Bruce Bartlett and Paul Krugman on Supply Side Economics

Bruce Bartlett wrote a very good piece for the New York Times on what supply side economics was when it started, what it is taken to mean now and how the two meanings have diverged. Mark Thoma picked it up and then in the comments both Paul Krugman and Bruce Bartlett chew over the points.

To cut to the chase the current usage of "supply side economics" (from both sides, both proposers and those wishing to denigrate it) is that cutting (marginal) tax rates always increases revenues collected.

This is an absurd over-simplification of the Laffer Curve. Bartlett rightly points out (as have other economists like Greg Mankiw recently) that this isn't what he and other proposers actually believed back then. Rather, that while that contention might be true in a limited number of cases, the great insight is that cutting tax rates does not lead to a loss of revenue equal to the amount those rates are cut. People's behaviour does indeed change according to different incentives and so some (but rarely all) of the revenue "lost" is made up as a result of those changes in behaviour.

I recall, for example (sorry, no link, lost it) a recent Congressional Budget Office paper that said that cuts in capital taxation were recouped at a rate of about 50%, those on labour by about 17%. That is, for example, if you used a static model of how much a tax cut was going to lose in revenue you would say $100. If you used a dynamic model, incorporating the effects of those changed incentives, then you would expect to lose $50 in a capital tax cut and $83 in a labour tax cut.

Now that, according to Bartlett, was the original message of "supply side economics" and it appears, at least to me, to be blindingly obvious. It's also a debate that is still raging, but in different terms. Should we be using static models to predict the effect of tax changes (as both the UK and US currently do) or dynamic ones? The latter would appear to accord more closely with reality, so probably we should.

However, there's a part of this discussion that rather disappoints me (yes, I know, blogger complaining about three experts, so sue me). Perhaps it's to do with the difference between English and American.

That's the whole definition of what "supply side reform" actually means. To me this reduction to talking only about reforms to, lowering of, marginal tax rates is just that, a reduction, almost ad absurdam. Supply side reform to me means just that, reform of the supply side.

Nationalizing or privatizing the railroads is supply side reform, deregulating the airlines is supply side reform, adding or subtracting to farm subsidies is supply side reform, as was welfare reform (as Richard Layard went on about for years, it was to bring the long term unemployed back into the reserve army of the unemployed and thus influence or shift the Phillips Curve). To claim, whether in support or in opposition, that it's all about marginal tax rates is to me to miss the entire point.

There are parts of the economy, at times, which need to reform so as to free them (and equally,  in other places and times, restrain them, like the break up of AT&T) and thus reform the supply side. That, to me at least, is the point about such supply side economics and to lose that insight in a squabble over marginal tax rates is a pity, at the very least.