Ashby: I Guess the Emperor Does Have Clothes

I know it was inevitable, but it’s still sad.  To placate the right wing of the Republican Party, John McCain has proposed a new corporate tax cut as a means of promoting growth.  After years of sanity, McCain is now paying lip service to the fantasy of Supply Side economics.

Proponents of Supply Side economics present it as a bit of a magic potion.  They argue that reducing taxes on businesses and the wealthy will increase the pool of capital for business investment and lessen the disincentive to taking risk, which results from high taxes.  The additional investment in building new factories and plants, in increasing supply, would result in an increase in demand as well – more jobs in factories, more small businesses supporting the workers, more wealth generated for everyone.  Supply Siders argue that this additional economic activity would also increase the government’s tax collection, making up for the revenue lost through the tax cut.  Yes, the Supply Siders believe that cutting taxes for the wealthy benefits everyone and pays for itself.

High taxation could certainly keep companies and investors from taking risks; companies won’t bother trying to make more money if the government takes too large a share.  Yes, access to capital is certainly a consideration in any possible expansion – companies need to be able to finance their new factories at a reasonable cost.  However, there is nothing to suggest that either of these situations actually exist.  The growth rate under Clinton was higher than under Bush, even though the tax rate was higher; clearly people were still taking risks. Nor is there a shortage of capital; even with the recent credit crunch, the world is awash in capital.  More importantly, access to credit is a secondary factor in any consideration of adding capacity – the decision is instead based on the ability to sell the additional output.  Giving businesses access to slightly more capital won’t cause them to build new factories if they don’t think they can sell what they make.  Again, a comparison of the Clinton and Bush Administrations illustrates the point.  According to the Supply Siders, business investment and new business startups should have jumped up after the tax cuts.  They didn’t.  There was no appreciable increase in business investment during the Bush Administration, nor increase in jobs. The Bush Administration certainly doesn’t highlight the point, but the tax cuts led to more job growth in China than in the U.S.

This is not to say the Bush tax cuts didn’t create economic activity.  The wealthy, who received the bulk of the tax cuts, invested the money into private equity funds and hedge funds.  The private equity funds used this investment with very high levels of debt to buy existing companies. The hedge funds used the tax cut money, again leveraged with massive amounts of debt, to speculate on gas and oil and to purchase high-yield sub-prime mortgage bonds.  Unfortunately, it is hard to say if this economic activity was good for our country.  Many of the companies bought by the private equity funds then had to reduce employment, to help cover their interest costs.  While the sub-prime mortgage bubble did create jobs in the short run, all of these jobs are now disappearing and won’t be back for a long time.  Our country has built all the housing it will need for the next several years. 

Something else the Supply Siders got wrong was the ability of tax cuts to generate enough new activity and tax revenue to pay for themselves.  Instead, we will have added $4 trillion to the U.S. debt, if the money borrowed from Social Security is counted.  All of the money we had to borrow because of the tax cuts will still have to be repaid out of tax future revenues. The Bush tax cuts are in reality just tax deferments – future generations will have to pay more in taxes, even while getting less in government services.

McCain recognized the fallacies of Supply Side economics and the extreme danger of massive deficit spending – McCain actually voted against the Bush Tax cuts, earning him the hatred of Republican economic conservatives.  McCain actually had the nerve to point out that the emperor had no clothes. Now he is running for President.  Even if the Democrats continue with their self-immolation, McCain will still need support and turnout from the economics conservatives of the Republican Party.  He will need the Supply Siders to think that he is one of them.  It’s a shame otherwise sensible Republicans still have to pretend to believe the Supply Side fantasy.  It’s a shame that John McCain has decided he has to say something he really doesn’t believe, just to have a chance to win the Presidency.

Most Commented Stories