Blog o’ Burns

Krugman, Paul. Peddling Prosperity. New York: W.W. Norton & Company, 1994.

I have to say, this post will be a bit out of my comfort zone and have a slightly less formal tone than I’m used to. This is partly because Paul Krugman’s book lays out a thorough but not strictly academic empirical analysis as to the impact of “Reaganomics”– its fallacies, its hypocracy, and some of its *er* sparse virtues. His approach is entirely appropriate considering the un-scholarly advocacy of supply-side economics during the 1980s, primarily instigated through Robert Bartley’s editorial pages of the Wall Street Journal (just for the record, Krugman says their news pages are fine).

Krugman definitely imparts the sense (and even explicitly says at one point) that Reagan supply-siders had sort of a cult mentality, with most of its prominent economists like Arthur Laffer and Robert Mundell falling out of the mainstream. Most other supporters had almost no background in economics and promoted their views through journalism. I don’t want to dwell on the questionable motives and credentials of the supply-siders, but it definitely puts a creepy aura around the whole theory.

Speaking of theory– what exactly was Reaganomics? Well, Krugman clarifies that having conservative views about fiscal and monetary policy and believing in the dominance of the supply-side of the economy does not necessarily classify you as a “supply-sider.” The truth is that Reaganomics was an unclearly defined theory based on two premises: 1) demand-side (particularly monetary) policies are completely ineffective; and 2) productivity is highly responsive to changes in the tax burden.

It is true that high marginal tax rates reduce incentives to produce– this is a point that any economist would find hard to disagree with.  However, supply-siders translated this positive economic fact into an extreme normative policy: tax cuts are always appropriate whether an economy is in recession or not.  Using the Laffer Curve to support such policies, supply-siders predicted that tax cuts might actually increase tax revenues by encouraging people to work, save, and invest.  And even if deficits increased, the increased saving brought on by the tax cuts would easily finance it and still allow for more investment.

Krugman makes it clear that taxes do indeed cause distortions in the economy, particularly with respect to incentives to invest.  Investment reflects people’s willingness to sacrifice current consumption for future consumption.  By taxing gains on investment, there will be less incentive to invest, causing too much present consumption and too little consumption in the future.  However, the supply-siders emphasized the large role that taxation plays in hindering prosperity.  All booms and slumps in the economy were due to changes in tax policy that impacted aggregate supply.  For instance, the Smoot-Hawley tariff allegedly reduced returns to work and investment to such an extent that it caused the Great Depression (during which employment dropped by a third), despite only constituting an effective tax increase of 2.5%.