Supply Side Economics

Neo-classical or supply side economics is a micro-economic-based approach to macro-economic analysis and policy development. It assumes that markets work (they clear quickly and efficiently) and that producers (workers, savers, and investors) respond rationally to (after-tax) rewards. It measures the effect of fiscal policy on people's behavior and on the macro economy by looking at its impact on important price signals in the marketplace. This is in contrast to the Keynesian view that government taxes and spending affect the economy by directly changing the amount or composition of total "aggregate demand" for goods and services.

Neo-classical or supply-side economists view the economy as responding to price signals, and believe that government policy affects the economy by altering relative prices. The key relative prices affected by taxation are the prices of labor versus leisure, and of saving versus consumption, which affect the quantities of labor, capital, and total production.

People provide labor and capital services in order to earn after-tax returns for their efforts. Workers give up leisure for after-tax wages. The marginal tax rates imposed on incremental earnings reduce the incentive to work an extra hour relative to taking an extra hour of leisure. Similarly, savers give up immediate consumption for future returns. Marginal tax rates levied on incremental earnings of saving raise the cost of saving an extra dollar or buying an additional machine relative to enjoying an incremental amount of current consumption. In the neo-classical world, it is the affect of these price signals on the supply of factors of production and the supply of goods and services that affect the economy's level of employment, output, and, therefore, total income (which is payment for production).

By contrast, Keynesian theory asserts that people readily supply goods and services in response to demand, and managing demand is the primary tool of government economic policy. It is assumed that government tax and spending policies can regulate economic outcomes by directly manipulating the total spending (aggregate demand) by consumers, businesses and government. Tax changes are thought to affect the economy by reducing (via a tax hike) or increasing (via a tax reduction) the disposable income of the population, thereby restricting or encouraging private sector spending. Government spending increases and faster money creation are also assumed to boost demand.

IRET's founder, the late Dr. Norman B. Ture, was one of the leading proponents of the neo-classical approach to macro-economics, and one of the leading tax theorists of the 1960s through the 1990s. His views on taxation had an important influence on the Kennedy tax cuts of the early 1960s, on the Reagan tax cut of 1981, and on the tax reform debates that continue to this day.

Norman Ture was more than a supply side economist. He was also a student of political economy and public choice. The first two papers listed below, "Taxes and the Good Society" and "Federal Tax Policy and the U.S. Economy: Policy Options for Improving Both", present Dr. Ture's philosophy of what constitutes a good tax system, taking economic efficiency, the political process, and social considerations into account.

The third paper, "The Inflow-Outflow Tax", presents a tax system consistent with Ture's principles of optimal tax policy. It is a summary of Ture's last work on tax policy before his death in 1997, edited by Stephen Entin, Ture's successor at the Institute.

The fourth paper, "The Economics of Taxation and the Issue of Tax Reform", lays out in simple terms the micro-economic basis for analyzing the effects of taxation; compares Keynesian, monetarist, and neo-classical/supply side views of fiscal and monetary policy; explains the difference between average and marginal tax rates; describes the U.S. tax system, its various taxes and tax rates, and the tax bases on which they are imposed; examines biases in the current income tax system against saving and investment (in favor of consumption); and explores and rates alternative "neutral" tax systems that would improve economic performance, and the tax reforms that would implement them.

The fifth paper, "Fixing the Saving Problem: How the Tax System Depresses Saving, and What to Do About It", takes the supply-side view that the tax system, not the budget deficit, is the chief problem for saving and capital formation, and that tax increases to lower the deficit are not the appropriate answer.

The next paper, "Reforming Taxation: Advantages of a Saving-Consumption Neutral Tax Base, and Principles to Guide Reform", describes a tax system that would be less distortionary, simpler, and more favorable to growth than the current federal income tax system. A slide presentation expands upon the material in this paper.

To dig a bit deeper into the technical aspects of supply side or neo-classical theory, and the differences between neo-classical and Keynesian theory, see the two chapters reproduced from Essays in Supply Side Economics. Chapter 1, "Supply Side Analysis and Public Policy", by Dr. Ture, demonstrates that taxes and spending affect the economy by first altering relative prices (the first order effect), leading to changes in production, income, and then to changes in demand (the second order effect), not by first changing disposable income and demand, as in the Keynesian view of the world.

Chapter 2, "The Theoretical Heritage of Supply Side Economics", by David Raboy, traces the origins of neo-classical or supply side economics back to the market-based ideas of Adam Smith, Jean Baptiste Say, and the economists who developed modern microeconomics. Raboy also traces the origins of Keynesian thinking back to Thomas Malthus and others who doubted the smooth functioning of markets and fretted about the natural stability of the economy. The economic and policy debates we face today are not new; they are over two centuries old!

Taxes and the Good Society
Lecture by Norman B. Ture
September 13, 1995
Author: Dr. Norman B. Ture

Federal Tax Policy and the U.S. Economy; Policy Options for Improving Both
March 13, 1997
Author: Dr. Norman B. Ture

The Inflow Outflow Tax; A Savings Deferred Neutral Tax System
1998
Author: Stephen J. Entin and Dr. Norman B. Ture

The Economics of Taxation and the Issue of Tax Reform
April 16-19, 2009
Author: Stephen J. Entin, President and Executive Director

Fixing the Saving Problem: How the Tax System Depresses Saving, and What To Do About It
August 6, 2001
Author: Stephen J. Entin, President and Executive Director

Reforming Taxation: Advantages of a Saving-Consumption Neutral Tax Base, And Principles to Guide Reform
February 16, 2005
Author: Stephen J. Entin, President and Executive Director

Slide Presentation to accompany: Reforming Taxation: Advantages of a Saving-Consumption Neutral Tax Base, And Principles to Guide Reform
Author: Stephen J. Entin, President and Executive Director

Essays in Supply Side Economics
Chapters 1 and 2
1982
Author: David G. Raboy, Ed., Chapters by Norman B. Ture and David G. Raboy

George Mason University Presentation
Author: Stephen J. Entin
For the text accompanying this slide presentation, see "The Economics of Taxation and the Issue of Tax Reform" above.