Transcript PPT

Supply Side Economics
(Defeats Keynesian Economics)
Jamie Kadonsky
Elliot Boettcher
• Why should we use supply side economics?
– Economic growth can be most effectively created
by lowering barriers for people
• Adjusting income tax and capital gains tax rates
• Allowing greater flexibility by reducing regulation
– Consumers will benefit from a greater supply of
goods and services at lower prices
• Supply side economics
– Higher income levels and living standards cannot
be achieved without expansion in output
– Supply-side economics is used to describe the
changes in marginal tax rates
• The percentage of that next dollar of income that you'll
actually be allowed to keep is 100% minus your
marginal tax rate
• Marginal Tax
– High marginal tax rates strongly discourage income,
output, and the efficiency of resource use
– Typical policy recommendations of supply-side
economics are lower marginal tax rates and less
regulation
– 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
-Affects the incentive to earn
• Marginal Tax
– An increase adversely affects
the output of an economy in
two ways
• First, the higher marginal rates
reduce the payoff people derive
from work and other taxable
productive activities.
– Higher rate = less money for
taxpayers
• Thus, when marginal tax rates
rise, some people—those with
working spouses, for example—
will opt-out of the labor force.
Others will decide to take more
vacation time, retire earlier, or
forgo overtime opportunities.
• Marginal Tax
– High tax rates will even drive highly productive
citizens to other countries where taxes are lower
– High marginal tax rates encourage forms of taxavoidance taxpayers facing high marginal tax rates
will spend on pleasurable, tax-deductible items
• Such as plush offices, professional conferences held in
favorite vacation spots, and various fringe benefits.
– Real output is less than its potential because
resources are wasted producing goods that are
valued less than their cost of production
(HIGHER TAXES)
(LOWER TAXES)
• Critics of supply-side economics point out that
a 10 percent change in after-tax wages
increases the quantity of labor supplied by
only 1 or 2 percent. This suggests that changes
in tax rates would exert only a small effect on
labor inputs.
• These estimates are of short-run adjustments
– Compare countries, such as France, that have had
high marginal tax rates on even middle-income
people for a long time with countries, such as the
United States, where the marginal rates have been
persistently lower
• Recent work by Edward
Prescott, co-recipient of the
2004 Nobel Prize in economics,
used differences in marginal tax
rates between France and the
US to make such a comparison.
Prescott found that the
elasticity of the long-run labor
supply was substantially greater
than in the short-run supply and
that differences in tax rates
between France and the United
States explained nearly all of
the 30 percent shortfall of labor
inputs in France compared with
the United States.
• The supply-side economic policy of cutting high
marginal tax rates, therefore, should be viewed as
a long-run strategy to enhance growth rather
than a short-run tool to end recession.
• Changing market incentives to increase the
amount of labor supplied or to move resources
out of tax-motivated investments and into higheryield activities takes time.
• The full positive effects of lower marginal tax
rates are not observed until labor and capital
markets have time to adjust fully to the new
incentive structure
• Because marginal tax rates affect real output,
they also affect government revenue.
• An increase in marginal tax rates shrinks the
tax base, both by discouraging work effort and
by encouraging tax avoidance and even tax
evasion.
– An increase in tax rates leads to a less than
proportional increase in tax revenues.
• The bottom line is that cutting all rates by a
third will lead to small revenue losses (or even
revenue gains) in high tax brackets and large
revenue losses in the lowest brackets.
– As a result, the share of the income tax paid by
high-income taxpayers will rise.
• And to spice up the presentation….
WHY KEYNESIAN ECONOMICS IS
WRONG…
• As the Keynesian perspective triumphed following
WWII, most economists believed tax reductions affect
output through their impact on total demand.
• The potential supply-side effects of taxes were ignored.
• However, in the 1970s, as inflation pushed more and
more Americans into high tax brackets, a handful of
economists challenged the dominant Keynesian view.
• Led by Paul Craig Roberts, Norman Ture, and Arthur
Laffer, they argued that high taxes were a major drag
on the economy and that the top rates could be
reduced without a significant loss in revenue. They
became known as supply-side economists.
• During the presidential
campaign of 1980, Ronald
Reagan argued that high
marginal tax rates were
hurting economic output,
but contrary to what many
people think, neither
Reagan nor his economic
advisers believed that cuts
in marginal tax rates would
increase tax revenue
• Keynesian continued to focus on the demandside effects, claiming that it was irresponsible to
cut taxes at a time when inflation was already
high.
• They expected the rate cuts to lead to larger
budget deficits, which they did, but also that
these deficits would increase demand and push
the inflation rate to still higher levels.
• Contrary to the Keynesian view, the inflation rate
declined substantially from 9 percent during the
five years prior to the tax cut to 3.3 percent
during the five years after the cut.
• Furthermore…
– Supply side = WIN!
• Thinking about the future
• Adds to deficit… BUT inflation rate decreases
• Low marginal tax rates = more income, output, and the
efficiency of resource use
– Keynesian = LOSE!
• Thinking only about now
• Adds to deficit… AND no new money is in circulation
• High marginal tax rates = less income, output, and the
efficiency of resource use
Supply Side, The Better Side