Why Supply-side Theory Hasn't Worked for the Last 8 Years

Although the US is not technically in a recession since the GDP (gross domestic product) has increased minutely in each of the last two quarters; the American economy is still suffering under the growing federal deficit. The current leadership seems to subscribe to the supply side economic theory that supports decreasing the tax burden of consumer and corporate citizens “to stimulate enough economic activity to keep revenues from falling.” (McEachern) Admittedly, supply-side economics develops from the fundamentally accepted invisible hand principle; however, several other factors of consumer and government behavior add variables that cause the practical application of this theory to be flawed. So while most people applaud the idea of lower tax rates, this is a short-sighted victory if not combined with a severe cut to national spending.
Spending that exceeds revenue is not a new issue in American economics. There have been three major reasons that justified this excess spending over the years. Capital spending that increase the country’s capacity for production is one. Investment in better roads and new plants, in improving the quality of public education, or even health technology research increase production. Graphically this economic growth would be represented by an outward shift of the production possibilities frontier in the next period.
Another justification for deficit spending is to provide services that serve to redistribute wealth. Transfer payments such as unemployment go up when the economy is slumping increasing spending at a time when revenues are also lower. As people live longer, continued funding of the Social Security program represents a potentially ongoing increase in spending on individuals whose contribution to the revenue pool is decreasing. The Social Security system represents a prime example of good politics prevailing over good economics. The average American cringes at the suggestion that Social Security will not be there when they retire even though depending on Social Security as one’s primary retirement strategy has been proven an ill-advised decision. (Tanner) Good economics suggest privatization or self-directed national retirement savings would be more efficient and monetarily effective for the consumer. Politicians, however, are accountable to the local masses who for the most part call for saving the present Social Security system at all costs.
Finally, spending for national defense has always been considered a acceptable especially in times of crisis. The costs of homeland security and wars in Iraq and Afghanistan have required hundreds of billions of dollars in additional spending. Economists note that increased spending on defense in the 80’s is what derailed the benefits of the Reagan era tax cuts. (
To balance our budget and start reducing the deficit, spending will need to decrease and/or revenue has to increase. President Clinton was able to create a budget surplus in the late 90s by increasing tax rates to increase revenue. Clinton did not face the escalated challenges of financing several wars and anti-terrorism efforts. However, increasing taxes enough to balance current levels of spending might cause more harm than good. The Laffer curve demonstrates that at some point, increase revenue from tax hikes will slow and reverse as the tax burden discourages consumers to work.
The government, like everyone is subject to scarce resources which means there is not enough money for politicians to fund all the programs that the people want. Economic stability will certainly require curtailed government spending especially reviewing our defense spending allocations. The monetary costs of the war in relation to other defense spending or even non-military spending can be represented on a PPF. However there are nonmaterial costs to weigh also. Our perception as a team-leader in international politics represents one such opportunity cost. Attention to other international issues such as global warming and human rights is another.
In a socialist society the issue of deficit wouldn’t exist because the government would only produce what was needed to sustain its society. Revenue would equal costs of these services since everyone willing to bare their equal share of those costs as they would receive equal benefit. There’s be no incentive to overproduce or over spend as economic growth as a government priority is secondary to providing for the social welfare of all citizens. In a purely capitalist society, the government would only supply services up to the amount that the people would be willing to pay more. The invisible hand at work in the market place dictating what products and services will be produced as each individual pursued his own self interest (McEachern) The expectation of the government to take care of the sick or elderly who don’t have human capital valuable enough to trade in the free market would not exist.
America is a mixed economy though strongly rooted in capitalist tradition. There is a presumed expectation that the government will guarantee our safety at all costs, will ensure the well-being of those that cannot do so for themselves, and will act to promote economic prosperity for generations to come. As accepted parts of our society, we must understand that these benefits come with a price. The country’s continued economic health depends on its citizens reasonable contributing to the revenue pool and to our government diligently restraining its spending.

Sources Cited

McEachern, William A. Economics
Yanner, Michael. “Saving" Social Security Is Not Enough. http://www.socialsecurity.org/pubs/ssps/ssp-20es.html