Return of the Supply-Siders

By Lawrence Chimerine

Tuesday, July 23 1996; Page A17
The Washington Post

Like the proverbial bad penny that always shows up, supply-siders are back again, this time proposing a large across-the-board income tax cut. If you want a demonstration of how well it will work, they say, just look at the experience of the 1980s.

Don't believe it. Such tax cuts would undermine current efforts to balance the budget in the intermediate term and would make the huge, entitlements-driven deficits in the next century even bigger. Furthermore, most of the benefits would go to upper-income families that have already prospered in recent years, rather than to the lower-income groups that have been squeezed. Most important, an accurate reading of the evidence reveals that the 1980s tax cuts failed to deliver the benefits promised by the supply-siders. In fact, they proved to be counterproductive in many ways.

Perhaps the supply-siders' most notable prediction in the early 1980s was that the drop in marginal tax rates, plus the enactment of individual retirement accounts and other tax incentives, would lead to a savings and investment explosion. Exactly the opposite happened: The personal savings rate dropped to a postwar record low, and the overall national saving rate dropped even more sharply because of the huge deficits caused in part by the tax cuts. The rate of investment as a share of gross domestic product also dropped in the 1980s, contrary to supply-siders' promises. This was especially distressing because our investment rate was already lagging far behind most of our foreign competitors.

Not surprisingly, with savings and investment on the decline, productivity growth was extremely weak in the 1980s. Admittedly, this trend began during the 1970s, but one enticing justification for the supply-side tax cuts was that they would revitalize productivity. Very simply, they did not. Furthermore, U.S. international competitiveness plummeted to its lowest point since World War II. In part, this reflected the overly strong dollar produced by supply-side policies -- the combination of loose fiscal policy and tight monetary policy -- but it also reflected low investment and weak productivity growth. The result was record-high, triple-digit trade deficits on a regular basis.

Supply-siders tried to put a positive spin on the bad news -- claiming stronger import demand and increased foreign investment were signs of strength -- but it is clear that the huge trade imbalance sapped economic growth and contributed to the stagnation in living standards.

Even the much ballyhooed increase in new jobs during the 1980s was dramatically overstated. First, the rate of job growth was little improved from the 1970s. Second, most of those new jobs yielded low pay and little benefits. Finally, the job growth of the 1980s was not the result of increased work effort caused by lower marginal tax rates; the new jobs were largely second jobs, or new working spouses, because more families were forced to generate second incomes in order to maintain living standards.

Perhaps the most significant misrepresentation by the supporters of Reaganomics is that the early-1980s tax cuts substantially increased economic growth. True, the economy grew for seven straight years during the mid-1980s, but because the rate of the growth lagged behind previous expansions, and because that period was preceded and followed by recession, the 1980s ended as the slowest growth decade since World War II.

Furthermore, as indicated earlier, the growth we experienced during the mid-'80s was fueled not by any improvement in long-term fundamentals but, rather, by short-term demand stimulus resulting from the tax cuts and military spending increases, by reversal of the oil price increases of the 1970s and by an unprecedented leveraging of the economy. When these temporary stimulants disappeared, the economy entered into a long period of stagnation.

Supply-siders also predicted their tax cuts would pay for themselves. This was nonsense from day one, because the credible evidence overwhelmingly indicates that revenue feedback from tax cuts is 35 cents per dollar, at most. The result, of course, was budget deficits soaring off the charts, instead of the promised budget surpluses. Supply-siders claim that, because tax revenues as a share of GDP remained constant during the 1980s, the deficits were caused by the absence of significant spending cuts and not by the tax cuts.

They neglect to mention the huge Social Security tax increases enacted early in the decade to ensure future trust-fund solvency -- income tax revenues as a share of GDP were considerably lower at the end of the decade than in 1980, exactly as conventional economists had predicted when the tax cuts were enacted. Further, increased spending in the 1980s largely reflected the huge increases in interest expense to service the exploding national debt.

The bottom line is that the supply-side tax cuts of the 1980s were a national disaster. They have proven to be harmful for the economy and have put a huge and unconscionable burden on future generations. There is no reason to believe that a new round of large income-tax cuts would be any better for the economy now. At most, they would provide a small boost to the economy in the very short term, but the larger deficits and higher interest rates they would cause would actually reduce long-term economic growth. A better approach would be a combination of tax reform and targeted tax cuts that really stimulate job creating long-term investment.

Today we continue to dig ourselves out of the mess created by the excessive tax cuts of the 1980s. It seems unimaginable that tax-cut advocates would expect us to repeat history and fall once more for promises of something for nothing. Are we really gullible enough to accept a free dinner while still suffering the indigestion caused by our "free" lunch?

The writer is managing director and chief economist at the Economic Strategy Institute in Washington.

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