The Difference Between Keynesian Stimulus And Supply Side Tax Cuts
February 26, 2001
Although both Ronald Reagan and George W. Bush proposed tax plans which cut marginal income tax rates across the board, the philosophy underlying them is different. While the Reagan plan was based on supply-side economics, the Bush plan owes much more to Keynesianism.
In the Keynesian model, consumption spending by individuals and investment spending by businesses drive the economy. The government can add to total spending by running a budget deficit, either by purchasing goods and services or by reducing taxes.
Throughout most of the postwar era, whenever the economy slowed down, Congress usually increased public works outlays, but occasionally cut taxes. Beginning in the 1970s, supply-siders argued the Keynesian focus on spending was misplaced because it ignored the role of incentives, particularly the marginal tax rate -- the tax on each additional hour worked or dollar earned.
Bush says he shares Reagan's vision. However, his arguments -- putting dollars in people's pockets, increasing disposable income and countering an economic slowdown -- are closer to the old-fashioned Keynesian model than supply-side economics.
Bush should stress the supply-side argument about the long-term benefits of lower marginal tax rates, which can help defuse concern his plan will extinguish the surplus. He should point out that faster growth will lower the budgetary cost of his tax cut.
- Harvard University economist Martin Feldstein estimates faster growth will reduce the actual revenue loss from Bush's tax plan from $1.6 trillion to $1.2 trillion over 10 years.
- A new Heritage Foundation study finds even stronger feedback effects, with faster growth recouping almost half the static revenue loss (see figure).
Bush does not need to stop talking about how his tax plan will help average people and perhaps counter a recession. But he should not neglect the supply-side argument.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, February 22, 2001.
Browse more articles on Tax and Spending Issues