SUPPLY SIDE ECONOMICS ALTERNATIVE TO KEYNESIANISM RESPONSE TO THE “STAGFLATION” OF THE 1970S – BOTH HIGH INFLATION AND HIGH UNEMPLOYMENT SOME ECONOMISTS SAID NEEDED A NEW MODEL OF THE MACROECONOMY

ELEMENTS OF SUPPLY SIDE ECONOMICS KEYNES FOCUSED ON THE DEMAND SIDE – IMPROVING CONSUMERS’ ABILITY TO BUY SUPPLY SIDE ECONOMICS FOCUSES ON THE SUPPLY SIDE – ON THE COST TO BUSINESSES TO PRODUCING AND HIRING

THREE ELEMENTS OF SUPPLY SIDE ECONOMICS PURPOSE: “UNTIE” BUSINESSES SO ARE MOTIVATED TO INCREASE PRODUCTION AND HIRING FOCUS ON: * LITIGATION * REGULATION * TAXATION

LITIGATION FOCUS ON COSTS OF LAWSUITS BALANCE BETWEEN PROTECTING THE CONSUMER AND ENCOURAGING “FRIVOLOUS” LAWSUITS LAWS SHOULD CONSIDER THEIR COSTS AND BENEFITS

REGULATION SAME IDEA – FOCUS ON THE BENEFITS AND THE COSTS OF REGULATION “OHSA” – OCCUPATIONAL HEALTH AND SAFETY ADMINISTRATION “SMART” REGULATIONS

TAXATION COULD HIGH TAX RATES DISCOURAGE SO MUCH ECONOMIC ACTIVITY THAT ACTUALLY BRING IN LESS REVENUE? TAX REVENUE = TAX RATE * TAX BASE TAX RATE AND TAX BASE MAY BE INVERSELY RELATED

THE “LAFFER” CURVE SHOWS RELATIONSHIP BETWEEN TAX RATE AND TAX REVENUE LEFT PART OF CURVE – TAX REVENUES RISE AS TAX RATES RISE BUT BEYOND A CERTAIN TAX RATE, TAX REVENUES FALL BECAUSE SO MUCH BUSINESS ACTIVITY IS DISCOURAGED

QUESTION – WHERE IS THAT TAX RATE, BEYOND WHICH, TAX REVENUES FALL? VARIES BY THE TYPE OF TAX, BUT A COMMON FINDING IS 60% - SO TAX RATES ABOVE 60% ARE COUNTERPRODUCTIVE NOTE: THIS DOESN’T MEAN THE TAX RATE SHOULD BE 60% - JUST THAT 60% WOULD YIELD MAXIMUM TAX REVENUES

TERMINOLOGY USED IN TAX IMPACT STUDIES STATIC ANALYSIS – ASSUMES NO RELATIONSHIP BETWEEN TAX RATE AND TAX BASE DYNAMIC ANALYSIS – ASSUMES A RELATIONSHIP BETWEEN TAX RATE AND TAX BASE

HOW TO MEASURE “TAX INCIDENCE” TAX INCIDENCE: IMPACT OF TAX CHANGES FOR HOUSEHOLDS OF DIFFERENT INCOME LEVELS ONE WAY: CHANGE IN AMOUNT OF DOLLARS PAID SECOND WAY: CHANGE IN % OF TAX PAID OFTEN DIFFERENT ANSWERS

AN ALTERNATIVE TAX FAVORED BY SOME “SUPPLY-SIDERS” A BUSINESS TAX ON VALUE-ADDED VALUE-ADDED = $ VALUE OF PRODUCT MINUS $ VALUE OF NON-LABOR INPUTS DIFFERENT THAN PROFIT: PROFIT = $ VALUE OF PRODUCT MINUS $ VALUE OF ALL (NON-LABOR AND LABOR) INPUTS SOME WANT TO REPLACE INCOME TAXES (INDIVIDUAL AND CORPORATE) WITH THIS

MIS-USE OF SUPPLY SIDE ECONOMICS SOME WANT TO CLAIM TAX REVENUES RISE EVERY TIME TAX RATES ARE REDUCED “CAKE AND EAT IT TOO” ONLY HAPPENS IF BEGINNING RATE IS ABOVE THE RATE FOR MAXIMUM REVENUE

AGREEMENTS ABOUT SUPPLY-SIDE ECONOMICS THAT TAX RATES DO IMPACT ECONOMIC GROWTH THAT TAX RATES CAN BE “TOO HIGH” – MEANING THEY RESULT IN LESS REVENUE THAN WITH LOWER RATES THAT BOTH THE ECONOMIC BENEFITS AND COSTS OF LITIGATION AND REGULATION SHOULD BE CONSIDERED

BUT DISAGREEMENTS ABOUT SUPPLY SIDE ECONOMICS WHAT IS THE MAXIMUM RATE? HOW TO MEASURE BENEFITS AND COSTS ACCOUNTING FOR THE BENEFICIAL IMPACTS OF GOVERNMENT SPENDING