National Post - September 30, 2003

by Bruce Bartlett


Contrary to a widespread misconception promoted by Princeton economist Paul Krugman and others, supply-siders have academic allies. Take, for example, a recent paper from the International Monetary Fund, An Analysis of the Underground Economy and Its Macroeconomic Consequences. "Our model simulations show that in the absence of budgetary flexibility to adjust expenditures, raising tax rates too high drives firms into the underground economy, thereby reducing the tax base."

In other words, the Laffer Curve works -- and this from an organization hardly known as a hotbed of supply-side economics. Nor is this the only instance in which the IMF has acknowledged fundamental truths about supply-side economics.

The IMF is not alone in its acknowledgment of supply-side truths. Across the street, the World Bank has done similar studies. Bank and Fund officials have seen with their own eyes the impact of low marginal tax rates in places like Russia, where implementation of a 13% flat tax in 2001 led to a significant increase in government revenue. Although rates were much higher under the old system, evasion was so pervasive that little revenue was actually collected. Under the new system, it was no longer worth as much to risk punishment for evasion, leading to increased compliance and higher revenues.

As for academics, a good example is Nobel Prize-winning economist Robert Lucas of the University of Chicago. After many years of dismissing supply-side economics, he finally took a serious look at it. In a 1990 article in the Oxford Economic Papers, he admitted that he had been wrong, that reducing taxes on capital could in fact deliver a huge economic windfall, just as the supply-siders had argued. Said Prof. Lucas, "The supply-side economists, if that is the right term for those whose research I have been discussing, have delivered the largest genuinely free lunch I have seen in 25 years in this business, and I believe we would have a better society if we followed their advice."

Earlier this year, Prof. Lucas reiterated support for supply-side policies in his presidential address to the American Economic Association. He compared supply-side economics with Keynesian stabilization policies and found the former far superior to the latter. "The potential gains from improved stabilization policies are on the order of hundredths of a percent of consumption, perhaps two orders of magnitude smaller than the potential benefits of available 'supply-side' fiscal reforms," he concluded.

Supply-side economics is far from the academic outcast its enemies wish it was.