Few phrases seem to have achieved more public relations mileage on less intellectual fuel than "supply-side economics." Only two years ago it was an alien and unfamiliar term: today it's part of the pervasive political and journalistic jargon. The Reagan administration is populated by supply-side economists, and the president's policies -- particularly the 30 percent Kemp-Roth tax cut -- are promoted as supply-side programs.
There's something vaguely discomforting about all this. You get the feeling that a lot of people are using supply-side rhetoric without knowing what it means -- or, at any rate, what it ought to mean. Probably most people are monumentally confused. They want to like supply-side economics, if they could only figure out what it is.
Viewed broadly, there's nothing really new about it. It's simply a useful reminder of the enduring relevance of the law of supply and demand. If supply falls short of demand, prices must rise or scarcities result. If supply dwarfs demand, prices must fall or surpluses accumulate.
Today car prices are excessively high, and the result is unwanted surplus -- swollen inventories, idle factories and unemployed workers. Lower car prices would mean higher production and less unemployment. If the government can't influence car prices easily, at least this sort of analysis identifies the correct economic problem.
But in its modern incarnation, supply-side economics goes beyond this traditional framework. What makes supply-siders so controversial is their insistence that the broad logic of supply and demand, applied to taxes, can increase economic growth significantly while reducing inflation. In the supply-side view, high tax rates have lowered the "prices" received by workers and investors -- their after-tax wages and profits. Therefore the workers and investors supply less labor and investment; scarcity stunts the economy.
The supply-siders say we can change that by lowering tax rates. This raises after-tax wages and profits; workers and investors increase their supply of labor and investment capital. Economic growth increases and inflation subsides. Supply-side economist Arthur Laffer even thinks that tax revenues resulting from more workers and higher growth may offset revenue losses resulting from lower rates.
No one disputes the general theory. Clearly, in a free society, if government taxed away all wages and returned nothing, only the most manic workaholic would continue toiling. Excessive taxation of saving and investment would produce a similar evaporation of investment funds.
But theory is less important than the actual state of the economy: Do today's tax rates actually produce large discouraging effects? By and large, most economic investigators have answered "no."
Given more wages, workers can do one of two things: work more (because higher wages make work more attractive) or work less (because higher income makes it easier for them to pass up overtime, take extra vacations or quit a second job). For men, most studies find that the effects roughly cancel each other. For married women, lower tax rates are believed to result in more work; wives are assumed to be second workers, and so the starting tax rate is the husband's highest rate. Tax cuts have a bigger effect.
The most favorable economic studies do not project increases in labor supply (or economic growth) sufficient to offset the tax revenue lost by lower rates. Here are the estimates of Jerry A. Hausman, an economist at the Massachusetts Institute of Technology, of the effects of a 30 percent cut in tax rates. The first line shows the change in the labor force and the second the change in tax revenues [TABLE OMITTED]
Even this result is unlikely today under Kemp-Roth. Hausman assumes the tax cut is "real": that is, rate cuts aren't partly offset as inflation kicks people into higher income brackets. That's precisely what would happen today.
As for savings and investments, identical uncertainties apply. Higher rates of return may induce people to same more, but higher income on their savings also may incline them to save less. On balance, increased savings may be modest.
Does this mean that all supply-side arrangements are mostly bunkum? Not necessarily.
Today's tax system has marginal rates -- that is, rates on the last dollar of income -- that are extraordinarily high: 50 percent on earned income (most wages and salaries) and 70 percent on interest, dividend and other investment income. But most taxpayers take a much longer time getting to the highest rates than the official tax schedules suggest. Brookings Institution economist Joseph A. Minarik roughly estimates that in 1977 taxpayers with incomes above $30,000 paid at rates roughly two-thirds the official level.
The difference largely reflects the proliferation of deductions and credits allowed taxpayers, plus -- at higher income levels -- legal tax shelters. The tax advantages of certain types of favored spending do exactly what supply-siders would predict: They create massive distortions. The deductibility of mortgage interest payments, for example, has caused many middle-class families to funnel excessive amounts of savings into housing.
There are appealing grounds for an alliance between supply-siders and traditional liberal tax reformers. The former want to reduce high marginal rates; the latter deplore the provisions by which many upper-income taxpayers reduce tax payments. But only by eliminating many of these deductions and credits can the administration hope to reduce marginal rates.
What that would do is create a simpler, more efficient and more honest system. More income would be taxable, but tax rates would be lower. The reason such a sensible alliance evades us is that economic theories generally serve broader political interests. Just as liberal tax reformers want to skew cuts to the lower half of the income scale, the supply-siders want to skew it to the upper half.