) recovery and a historically long run of growth.

In short, the this-then-that version of reality is at best a contest of anecdotes. Even in that simplified argument, however, the anti-supply-side group (that is, almost everyone outside of the Republican Party, conservatives and liberals alike) has the better of that argument, because the examples of anything-but-disastrous tax increases destroy supply-siders’ claims that taxes inevitably kill growth.

And certainly the utter failure of Kansas’s supply-side tax cut experiment—a failure so complete that even many frustrated Republicans in the state legislature recently joined with Democrats to override the true-believing governor’s veto of a budget-saving tax increase—would have to count heavily on the anti-supply-siders’ list of the type of simple this-then-that stories on which Trump and the Republicans rely.

Taking the Full Range of Reality Into Account

Even so, it is simply wrong to rely exclusively on such examples in order to understand economic phenomena. Everyone knows that any number of relevant factors might have intervened to throw off a simplistic one-cause prediction.

Again, some non-economic examples will be helpful. A company selling a diet pill might say, “This person took our pill and lost 30 pounds in 3 months!” What they do not say is that the person might have gone into training for an Ironman competition, or cut down to a 1500-Calorie-per-day diet, or developed a wasting disease.

Or think of a kid who says that he is the best baseball player ever. Each time he strikes out, he has an excuse. Something else intervened to prevent his athletic prowess from showing through. At some point, a loving but skeptical parent might ask, “Did the sun get in your eyes every time you struck out?”

And even Republicans know how to use this logic when it suits them. Back in 2011, before Paul Ryan helped to drag down Mitt Romney’s doomed presidential candidacy, he was asked about the counterexamples to his simplistic tax-cuts-are-always-good-and-tax-increases-are-always-terrible belief system.

Ryan, much to my surprise, actually made a good point:

I wouldn’t say that correlation is causation. I would say Clinton had the tech-productivity boom, which was enormous. Trade barriers were going down in the Clinton years. He had the peace dividend he was enjoying.

What about the disappointments of the Bush tax cuts? Again, Ryan pointed out other factors, such as “a couple of wars” (as if those were not a policy choice that he had enthusiastically embraced) and the economic effects of the 9/11 terrorist attacks. He concluded: “Some of this is just the timing, not the person.”

True enough. Ryan was willing to say that life is complicated, which sadly counts as a breakthrough for a Republican.

But it is also essential to point out that the growth that we saw after passage of the Reagan tax cuts is easily explainable by a huge defense buildup (which is a terribly expensive way to increase growth, but it does work) and by the Federal Reserve’s aggressively expansionary monetary policy at the time. And the Kennedy expansion similarly coincided with a defense buildup (Vietnam) and other more fortunate economic tailwinds.

In short, even though non-supply-siders have the stronger argument in the battle of historical anecdotes, the important thing is to take more than one factor into account when trying to determine whether a policy succeeded or failed.

And that is where the economics profession comes in. For all of its dysfunction and focus on abstract theorizing, there are times when economists are able to reach nearly unified conclusions about empirical controversies.

For years, that consensus has been resounding. Neither the strong nor the weak version of supply-side economics is backed up by sophisticated analyses that try to control for all of those potentially confounding and contradictory factors.

We know from years of careful study that tax cuts do not pay for themselves and that tax cuts for businesses and the wealthiest Americans do not increase growth. This might be as close to the all-but-unanimous scientific consensus on human-induced climate change as one will find in economics. But we know what Republicans think about climate science, too.

Moreover, it is notable that the economy’s maximum possible growth rate has been falling throughout the past generation or more, through both increases and decreases in tax rates. When the Trump people say, “Well, we’re going to make growth go up to 3%, which must be possible because the U.S. has grown that quickly in the past,” they are simply ignoring other factors that make such growth impossible to achieve sustainably today.

Or as the economist Lawrence Summers recently put it more colorfully:

Apparently, [Trump’s] budget forecasts that U.S. economic growth will rise to 3.0 percent because of the administration’s policies—largely its tax cuts and perhaps also its regulatory policies. Fair enough if you believe in tooth fairies and ludicrous supply-side economics.

One might also note that even if one is obsessed with high-end tax cuts, the Kennedy bill reduced marginal income tax rates for the wealthiest Americans from 91% to 70%, whereas the top federal rate is now 39.6%. It just might be the case that the effects are different at lower rates.

Indeed, research by the famed economist Thomas Piketty and his co-authors suggests that marginal tax rates in the 75-80% range for high-income earners are consistent with high economic growth. As a bonus, such rates would also begin to turn the tide against the growing inequality that has had such disastrous effects on the U.S. and the world.

As an aside, those who are looking for economic policy suggestions that might increase the economy’s growth possibilities will find that it is liberal policies that are the most promising, as I wrote recently.

In any case, the bottom line is that Trump and the Republicans (and their motivated supporters) are continuing to embrace a view of economics that was never widely accepted by economists and that has been debunked both theoretically and empirically many times over. We must reject their regressive policies.

  • Ted Harvatin

    Every major tax cut has resulted in increased federal revenue. You get an F.

  • Frank Willa

    Professor, thank you for continuing to shed light on the supply side fantasy. In my view another causation of growth in the 80s was simply the coming of age of a large number of baby boomers; they were getting out of High School and College and entering the work force. The larger adult population swelled economic activity and demand for housing, and the stuff to furnish it, and things like cars and other things and services. We had gone from a work force of about 75 million in the 60s to about 105 million in the 80s. This expansion in the size of the U.S. was foreseen as the we went through the post WWII era. In my opinion the transfer of wealth by Reagonomics to the upper tier in fact blunted the “multiplier effect” ( I seem to recall the Economists of the time re-dubbed it the “ripple effect’ so as to try to “spin” down its importance) of money rising from the lower strata to the top during the 80s.

