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Wednesday Oct 1, 2008

Supply-Side Economics never made sense

As we see the collapse of Wall Street, AIG, Bear Stearns, Merrill Lynch, Washington Mutual and Lehman Brothers, we all must wonder what happened. We have been told that our economy was strong. Yet within the last seven to eight months we've seen 19 banks collapse and the kind of volatility in the stock market that makes us all queasy and seasick.

Within 20 years, we went from being the most prosperous nation on the earth to the nation carrying the most debt. Personally, I think we have to look back to the 1980s for the answers. This was the so-called Me Generation. It was all about nicer clothes, nicer cars and the biggest house in the gated community. It didn't matter if you obtained all of this through credit cards, six mortgages and a loan from Guido down the street. The bottom line was it was all about Me.

Some of this thinking came from supply-side economics. The theory behind supply-side economics: tax cuts for the wealthy and for businesses will free up capital; the wealthy would spend more money; business and the wealthy would hire more people. This prosperity would trickle down to everyone. On the surface, this makes a lot of sense but upon further reflection we see it is a magician's trick. Before we get the hard data, let's just think about this. If you're a wealthy businessman who makes $10 million a year, for argument's sake, you pay 40% of what you make in income tax. This comes to $4 million. With tax cuts, your tax rate is changed from 40% to 35%. You take home an extra $500,000. What are you going to do to spur the economy? You already have a new car, maybe two or three. You have a house, possibly two. You already have a maid and someone to cut your grass. Most likely, you will do what most multimillionaires would do, which is to invest that $500,000. The logic for business is about the same. Businesses don't hire people just because there's extra money lying around. Extra money from tax cuts can be paid out as bonuses (remember upper management is very fond of bonuses and stock options) or distributed as increased dividends to stockholders. Therefore, in this example, it appears that supply-side economics lines the pockets of the rich.

With President Bush, President Clinton and President Reagan, we are able to look at two eras of supply-side economics. Squeezed in the middle is a more traditional economic approach. Real investment growth was greater in the period of 1993-2001 at the rate of 10.2%. President Reagan had a growth of 2.8%. President Bush has had a growth of 2.7%. Gross Domestic Product, a measurement of economic growth, increased at an average annual rate of 3.9% during the era of President Clinton. Reagan and Bush had rates of growth of 3.9% and 2.5% respectively. For me, the most important indicator of how we are doing is real average annual median income. With the tax increases during Clinton's presidency, real average annual median income grew at a rate of 2.0%. Reagan's presidency spurred an increase 1.4% and under President Bush the increase was only 0.3% (data from Center from American Progress).

There are multiple excuses that true supply-side believers will give us as to why supply-side economics did not work. They will claim that any change in the economy takes years to make an effect. This plainly contradicts the father of supply-side economics, Art Laffer, who stated that we would see changes in our economy "before the ink is dry" on the legislation for tax cuts. They will argue that there weren't enough government spending cuts. There's further data to support a more traditional economic approach. This approach includes higher wages, higher employment growth and results in decreased federal deficits. Such was the case during Clinton's years in office, as compared with either supply-side era. In spite of all this data, though, some still advocate tax cuts for the rich. Why? Why indeed.

Supply-side economics simply does not work for America. Maybe, this Me first, everything else second mentality helped cause the craziness that we're seeing on Wall Street. I'm just askin'.

Posted by Errington Thompson on Oct 1, 2008 email post email Spotlight / / You are in Economy
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