Supply-Side Tax Tonic Has Been a Fantasy

Supply-side economics, in its vulgar form, claimed that lowering tax rates would actually increase tax revenues. Supposedly, if the tax man took less of a bite, people would respond to the bigger carrot; workers would strive harder and capitalists would invest more diligently.

This vision, of course, was fantasy. Tax rates were cut in the epic tax bill of 1981 and tax collections plummeted. The result was the enormous federal deficit.

Yet, as Congress wrestles with the dilemma of how to find the tax revenues to close the deficit, the ghost of supply-side economics lives on. We are warned that if taxes on the wealthy are restored, the savings that America needs to finance its investment will fall.

A number of unreconstructed supply-siders continue to insist that the experiment really worked. Sen. Robert W. Kasten Jr. (R-Wis.), one of the architects of the 1981 tax cut, recently argued that supply-side tax cuts actually “soak the rich,” pointing to the fact that “although the 1981 Tax Act slashed the top rate from 70% to 50%, upper-income individuals making more than $100,000 paid 84% more taxes in 1985 than they did in 1981.”

Much of Kasten’s artful statistic simply reflects inflation. It’s true, however, that the share of total taxes paid by the wealthy has increased slightly. But the reason that the rich paid more money despite lower rates is simply that after 1981, the rich got richer and the poor got poorer. According to the congressional budget office, the average income among the top 5% of Americans has gone up about 20% after inflation during the past decade, while the average income among the bottom 10% has gone down by about 15%.

The supply-siders claimed that their medicine would be a tonic for America’s sick rates of savings and investment. But after we cut taxes, savings rates steadily fell.

In 1981, the year before the epic tax cut, America’s gross savings rate was 19.8%. That includes savings by government, savings by individuals and corporate earnings. But despite the “supply-side incentives” to individuals--lower income taxes, lower capital-gains taxes, tax-sheltered individual retirement accounts, and so on--the individual savings rate gradually sank from 6.9% in 1981 to 5.2% in 1985 and to an estimated 4% this year.

Government savings also fell. During most of the postwar period, government had been a net source of savings because state and local government surpluses normally exceeded slight federal deficits.

But thanks to the supply-siders and their federal deficit, government after 1981 became a big drain on savings. And despite the huge corporate tax cuts, corporate earnings have continued to sag. Corporate investment has fluctuated according to consumer demand, not to tax gimmicks.

Overall, investment in productive machinery has remained just about where it was. In 1981, before the supply-side cuts took effect, America invested about 12.2% of its total income in new plant and machinery. Since the big tax cut, new investment has fluctuated narrowly, from a low of 11% in the 1983 recession to a high of 12.6% in the 1985 recovery. This year, it is running at about 11.5%.

In short, none of the supply-side tax cuts had the beneficial effects that were claimed. Ultimately, they left America with one genuine legacy, the burden of the budget deficit. George Bush’s famous description of “voodoo economics” was prophetic.

In the 1950s and ‘60s, when the top rate on the personal income tax was 91% and corporations paid far higher tax rates than they now do, America enjoyed a far higher rate of economic growth and a healthier economy.

Who should bear the burden of paying the taxes and balancing the budget is always a political choice, never an economic imperative. We should bear that in mind as we clean up the fiscal mess. If America’s wealthy have truly convinced the rest of us that our own well-being depends on their tax holiday, we will have only ourselves to blame when we get stiffed with the bill.