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A Critical Take on Supply Side Economics

Not every economic argument in the campaign at the moment is about what to about the fast moving financial crisis. One of the defining economic battles over the last several decades has been the fight over supply side tax cuts and their role in spurring growth. The core of the debate: do such tax cuts help promote economic growth and thereby leads to greater tax revenues, rather than larger deficits. Such ideas were behind the 2001 and 2003 tax cuts proposed by President George Bush, as well as earlier supply side cuts put in place by President Ronald Reagan. Numerous studies by economists since then have raised questions about that theory, not least of which was a 2005 study by the Congressional Budget Office under Douglas Holtz-Eakin, currently the senior economic advisor to Senator John McCain.

But McCain has made another round of big tax cuts the central plank of his economic program, arguing that lower taxes are the best way of bolstering economic growth. And with McCain gaining in the polls as the two campaigns are increasingly battling over the economy, that has influential Democratic economists and policymakers warning that a McCain election would mean a continuation of what they see as the fiscally-ruinous policies that have stemmed from the Bush Administration?? extensive tax cuts and runaway spending. To hammer that point home, the Center for American Progress and the Economic Policy Institute, two liberal think tanks, held a conference last Friday critiquing supply-side tax cuts. The panel featured former Treasury secretary Larry Summers, Gene Sperling, the former head of President Clinton?? National Economics Council, and Jeffrey Frankel, a former member of the Council of Economic Advisors who is now a professor at Harvard?? Kennedy School of Government.

There was no mincing of words when it came time for each to describe his views of the impact such supply-side tax cuts have had on the deficit and the economy ?or would have in the years ahead were a President McCain to be elected and keep on the same path. Sperling, now an advisor to Senator Barack Obama, described the policies as “Rosemary Woods economics – you have to contort yourself in an unseemly way to make your case.” But perhaps the title of the paper presented by Frankel at the conference says it best: Tax Cut Snake Oil. He argues that cutting U.S. income tax rates “reduces revenue, precisely as common sense would indicate.” Both the Reagan tax cuts of 1981-1983 and the Bush tax cuts in 2001 and 2003 “were followed by large and record budget deficits.” To argue otherwise, he adds, is clearly a case of deceptive advertising.

Summers, who is also advising Obama, was, if anything, even sharper in his critique. He argued that there is no evidence that higher income tax rates around the mid-to-high 30s levels in place today discourage additional work or savings; nor, he argues, do higher capital gains rates lead to a decline in asset values as some supply-siders have suggested. He also pointed out that high-income taxpayers aren’t the ones that pay the highest marginal tax rates; that honor belongs to taxpayers at the bottom of the income scale. “So to the extent that one decides that marginal tax rates are a disincentive to work,” he said, the right action would be to trim marginal rates on the low end, not on high-income taxpayers.

Summers also added that any tax cuts today that lead to increased deficits simply mean the costs have been put off – and ultimately, since the government will eventually have to pay back any funds borrowed, with interest, deficit financing is more costly.

But his most scathing criticism came when he focused on the risks ahead. “We are in the midst of a period of substantial financial instability, and also in the midst of what is an unprecedented geo-political experiment,” he said. “The world’s greatest power is also the world’s greatest borrower. I think it’s very risky to expand that borrowing.” He argued that a decision today to cut taxes on a large scale, particularly to finance further tax cuts on people at the top of the income ladder in the US “is a decision to continue to borrow large amounts of money from the Chinese, in the form of imported goods, in order to finance extra spending for the wealthiest 1% of the population. The question is: is that what we want to do?”

If Obama is to be elected, American voters will have to conclude the answer is no.

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