Supply Side Economics claimed that if the government cut taxes on the wealthy, it would jump-start the economy as the wealthy plowed their tax savings back into investments. New factories fitted with new technologies would produce goods at lower cost, taming inflation. And the newly hired workers would tame unemployment. It would, in effect, square the economic circle, fixing both inflation and unemployment at the same time.
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In 1980, Ronald Reagan promised that, if elected, he would cut taxes, raise military spending AND balance the budget--all at the same time. His opponent, George H.W. Bush called it "voodoo economics". But Reagan won the election and kept his promise. He cut the marginal tax rate on the highest income earners from 75% to 38%. What happened?
In 1982, the first full year for Reagan's policies, the economy shrank by 2%, the worst performance since the Great Depression. Investment -- the magic transmission belt through which all other Supply Side benefits were supposed to flow -- actually declined as a percent of GDP over the 1980s. Worse, Reagan's Supply Side policies created the biggest budget deficits in history. The numbers tell the story.
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Revealingly, Supply-Siders strenuously resisted calls to tie tax cuts to actual productive investments, that is, give the tax cut only after the investment had been made. This led critics to suspect the real motives behind the "theory." The only thing that was certain was that the rich would become richer and revenues to the government would be lower. Beyond that, it is all just wishful thinking.
Contrast this wishful thinking with Demand Side economics. Demand Side Economics, says that if taxes are to be cut, they should go to those who earn the least amount of money. The reason is that low-income workers spend virtually all of their incomes. Money given to them goes right back into circulation, fueling a boom in consumer spending. This is essentially the policy that rescued the U.S. economy from the Great Depression. This, say the Demand Side economists, is the real foundation for an expanding economy. How has this theory held up in practice?
Bill Clinton reversed Reagan's Supply Side policies, raising taxes on the wealthy and lowering them on the working and middle class. This Demand Side formula was fiercely resisted by Republican leaders in Congress who predicted a stock market crash and another Great Depression. Indeed, every single Republican member of Congress voted against it. It took a tie-breaking vote by Al Gore in the Senate to get the bill passed. What happened?
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