Tuesday, October 9, 2012

Supply side economics

By: Greg

In this blog post, I want to look at what is and isn’t “supply-side economics,” also known as “trickle down economics.”

The fundamental idea behind supply-side economics is that investment spurs growth. What do I mean by investment? Investment means spending money now to generate more production in the future – in other words, we choose to consume less today so we can consume more tomorrow. A few examples of investments include: factories, cement trucks, education and training programs, roads, etc. I would suggest that few people buy a factory just because they like factories. They buy them so they can make more stuff. The factory is an investment – it involves spending money today in order to get more in the future. All of these investments increase output per person. If we have more stuff but the same amount of people, then we are all richer.

Read that last sentence a few times until it sinks in.

A common fallacy is to think “Well, all that extra stuff we’re making will just sit on the shelf because people can’t afford it!” But remember, if there is more stuff and the same number of people who want it, the stuff gets cheaper and we buy more. If this doesn’t make sense please comment and I will explain further.
So what government policies would encourage increased investment in the economy? Most economists (http://www.npr.org/blogs/money/2012/07/19/157047211/six-policies-economists-love-and-politicians-hate  proposal three) agree that one of the best ways to promote investment and hence growth is to cut or remove corporate taxes. Businesses are the world’s investors, so if you like to promote growth, tax them less. Many people think we should tax corporation because they are led by greedy, overpaid executives and we don’t like that. But, if you think someone is overpaid, tax them, not the company they run.
Another policy would be to decrease the capital gains tax rate (a special, lower, tax paid on earnings from stocks). The impacts of this policy are harder to see, but when we buy stocks we are investing in a business which allows them to invest that money as they choose. Advocates of supply side economics are highly against capital gains taxes.
Notice that we didn’t mention giving heavy income tax breaks to the super rich. This practice is not true supply side economics! Though it can be argued that they are the most likely people to invest the money which would in turn grow the economy, this is a more indirect and sloppy approach. Though there are other reasons why we wouldn’t want to tax the heck out of the rich, they don’t relate to supply side economics.
100% pure, unadulterated supply side economics would go so far as to advocate getting rid of the income tax for all income levels. Why? Any form of income taxation discourages work. (You might wonder how the government would be funded under this practice – tax revenue would come from increased consumption taxes like sales taxes).

As a review, supply side economics holds that economic growth first requires investment. Investment is choosing to consume less today so we can consume more tomorrow. Good investments increase output per person which makes us all richer because there is more stuff for less money. Supply siders believe that we can promote investment by reducing corporate and capital gains tax rates.

That’s it! Let me know if you any questions and I would be happy to explain anything that doesn’t make sense.

Coming next: an explanation of demand side economics


  1. What might be the practical difference between taxing income, thereby somewhat discouraging work, and taxing consumption, thereby discouraging consumption to some extent? What would be the differences in the effects on the economy as a whole?

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    2. Thanks for asking a question! A good one too. Let me first describe why we would want to discourage consumption. First, I think it is helpful to use an equation which I will also describe in words. The equation is, GDP= Consumption + Investment + Government Spending. Though an important part of the equation, for simplicity let's throw out Government Spending since it is more difficult for individuals to decide how much that will be. The equation then becomes GDP = Consumption + Investment. That means that we buy something we are either consuming or investing. Oviously there is a lot of grey area for each individual purchase such as if buying a car you get to work as well as go on vacation is consuming or investing but I don't want to get into that nitpicky stuff. From a supply side economic's view since we like investment we must cut back on consumption today. The way to do that? Sales tax.

      Breifly, you might wonder how sales taxes would be fair at different income levels. One way would be to have increasing tax rates for increasingly luxurious goods. Bread, milk, eggs would be tax free. Low income households spend a much larger percent of their income on these types of goods. Porche's and first class plane tickets would be taxed at very high rates.

      To touch on why we would want to encourage work is because we all benefit from someone else working harder. If someone else is encouraged to work more, then they will make more stuff for me to consume, and I'm richer.

  2. This is super helpful. I love this. I like your all's blog, keep the posts coming.