Everything in economics comes down to the basic ideas of supply and demand. Stimulating demand was the goal of Keynesian economists who dominated U.S. economic policy until recently. Stimulating the economy's ability to supply more goods and services is the current trend that has attracted political support in both parties. Supply-side economics is a great idea, but one whose time has not yet come.
Supply-side economics arose as an overdue reaction to the Keynesian policy of stimulating demand through federal deficits. Stimulating demand was a good solution to yesterday's problem of depression, but it is no solution at all to today's problems of inflation, low productivity gains and energy.
Like many good ideas, Keynesian economics reached the highest point of popularity coincident with its lowest point of utility. By the time Richard Nixon proclaimed himself a Keynesian, Keynesian economics was finished as a tool to solve the nation's problems. New problems required new ideas, and the supply-side school of economics arose to provide those new ideas.
Both moderates and optimists agree on the need to reform the nation's tax system to stimulate productivity. They favor tax incentives for capital spending such as accelerated depreciation and investment tax credits. They also favor tax incentives to encourage individual saving rather than consumption. Any tax cut to counter the current recession is likely to include a large component of supply-side ideas.
The moderates and the optimists part company on the issue of drastic tax cuts. Ronald Reagan endorses a 30 percent cut in income taxes over a three-year period as a way to stimulate productivity. Using theories of professor Arthur Laffer, he argues that the tax cut will stimulate enough new production to make up lost tax revenues.
At this point the moderates, including many administration economists, counter that such a drastic tax cut will widen the federal deficit and worsen inflation. They argue that the productivity gains of such a tax cut are likely to be long term and uncertain, while the inflationary consequences are likely to be immediate and devastating.
Supply-side economics will be a stunning success if it raises productivity growth from its anemic rate of 1 1/2 percent back to the 3-percent rate that prevailed prior to 1970. A 1 1/2 percent gain in productivity, desirable though it is, will make only a small dent in the underlying inflation rate of about 10 percent. Using supply-side economics to stop inflation is likely to be no more successful than using a fly swatter to stop a charging elephant.
Worse yet, inflation is likely to swamp the beneficial effects of supply-side policies. Inflation is so large and powerful a force today that supply-side policies are likely to get lost in the shuffle. Supply-side policies probably will be effective once inflation is cured, but that time has not yet come.
Conservative politicians see supply-side policies as the means to bring about what Rep. Jack Kemp (R-N.Y.) calls a "renaissance of America." They state their case with a missionary zeal that seems lacking among liberals who no longer seem as certain as they did a few years ago.