    The big defense increase was started by Carter, and he appointed the “Fed” chair that tamped down inflation in the 80s, and as with the increase in the economy, and reduction in inflation, Reagan took credit for something he did not do.
    I would also like to share my view of how the reality denying gained ground in the 80s, at least in part. During that time there was a surge in religious influences intruding into the political and cultural spheres, here and abroad. Among the notions that those proponents of religion espoused was the elevation of “creationism” as an equivalent to reality. Some propounded that the earth was 4,000 years old, others that dinosaurs and man co-existed, etc. The culture was “bent” to allow beliefs if religiously held, or somehow deeply felt, to stand equal to science, with its “reality tools” like carbon dating, and DNA tracings through the commonality of all animals- evolution, of which we are one. So, now if you want to believe something, or not believe, there is no difference between fantasy and reality; and therefore no reason to have your belief influenced by facts.

  • Jerry James

    Perhaps it would be worthwhile to try a two-track income tax program. On the first track would be something like the current set of brackets with the highest being set back to 70% or so. For the second track have a single bracket for which the percentage is set according to the unemployment rate, GDP, and/or other economic factors that relate to how the country and its citizens are doing economically. The better we are doing the lower the second-track tax rate.
    Those who insist that they can use their wealth to help boost economic activity can choose the second track tax route. If the economy performs better than some chosen baseline in one year, the next year will have a lower second track tax rate. If it performs worse, the rate the following year would be boosted to make up any lost tax revenue due to this under-performance.
    Instead of arguing endlessly about whether high tax rates on the wealthy help or hurt the economy, let those who insist there is a connection do the experiment by signing on to the second track tax rate. If they are right, both they and the country do well. If they are not, the country should still do well and they at worst would be only a little less wealthy. My guess is that few would be willing to actually join in the experiment and would stay with the first track, even with an 70% tax rate.
    Obviously, this is just the sketch of an idea, and one that has no chance of being implemented in any form. But, I would like to see something even close to it being discussed as a way to find out if the wealthy actually believe in the supply-side myth by risking some of their own skin. As it is now, they only risk the welfare of everyone else.

  • Jerry James

    Those who support the supply-side argument for increasing economic activity will never accept that it doesn’t work. This is because it always works for them, those with lots of extra capital. They are ready and willing to do the experiment because they are risking nothing. It’s everyone else who does the risking.

    Here’s an idea for a way to change that. We should set up a second income tax track in addition to the current one. Modify the first track to set the highest marginal rate to something like 70%. The second track should have a flat rate, no deductions, that depends on the previous year’s economic well-being. Tie this rate to a set of metrics including GDP, unemployment rate, median income for workers, etc. If an agreed upon target is exceeded in a given year, the tax rate for those on the second income tax track would be reduced the next year. If the target is not met, the next year’s tax rate for these folks would be increased to at least make up for lost tax revenues due to economic underperformance. This approach puts the supply-side argument to a test that gives the pro-group a way to prove directly that the idea works. If it works, they and the country would win. If it doesn’t they would have to suffer the consequences along with everyone else.

    People should be given a choice of being on this new tax track as not all would agree that their investments have much effect on job creation, but the tax rate on higher incomes in the current tax system should be high enough to make them consider being on the new scale.

    Obviously, this is only the sketch of an idea, the point of which is that any scheme based on supply-side arguments should be set up to require the proponents to have substantial skin in the game.

    My own opinion, and probably that of most informed citizens, is that the investment income from the wealthy is not so much used to create jobs as it is to buy enough politicians, Democrats and Republicans alike, to ensure that their incomes and wealth are not threatened. This needs to be fixed.

    • Frank Willa

      Thank you for your thoughts as how to find some accountability for the supply-side proponents. In my view, which I think is similar to the notion that you put forward, is to somehow find a way to link the granting of tax cuts to the wealthy for the “alleged growth” that they think necessarily follows, that is, to what the benefit is spent on. For example, if the “investment tycoon” were to receive a 100 million dollar break, then it should be shown to be used to actually start a new business, or erect a new building, and or purchase machinery, and most of all pay new workers for their services. If, on the other hand, it were to be used to buy a 100 million dollar “Van Gogh” painting to decorate a room in one of many houses, thus only viewed several weeks out of the year; then no tax break should be given. Without the nexus between the “windfall” and concrete investment; there is no assurance that economic growth will be the result. As with your suggestions, this is a “raw” rough draft of an idea; so let the tax cut be linked to expenditures, to be forfeited if it is not.

  • Brett

    Mr. Buchanan is stuck in liberal fantasy-land where higher unemployment, out-of-control government debt, large numbers of Americans on food stamps and welfare are the norm.

  • Tax cuts have always caused the percentage of income to go down but that percentage does not reflect the overall federal tax income which has always dramatically increased in hard cash coming in from taxes. What seems like a disconnect is actually caused by a dramatic increase of business expansion which also has always caused an increase in employment and a small business increase. All of this also relates to an increase in Gross National Product so when some say the percent of tax revenue will go down they are correct but their shortsightedness, purposeful or not, does not include the overall picture of the tax environment.