Last week, in answer to a reader's question I tried to explain in plain terms the difference between supply-side economic theory -- the core of the Reagan administration's economic proposals -- and Keynesian, or demand, economics as practiced by our government for the past 50 years.
This week, I'd like to offer some personal observations about the proposed program.
In the first place, supply-side theory is based on a belief that income tax cuts will induce people to save and invest more of their money, thus providing the capital needed by industry to modernize and expand plant capacity.
But Keynesian economists hold that the result of such tax cuts is more, boosting demand and thus strengthening the economy. (And, in fact, this is what happened in 1946.)
Which school of thought is right? Well, supply-siders are gambling on a change in people's attitudes and behavior. I think it will take more than wishful thinking -- maybe special tax incentives such as a large increase in the exclusion provided for interest and dividend income, a reduction in capital gains taxes, and elimination of the present system of double taxation of dividends.
Industry gets no tax deduction for dividends paid to stockholders -- paid with after-tax money. In turn, the stockholders must report the dividends as income subject to tax, after the $200-per-taxpayer exclusion authorized for 1981.
Political expediency creates another problem with the proposed individual income tax cuts. Let's face it: People who are just barely making ends meet are highly likely to spend rather than save any extra bucks left in their pockets as a result of a tax cut.
So from a purely logical point of view, savings and investing would gain the most from a tax cut aimed at those who already have all the money they need to maintain their desired lifestyles.
But political considerations -- and human considerations too, at least in the short term -- do not permit a tax cut limited only to the wealthy. An across-the-board reduction such as the one proposed by President Reagan is probably the only idea with any hope of passage in Congress.
Another question that bothers me is also rooted in political politics. Administration economists have offered a two-point program: tax reductions and massive cuts in federal spending. But as the saving goes, the president proposes and Congress disposes.
If the tax cuts are enacted without the accompanying budget reductions, the federal deficit will grow even larger, putting severe pressure on both rates and inflation.
But, of course, tax reductions make for great public relations, while spending cuts -- especially in programs with wide public impact -- usually generate unfavorable reaction.
I hope Congress can resist the intense lobbying already being levied by scores of special-interest groups and can follow through with the intelligent budget cuts essential to the success of the total program.
Of course, there are some bright spots, too. Even an across-the-board tax reduction will affect the wealthy and the almost-wealthy along with everyone else and should result in savings and investment.
A reduction in the rate of tax on capital gains should act as a spur to increased investment. And the proposed improvements in depreciation schedules to more realistic time frames should encourage plant modernization and construction.
Continuing restraint by the Federal Reserve Board in the money supply, together with a significant reduction in the federal deficit, should bring lower interest rates in time -- which would provide a big boost to the auto and construction industries.
Growing public awareness of the seriousness of the problem may result in more savings and less spending and may also provide a more favorable climate for Congress to act wisely.
Perhaps most important of all: Demand economics hasn't worked well in the past decade, and it probably is time to try something else. Maybe supply-side economics coupled with reduced government control overall will prove to be just the answer we need right now.