Supply-Side Economics
“Supply creates its own demand”
- Say’s Law
SUPPLY SIDE
Economics
• 1980’s –Early 2000’s
• Producer Based
• Milton Freidman
• Government tries to influence GDP by influencing
aggregate supply (the total quantity producers are willing
and able to supply)
• Goal is to promote full employment while decreasing
prices
Theory
• Production (supply) is the source that drives
consumption and living standards.
– In the long run, our income levels reflect our
ability to produce goods and services that people
value.
Business organizations:
1. do not have profits as a
goal.
2. have similar ownership
structures.
3. do not include retail firms.
4. serve to link scarce
resources and consumer
satisfaction.
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How it changes Supply & Demand
START
GOAL
Government Actions
(Supply Side)
• Incentives for businesses
• Laissez-Faire Principles
• Decrease regulations
• Taxes Decrease (especially for Businesses)
• Can lead to Federal Deficits
Government Regulations
• Regulations strangle the growth of Aggregate
Supply limiting the amount being produced
• Favor a laissez-faire government policy
Reduce Government Sector
Restrict
Monopolies
Privatization
to increase
incentives and
reduce costs
Deregulation
to encourage
competition
and efficiency
Reduce
Government
Sector
Private
Financing of
Public
Services
Outsourcing
to Private
Sector
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Taxes Decrease (especially for
Businesses)
• “Supply-side economics” is also used to
describe how changes in marginal tax rates
influence economic activity. Supply-side
economists believe that high marginal tax
rates strongly discourage income, output, and
the EFFICIENCY of resource use.
The Marginal Tax Rate
• The MARGINAL TAX RATE is crucial because it affects the incentive
to earn. The marginal tax rate reveals how much of one’s
additional income must be turned over to the tax collector as
well as how much is retained by the individual.
– For example, when the marginal rate is 40 percent, forty of every one
hundred dollars of additional earnings must be paid in taxes, and the
individual is permitted to keep only sixty dollars of his or her additional
income. As marginal tax rates increase, people get to keep less of what
they earn.
An increase in marginal tax rates adversely affects
the output of an economy in two ways:
• First, the higher marginal rates reduce the payoff people
derive from work and from other taxable productive activities.
• Second, When people are prohibited from reaping much of what they sow,
they will sow more sparingly. Thus, when marginal tax rates rise, some will
opt out of the labor force. Others will decide to take more vacation time,
retire earlier, or forgo overtime opportunities. Still others will decide to
forgo promising but risky business opportunities. These adjustments and
others like them will shrink the effective supply of resources, and
therefore will shrink output.
The major incentive for taking risks to
own a business is based on:
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managing others.
paying taxes.
making a profit.
having more leisure
time.
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The Laffer Curve
• Economists Arthur Laffer
argues:
– after a point the
disincentive effect of
higher tax rates will result
in high rates reducing tax
revenue
Implications of Laffer Curve
• it’s possible to raise rates and get less revenue
– the higher rates cause a “recession”
• it’s possible to lower rates and get more
revenue
– if the lower rates stimulate the economy enough
– eliminate government debt, resolving any
apparent conflict between reducing revenue and
fiscal responsibility.
Increasing Incentives
• Supply-side economists believe that the real
problem was that high rates of taxation and
heavy regulation had reduced the incentive
to work, to save, and to invest.
• What was needed was not a demand stimulus
but better incentives to stimulate supply.
Improve incentives by lowering
taxes
Lowering taxes on
interest income to
stimulate saving
and investment
Reduce personal
taxes to
encourage more
work
Lowering business
taxes to increase
investment, R&D
and innovation
Improve
incentives
for private
initiative
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Make labor more responsive to
supply and demand
Weaken unions to
provide greater
flexibility, increase
profits and spur
economic growth
Abolish minimum
wage to provide
greater flexibility
increase profits and
spur economic
growth
Reduce
unemployment
benefits to lower
unemployment rates
Make labor
more
responsive to
supply and
demand
Reduce job security
so firms can fire at
will
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"Supply-side" economics was
based primarily on:
1. stimulation of the
business (supply)
component.
2. government
stimulation of
consumer demands.
3. a repudiation of
"trickle-down" theory.
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4. increases in taxation.
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• Will people have the incentive to
work more if they pay less out in
taxes?
• Will the wealthy have the incentive
to produce more if they pay out less
in taxes?
Supply-Side Tax Cuts—Workers
• Problems: After-tax income is important to workers. But it is
only one -- a very important one, but nevertheless only one -part of total job satisfaction. Job security, work environment,
many other factors are also important, as numerous studies
have shown.
– Moreover, to enjoy the incentive of take home pay, you have to have some
pay to take home, and so these incentives mean nothing for the
unemployed.
Supply-Side Tax Cuts—Firms
As far as businesses, It doesn't matter if taxes are smaller, if
profitability expectations are dimmed because of a recession
and unemployment, firms aren't going to be increasing
productive capacity.
- They aren't able to sell all they can produce now.
- A capital gains tax cut does nothing to
guarantee
investment.
- An investment tax credit may help a little more, at
least then there is some incentive to invest.
• Among the criticisms of supply-side
economics is that it is unlikely a tax cut would
substantially increase the supply of labor.
• When households receive a higher after-tax
wage, they might have an incentive to work
more, but they may also choose to work less.
Has it worked?
• Reagan’s deregulation of the banking
system—led to
– Savings &Loan crisis; $500 billion + taxpayer
bailout
– 1990-91—Worst recession since WWII up to that
time.
Has it worked
• Clinton/Bush deregulation of banking systemled to
– “Too Big to Fail” investment banks collapse; $900
billion bailout + $800 billion Stimulus Package
• Debt grows from $1 Trillion in 1980 to $10
trillion by 2008
Has it Worked?
• Created massive income inequality
– Demand decreased as worker’s wages only
increased minimally
• Thus, tax revenue decreased under a combination of
reduced taxes on the wealthy and less taxes from
consumption.