Supply Side: The Next Generation

`The one good thing about Bob Dole's Presidential nomination," a Republican strategist told me, "is that it got him out of the Senate." Events seem to bear this out. As soon as Dole announced his Senate resignation, his likely successor as Majority Leader, Senator Trent Lott (R-Miss.), called for repealing the Bush and Clinton tax increases, and Senator Spencer Abraham (R-Mich.) proposed a 15% reduction in marginal income tax rates.

Republicans were supposed to have gotten supply-side tax-cutting out of their system. Its abrupt reappearance signifies a generational change in the GOP. Lott unabashedly says: "It was a mistake when we raised taxes under Bush. It was a mistake when we raised taxes $265 billion under Clinton." Abraham says that not only must taxes be cut but that it must be done in a supply-side way: "A tax cut that does not affect marginal incentives may stimulate some additional spending, which will give the economy a temporary boost. But it does nothing to encourage additional saving, investment, or production."

"GREEN" FOES. As for the alleged failure of Reagan's tax cutting, Abraham says: "The Reagan tax rate cut, once fully phased in, worked. In 1984, real gross domestic product growth reached 6.8%--the highest single-year growth rate since 1951. In President Reagan's second term, growth averaged 3.4% per year--well above the 2.5% per year average of the last three years, which President Clinton erroneously calls the best in three decades."

When supply-side economics appeared in the mid-1970s, its target was stagflation. Its opponents were budget-balancing Republicans epposed to giving up revenues and Keynesian Democrats who argued that tax-rate reductions would simply increase demand and inflation. Today, supply siders still have opponents, but they are different. Deficit-conscious Republicans have gone along with tax hikes only to watch economic growth rates and take-home pay decline. Keynesians came to terms with supply-side economics a decade ago when Paul Samuelson incorporated supply-side analysis into the 12th edition of his famous textbook.

Today's opponents are environmentalists, who oppose economic growth because it facilitates population growth and pollution, and egalitarians, who reject the income differences associated with a success-oriented society. Supply siders' new opponents are ideologically fiercer than the old, but politically weaker. Their antigrowth position does not resonate with the population outside of well-to-do liberal circles.

UP BY THE ROOTS. The U.S. tax system is an anachronism. It dates from a time when consumption was seen as the key to a sound economy. The tax bias against saving and investment (for example, the double taxation of dividends) was accepted as a rational policy that encouraged consumption over saving. With the rise of global capitalism, we look at these matters differently now. The race for capital is on. Since earnings on investments are aftertax computations, we have no alternative but to reexamine our tax policies.

House Ways and Means Chairman Bill Archer (R-Tex.) says he wants to pull the income tax system up by the roots, and Senator William V. Roth Jr. (R-Del.) of Kemp-Roth fame--now chairman of the Finance Committee--is planning hearings on supply-side tax reform. This doesn't mean it will happen this November. The unfolding drama of Whitewatergate is politically distracting, and the Republican nominee represents the old order uncomfortable with radical change. Still, it takes a policy to beat a policy, and supply side is the only one on the scene.

Don't expect a resurrection of Keynesian economics arguing for bigger budget deficits in order to boost aggregate demand and economic growth or monetarism promising noninflationary growth by controlling some measure of the money supply. It has taken the U.S. the better part of a century to recover intellectually from an egregious public-policy error that caused the Great Depression. As Milton Friedman has shown, the Federal Reserve misunderstood the situation and permitted a one-third reduction in the supply of money at that time. All of the interventionist policies of the New Deal and the postwar period followed from the disastrous and misunderstood consequences of a mistaken monetary policy that shook the economy and people's confidence in it. Capitalism was blamed, and Americans were taught that they would be insecure in a free economy. This fading belief is giving way to the realization that security in the next century will depend on high saving rates and market flexibility.

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