THE RISE OF SUPPLY-SIDE
The central concept of supply-side economics is that tax
cuts cause economic growth. Tax cuts allow entrepreneurs to invest their
tax savings, which creates higher productivity, jobs and profits. This,
ironically, allows the entrepreneur and his new workers to pay even more
taxes, even at lower rates.
The supply-side idea is a simple one, and makes a popular political
message. However, it is interesting to note that mainstream economists
-- even conservative ones -- almost universally reject supply-side theory.
In the early 80s, the influential and multi-partisan American Economics
Association had 18,000 members. Only 12 called themselves supply-side economists.1
In American universities, there is no major department that could be called
"supply-side," and there is no supply-side economist at any major
department.2 This is significant, because
academia in the 70s was dominated by conservative economic theory, and
conservative economists normally welcome any ideas that make the case against
government intervention. The fact that they scrutinized supply-side theory
and rejected it wholesale gives eloquent testimony to the theory's bankruptcy.
When candidate George Bush called it "voodoo economics" in the
1980 presidential campaign, he was doing so with the full backing of America's
Many people are surprised to learn that "conservative" does
not necessarily equate to "supply-side" economics. The difference
lies in spending. Mainstream conservative economists generally believe
that tax cuts should be accompanied by spending cuts -- that is, fiscal
responsibility. Supply-side economists believe that taxes should be cut
-- period. Spending cuts and deficits, they believe, are not important
considerations. The 1980 supply-siders claimed that the growth resulting
from tax cuts would be so great, and the total tax collections increased
so much, that America would simply outgrow its deficits. This did not happen,
of course. Growth in the 80s was no greater than growth in the 70s, as
the statistics here will show. But the national debt nearly tripled under
Reagan. Who deserved blame for this is a controversy that continues to
Supply-siders point out that their theories are not wrong simply because
academia rejects them. This would be falling for the "argument from
authority" fallacy. After all, it was once a scientific consensus
that the earth was flat. Besides, scientific revolutions have always started
out as minority opinions, which have often faced hostility from the consensus
of the time. Although these are worthy points, they are not conclusive
arguments against the value of scientific consensus. These are, after all,
our best and brightest scholars, whose day jobs are to analyze these issues.
Their theories should be among the first we consider. It does not mean
that they are correct, of course, but more often than not their information
is better, and their theories more coherent, than the average person's.
Who were the 1980 supply-siders? The following is my summary of Paul
Krugman, one of the world's top economists, who gives an excellent account
of their rise in his book, Peddling Prosperity. The supply-siders
were what many have called "cranks," or people who stand outside
the scientific mainstream and hurl accusations of basic stupidity and corruption
at the entire scientific community. Cranks are people who are cut off from
their academic colleagues, who neither argue before scientific conferences
nor write for peer-reviewed journals. Instead, they speak before groups
they themselves organize, and write for publications they themselves edit.
An unusually high percentage of supply-siders were not economists at
all, but journalists with no formal training. Robert Bartley, who has run
the editorial pages of The Wall Street Journal for nearly 25 years,
was perhaps the movement's greatest spokesman. (His contempt for his critics
can be seen in one of his chapters on the Reagan Years, entitled: "What
You Learned If You Were Awake.") Other journalists included Jude Wanniski
and Irving Kristol. Crusading in their national publications, they were
able to reach a much wider and more popular audience than most economists
could. Of course, journalists are normally reporters of stories, not creators
of theories. You would expect them to report the latest cure for cancer
-- but not claim that they had discovered such a cure themselves. This
is common sense in most fields like biology and physics, but, for some
reason, it is a line that many journalists like Bartley and Wanniski frequently
cross when it comes to economics.
The movement did have a few intellectuals, but even here, its professors
were far from the mainstream. Arthur Laffer has a Ph.D. in economics, but
he has contributed little to scientific conferences or peer-reviewed journals,
instead playing to crowds on the lecture circuit and writing for popular
publications. He is famous for the Laffer Curve, which purports to show
that productivity declines as taxation increases. Most economists agree
that the general principle behind the Laffer Curve is correct, but widely
disagree on how much taxation is necessary before productivity starts declining.
Laffer believed that the effects of taxation were so heavy that cutting
them would significantly boost productivity, thereby outgrowing any deficits
caused by the tax cuts. Again, this prediction proved false.
Another supply-side economist was Paul Craig Roberts, a Congressional
staffer for quarterback-turned-Congressman Jack Kemp. Another was Martin
Anderson, who, stung by academia's refusal to hire supply-side economists,
would go on to write a bitter tirade against academia in a book entitled
Impostors in the Temple.
The movement has always claimed, however, that world-famous trade economist
Robert Mundell was the father of supply-side theory. Although Mundell has
never discouraged this impression, there is little evidence that it is
true. Some of his beliefs -- for example, on the causes of the Great Depression
-- go against the very fundamentals of supply-side theory. Mundell established
his international reputation early in his career, but over the years his
behavior has become increasingly bizarre and eccentric. He long ago dropped
out of the academic circuit, and now accuses his former colleagues of "sheer
quackery." But he remains more of a mascot than an intellectual founder
of the movement.
