Introduction
Examination of an economy can never be complete without the examination of the two sides that make up the economy. These sides entail the demand and the supply aspects that interact with each other to bring equilibrium within an economy. Disequilibrium can cause negative impacts within the society and the economy at large.
The study of economics is a crucial subject to the society, and thus can be quite cumbersome and difficult to comprehend since it is wide. However, to simplify this subject and make it easier to understand, the subject falls into various categories with supply side of the economics being one of them. However, these divisions are theories that enhance the study of economics.
The supply-side economics, commonly defined as the trickle down economics, depicts an economic theory in relation to taxes. The theory recognizes that stimulation in the growth of the economy can be achieved through cutting down on taxes, thus enticing consumers into increasing their expenditure (Collins, 2007).
The theory also points out that in order to recover revenues lost due to reduction in taxes, the economic growth that will be experienced in the end will generate a large tax base that would consequently compensate for the lost revenues (Cooper, 2012). After the introduction of the Reaganomics, researchers rose to challenge the validity of this theory.
Controversies that faced the theory have initiated an examination of the theory in this paper. In the course of the study, this paper shall focus on the Reagan’s supply side of economics coupled with examining whether the theory was a success or not, and in case it failed, what are reasons that brought it down.
Reagan’s supply side economics advocated for the provision of tax cuts as an incentive to investors and entrepreneurs and it worked in the short run.
The economics
The supply side economics pioneered under the watch of Ronald Reagan, a former US President. As aforementioned, Reagan’s supply side economics advocated for the provision of tax cuts as an incentive to investors and entrepreneurs. The idea behind this incentive hinged on the assumption that due to reduced taxes, investors would be in a position to make more savings and invest more.
The investments put in place would yield huge economic benefits that would boost the overall country’s economy (Collins, 2007). Ronald Reagan based his supply side economy on the concept of Laffer curve developed in the late 1970s by Arthur Laffer.
While coming up with this concept, Laffer stated that there would be immediate effects of tax cuts on the budget of the federal government. Moreover, “an equal tax cut would have a multiplier effect on the growth of the economy” (Collins, 2007, p.106). For instance, the proponents of the idea stated that for every dollar reduction, there would be an increase in demand, thus stimulating growth amongst businesses.
This aspect would consequently result into additional employment (Fink, 1982). However, the impact of the tax cut would be determined through examination of the growth of the economy, the initial amount of taxes, and the category of taxes to be reduced.
Firstly, the Reagan’s theory was acceptable as it fulfilled all requirement of a theory. The theory also hinged on macroeconomics and was at the verge of offering an explanation in relation to prescription of policies that would ensure stability in the growth of the economy (Collins, 2007). The theory revolved on three pillars that included monetary, tax, and regulatory policy.
With the three pillars, the common idea among them was production, which in the supply side of the economy is the most crucial determinant of the growth of an economy. However, the supply side economic theory appeared to contradict the Keynesian theory. According to the Keynesian theory, demand is the most crucial factor that can alter economic growth as opposed to supply.
Keynes argues that a lag or reduction in demand by consumers is capable of driving the economy into a recession; therefore, the government should initiate fiscal and monetary policies as intervention measures.
The proponents of Reagan’s economics believe that manufacturers (suppliers) can set a crucial pace towards growth of an economy through their willingness to create and supply goods and services to the economy.
On the other hand, the supporters of the Keynesian theory believe that demand for goods and services by consumers are the key towards economic growth (Fink, 1982). This contention underscores the point that draws a distinction between the two theories.
The Reagan’s economic theory hinged on four pillars that included reduced federal income taxes, taxes on capital gains, reduction on government regulations, and increased government spending. There was also the idea of controlling the money being supplied and circulating within the economy in order to reduce inflation.
There had been stagflation in the US economy as characterized by an increase in the rate of unemployment and inflation among federal states. This scenario happed in the administration that existed before Ronald Reagan assumed office as the president.
Due to political pressure, the country moved on into increasing the money supply in the economy to stimulate economic growth. With the reign of President Jimmy Carter, several changes came in place including the creation of additional departments such as that of Energy, while phasing out price controls that had been imposed on petroleum.
Earlier on, other changes that had occurred included the creation of federal oil reserves coupled with complete scrapping of wage and price controls. However, in a bid to deal with the menace of stagflation, money supply would be restricted for a period of three years coupled with easing of oil supply and pricing (Collins, 2007).
With the assumption of office as the president of the United States, Ronald Reagan chose to take another path based on the urge to improve the economy. He started by stating his intentions to increase spending on the Defense Department together with initiating a decrement in taxes.
Due to these implementations by Reagan, the federal government had an annual deficit estimated to be 4 per cent of the federal government’s GDP (Cooper, 2012). However, Reagan introduced policies that brought growth in several sectors of the economy. Before he was elected into office, the Republicans considered the supply side theory as an unconventional move.
