Supply-Side Economics

8 Economics Lessons #4

It is true that taxation will discourage work and will damper investment. It is true that cutting taxes will encourage productivity within the economy. A supply-sider claims that you can actually increase tax revenue by decreasing taxes. The theory is that we will all work harder and earn so much more that we actually be paying more in dollars than we would have at the higher rate. 

In Naked Economics, Charles Wheelan acknowledges that at certain tax levels, supply-side theory will be true. (He believes that if the income tax rate is 95% and lowered to 50% it would almost certainly spur enough extra work to increase tax revenues.) So, does this mean that supply-side theory is true at all tax levels?

Well, no. We know this thanks to the empirical evidence provided by the Reagan tax cuts. Government revenue did not increase and the loss in revenue resulted in the largest deficits the country had ever seen to that point. With no real evidence to back up the theory, why do conservatives remain heavily invested in it?

I can't answer that. Either way, an economist named Arthur Laffer drew what was known as Laffer's Curve on the back of Dick Cheney's napkin in 1974. This was a theoretical graphical depiction of tax revenues increasing as tax rates decreased. It was used as the basis for Reaganomics and all that passes for conservative economic theory at this point. We have paid the price both in terms of our deficit and the poisoning of the collective consciousness.