NCPA - National Center for Policy Analysis

Supply-Side Economic Growth

September 22, 2003

Paul Krugman, New York Times columnist and economics professor at Princeton University, has turned some of his more inflammatory columns into a book, The Great Unraveling. The New York Times Magazine published an excerpt on Sept. 14. Krugman seems bothered that supply-side economics didn't come out of the universities, like monetarism or Keynesianism. Supply-siders went directly to policymakers and the media, bypassing the academics.

University economics departments were (and still are) overwhelmingly populated by Keynesians who thought that deficits were good, saving was bad and inflation didn't matter very much. The burden of taxation was of little importance to their analyses, nor did they think that the money supply affected anything. In the 1970s, many economists argued that the only economic impact of taxation was on disposable income; marginal tax rates were of no importance whatsoever. Mainstream economists also argued that when taxes went up, this actually encouraged people to work harder, not less, because people had a target level of after-tax income. Economists call this the "income effect."

Government policies based on this thinking caused double-digit inflation and interest rates in the 1970s. The Keynesian response was to deliberately raise unemployment, impose price controls and devalue the dollar to fight inflation.

Supply-siders saw stagflation as mainly resulting from excessively easy Federal Reserve policy and a tax system that was not indexed to inflation. Inflation pushed workers into higher tax brackets every time they got a cost of living pay raise, and investors saw their savings confiscated by a capital gains tax that did not differentiate between real gains and those arising solely from inflation.

Supply-side economics was based firmly on neoclassical economics. As Krugman concedes: "The starting point of supply-side economics is an assertion that no economist would dispute: taxes reduce the incentive to work, save and invest."

Source: Bruce Bartlett, senior fellow, September 22, 2003, National Center for Policy Analysis.


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