So where did the supply-side ideas actually come from? From Laffer
and Bartley, developed over a series of dinner conversations at Michael
1, a famous restaurant near Wall Street. It was here, scribbling on napkins,
that Wanniski showed Bartley the magical effects of tax cuts. Krugman writes:
"There it was that [Bartley] and Laffer discovered that Keynesian
economics was logically inconsistent - an insight that had eluded [Nobel
laureate] Paul Samuelson and a few thousand other people over the course
of hundreds of academic conferences. They also discovered that Milton Friedman
was wrong in believing that monetary policy could have important effects
on the economy - an insight that had similarly eluded [Nobel laureates]
Friedman, Lucas and the faculty of the University of Chicago over a generation
of notoriously brutal conferences. And the results of these deep thoughts
over dinner were for the most part published -- surprise -- on the editorial
page of The Wall Street Journal, or in Kristol's Public Interest."3
Why Reagan by-passed thousands of qualified conservative economists
for the council of a few supply-siders is a mystery. Perhaps the most likely
reason was practical: the supply-siders told Reagan what he wanted to hear.
To understand why, we should devote a paragraph to the economic problems
that Reagan faced in 1980.
Until the 60s, there had been a tradeoff between inflation and unemployment.
Government could achieve low unemployment by accepting high inflation;
or it could achieve low inflation by accepting high unemployment. Earlier
presidents had opted for low unemployment, which the Federal Reserve accomplished
by expanding the money supply, thus giving people more money to spend.
Extra spending means extra jobs. However, Milton Friedman and others pointed
out that business people would eventually come to expect these inflationary
increases, and they would simply compensate for them by raising their prices
by the anticipated amount. This would not only negate the job-creating
effect that more money in circulation would bring, but also make inflation
worse. Eventually, they predicted, inflation would shoot up and then so
would unemployment, breaking the tradeoff between them, and forming a twin
monster that Paul Samuelson dubbed "stagflation." And, true enough,
this is precisely what happened in the 70s.
Economists in the late 70s were at a loss for a cure. To fight high
inflation, governments traditionally raise interest rates and cut government
spending. To fight high unemployment, they do the opposite. Thus, fighting
one dragon would only make the other worse. But the supply-siders told
Reagan they had a solution. The Laffer Curve purported to show that tax
cuts would actually increase tax collections. This meant that government
could spend generously in an effort to curb unemployment, without requiring
the burdensome taxes to pay for it. That was the first selling point.
The second selling point was Mundell's. Most economists believe that
government spending and interest rates can only be used together, in tandem,
to slay either one dragon or the other. But Mundell argued that they could
be split up: government could spend generously to fight unemployment, and
raise interest rates to fight inflation. Hedrick Smith writes: "...Mundell's
argument was music to Reagan. A few advisors warned him that Mundell's
approach would not work, could not work -- indeed, Reagan's own experience
would prove that in 1982-83. But Reagan bought Mundell's theory anyway,
for it told Reagan what he wanted to believe: that you could cut taxes,
cut inflation, have economic growth, and balance the budget all at the
same time." 4
The man charged to make this all work was David Stockman, Reagan's
budget director. Stockman's genius and mastery of numbers was matched only
by his relatively young age, which earned him the title of "whiz kid."
Stockman, Roberts and Anderson came up with a massively optimistic forecast
for the economy, which today Stockman derisively refers to as the "Rosy
Scenario." The Rosy Scenario predicted that the 1981 tax cuts would
produce 5 percent growth in 1982. (In fact, 1982 was the worst year since
World War II, with negative growth of 2.2 percent.) Many budget-watchers
pointed out that the tax cuts would only increase the deficit, but Stockman
silenced all his critics with a blizzard of statistics and information.
"Like a child prodigy chess champion playing fifty matches at once,
Stockman answered every query, parried every countermove, checked every
challenge," Smith writes. "Congress was mesmerized."5
Today, Stockman admits it was all a performance. "Even the appearance
of being an expert is self-validating," he wrote five years later.
"I didn't know much about budgets, but I knew more than the rest of
But as early as August 1981, Stockman began having gnawing
doubts about his budget. Computer simulations failed to project the tremendous
growth he had predicted, and later he would admit to cooking the numbers
(!) before selling the budget to Congress. That December, the Atlantic
Monthly published an article in which Stockman made several damaging
and embarrassing confessions about the entire supply-side philosophy. He
admitted that the 1981 tax cut "was always a Trojan horse to bring
down the top [tax] rate" for the wealthy. Cutting taxes for the rich
had long ago been coined "trickle down economics" - and it was
an unpopular concept with the middle class. "It's kind of hard to
sell 'trickle down,'" Stockman told the interviewer. "So the
supply-side formula was the only way to get a tax policy that was really
'trickle down.' Supply-side is 'trickle-down' theory."7
The Rosy Scenario failed to materialize. The economy did not grow out
of its deficits. In 1986, Washington and the rest of the nation would again
be surprised when Stockman confessed all in a book entitled The Triumph
of Politics: Why the Reagan Revolution Failed.
Return to Overview
1 James Carville, We're Right, They're
Wrong: A Handbook for Spirited Progressives (New York: Random House,
1996), p. 12.
2 Paul Krugman, Peddling Prosperity:
Economic Sense and Nonsense in the Age of Diminished Expectations (New
York: W.W. Norton & Company, 1994), p. 85.
3Ibid., p. 91.
4 Hedrick Smith, The Power Game:
How Washington Works (New York: Ballantine, 1988), p. 345.
5 Smith, p. 353.
6 David Stockman, The Triumph of
Politics: Why the Reagan Revolution Failed (New York: Harper &
Row, 1986), p. 56.
7 William Greider, "The Education
of David Stockman," The Atlantic Monthly, December 1981, pp.