While in office, Reagan cancelled all domestic petroleum prices and controls that hindered allocation. He went ahead to reduce taxes on windfall profits in relation to oil and its products (Cooper, 2012). In 1986, the Tax Reform Act of 1986 was implemented in order to lower marginal tax rates for the rich, complete elimination of deductions, and significant increase in taxes for those in the annual earning bracket of less than $ 500,000.
In 1982, Reagan implemented a reduction in corporate and income taxes. Changes implemented by Reagan led to a complete change in the composition of tax revenue (Collins, 2007).
To some extent, the Reagan supply side economics succeeded, though not as anticipated. For instance, during his era, the US economy experienced a growth through the growth and expansion of business cycles and the monetary policies implemented. In addition, the economy had a positive progression since both unemployment and inflation kept on reducing (Collins, 2007).
Moreover, some economists also appreciated the fact that although Reagan did not meet all the requirements stipulated elements in his pillars, he made a remarkable progress. Due to this theory, most investors and entrepreneurs flourished courtesy of tax incentives presented by the new economic policies under the Reagan’s regime.
The economic growth hinged on the reduced tax rates and inflation in addition to reduced regulations, which led to the creation of favorable environment that allowed funding based on the conditions prevailing in the market.
Entrepreneurs also had the privilege of enjoying rewards of their success due to reduction in taxes that are believed to reduce profits generated by a business (Atkinson, 2006). Moreover, the implementation of laws that pose significant restrictions to entrepreneurs regarding the utilization of the generated profits erodes the entrepreneurs’ morale towards taking risks.
Due to the reduction on taxes charged on incomes, the economy and most businesses grew. A decrement in taxes means more disposable incomes to workers. In addition, due to increased expenditure, the demand for goods and services also increase, hence the establishment of additional businesses, which leads to additional employment opportunities (Cooper, 2012).
In addition, employees can also collectively bargain for an increment in their salaries and wage, which translates into higher revenues collected from the taxes charged. However, a decrement in taxes can influence expenditure pattern of an individual depending on his or her income level (Atkinson, 2006).
For instance, economists ascertain that reduction in taxes among low-income earners is likely to lead to increased spending and increased demand, hence growth of the economy. However, this trend might not be the case among high-income earners.
Instead, this category of individuals, given the same tax incentives, they would utilize the extra money earned through savings, investing, and paying debts incurred. This money is also channeled to stock markets and banks, which is not a significant stimulus towards the growth of the economy.
There have been controversies as to whether the Reagan supply side economics works or not because there exists challenges in finding the real world proof of this theory, as it is extremely difficult to separate the effects of reduction in taxes on the economic growth and the revenues generated.
For instance, when the former president, President Bush, initiated a reduction on taxes between 2001 and 2003, there was a positive progress on the economy accompanied by an increase in revenues. The proponents of the supply side economics attributed the change to the reduction of taxes. However, this issue attracted criticism from other economists.
Other economists “were quick to point out that low interest rates were the actual stimulators that led to the economic growth” (Cooper, 2012, p.62). The Bush government adopted the Reagan supply side economics as evidenced by the fact that the federal treasury created a model to support the idea that the tax cuts implemented by President Bush would lead to an economic growth.
In designing the model, it was assumed that revenues lost through the reduction would be compensated by maintaining a balanced budget and reducing fiscal spending. However, “this was not sustainable and the tax cuts were compensated by increasing taxes in the future, thus having a negative impact in the end” (Cooper, 2012, p.114). This move resulted in additional debts by the federal government.
Conclusion
The Reagan supply side economics tended to impose tax discrimination among different levels of income earners. For instance, some of the implemented tax reforms included the reduction of nominal rates of taxation amongst the wealthy, while on the other hand raising rates of taxes among low-income earners (Fink, 1982). This aspect becomes an impediment in the implementation or restoration of a flat system of taxation.
Moreover, during Reagan’s term in office, the US economy had an increased budget deficit in addition to the federal government’s debt (Atkinson, 2006). This aspect was attributed to increase in spending arising from increased disposable incomes due to tax cuts.
President Reagan failed to know that his theory would only be suitable if he desired short-term results. However, revenues lost due to reduction in taxes in the end can only be recovered partially (Fink, 1982).
Currently, economists still research on the issue to find out whether a reduction in taxes can result into growth of the economy in the future. However, Reagan supply side economics worked in the short run as the theory can be implemented in the short run to boost a poor performing economy.
References
Atkinson, R. D. (2006). Supply-side follies: Why conservative economics fails, liberal economics falters, and innovation economics is the answer. Lanham, MD: Rowman & Littlefield Publishers.
Collins, R. (2007). Transforming America: Politics and culture during the Reagan years. New York, NY: Columbia University Press.
Cooper, J. (2012). Margaret Thatcher and Ronald Reagan: A very political special relationship. Hampshire, UK: Palgrave Macmillan.
Fink, R. (1982). Supply-side economics: A critical appraisal. Frederick, MD: University Publications of America.