Learning the Lessons of Supply-Side Economics

The American public’s broad disapproval of the Biden administration’s handling of the economy should not be the mystery that has befuddled so many experts. Consumer prices have increased by 17% since early 2021. Real household incomes are down by nearly $4,000 since 2019. Labor productivity is lower today than it was two years ago—the first time on record for a new presidency. The federal budget deficit is forecasted to reach 6% of gross domestic product this year for the first time outside of an economic crisis or recovery since World War II despite the absence—at least for now—of U.S. involvement in a world war. 

Conservatives should take no glee in this disaster or prematurely congratulate ourselves for winning the argument. While the public is rightly upset by the hardships they continue to endure, they are not sold on the alternative. And what is that alternative, exactly? For decades, the Right’s opening and closing gambit has centered around tax cuts and deregulation as the main pillars of a supply-side agenda aimed at promoting economic growth. But despite a decades-long sales pitch, the public remains ambivalent toward generic “tax cuts.”

The mild reception does not indicate that conservatives should move on from supply-side economics. Rather, we must re-envision what it means to be a supply-sider in the 21st century. At its core, supply-side economics is not a dedication to top marginal tax rate cuts, laissez-faire regulation, untrammeled free trade, or any other specific policy. Nor is it just another term for libertarian economics. Fundamentally, supply-side economics is about enhancing and expanding America’s productive capacity by unleashing the full potential of its workers, ingenuity of its inventors and entrepreneurs, and industrial might of its businesses.

To achieve these aims, supply-side economics recognizes three important realities. First, prosperity is the fruit of production. Spending and redistribution use resources, not create them. Second, people respond to incentives. Punish productive, value-creating activity and there will be less of it. Reward idleness or rent-seeking and there will be more of it. Third, we operate in a world of tradeoffs, in which resources are finite. Much of the Left’s economic agenda is an attempt to suspend these realities, whether through efforts to “rescue” the economy through ever more government spending or through efforts to promote growth by penalizing the work, energy, and investment that create growth. Recent efforts by some on the Left to obfuscate the issue by co-opting and counterfeiting the “supply-side” label for the same old progressive priorities are fooling nobody.

The context and details of President Reagan’s initial supply-side revolution have understandably linked the principles of supply-side economics with a policy agenda of cuts to the top tax rate (an incomplete characterization that ignores his across-the-board reductions) and deregulation. Reagan inherited a sclerotic economy suffering under the burden of punitive tax rates and an ascendant, albeit tragically misplaced, faith among governing elites in rampant economic interventionism. Reducing top tax rates and deregulating entire sectors were important treatments for what ailed the patient. But America’s contemporary economic disease is different from the one that President Reagan helped cure in the 1980s. The top marginal federal income tax rate is roughly half the 70% rate that Reagan inherited. The airline and telecom industries have been deregulated. Technological change and trade—particularly with the IT revolution and economic rise of China—have upended the labor market and changed the incentives and opportunities for businesses.

Of course, economic shifts have happened before. Joseph Schumpeter coined the term “creative destruction” to refer to the churn of innovation and industry turnover in market economies that fuels economic growth while also meting out fickle disruption and displacement to those in its wake. But the constancy of economic change—or the failure of ill-conceived policies—should not lead inexorably to the conclusion that the best policy response is no response or one already sitting in past playbooks. Such a mindset is not an outgrowth of supply-side thinking, in any case.

Consider the tax code. Although some high-income Americans face cumulative marginal tax rates in excess of 50%, it is actually the working class and lower-middle class who face some of the steepest penalties for climbing the economic ladder toward greater self-sufficiency. Though their income tax rates are low, the sum of their income tax rate, payroll tax rate, and phase-out rate from means-tested government benefits (food stamps, housing assistance, etc.) can approach or exceed 100%. Put another way, a worker can accept a higher-paying job or work longer hours and end up no better off—or even worse off—than by staying put and abandoning their dreams. Needless to say, removing the incentives to build human capital by acquiring skills and experience, and to strive for success, is not a recipe for enhancing America’s productive capacity. In fact, human capital may be the most important form of capital in capitalism.

To fix this mess, an America First supply-side tax agenda ought to look beyond just the top marginal rate to address the morass of rates, deductions, credits, and benefit cliffs that hold America’s workers back. Addressing lower-income regions in the tax code has the added benefit of delivering the greatest relief to those who need it most in light of the ongoing cost-of-living crisis. Some libertarians may chafe at consideration of “need” as class warfare, but this misplaced objection is more relevant to abstract debates about political philosophy than to true supply-side concerns related to strengthening America’s economy. Viewed through a genuine supply-side lens, designing policies to maximize broad-based economic growth with consideration of their distributional impacts—that is, how they affect each and every American individually—is logical. It is about putting every American first. Nothing about the approach denounces success or robs Peter to pay Paul.

As for regulation, America still has too much of it, and the Biden administration’s climate agenda in particular has made matters much worse. However, many of the worst barriers to economic progress come in the form of occupational licensing requirements and housing supply restrictions. Only 5% of Americans required a government-issued occupational license to work in their chosen profession in the 1950s. That share has risen to 22%. The result, unsurprisingly, is a reduction in labor market mobility. The artificially inflated cost of housing—whether from green building codes, onerous environmental reviews, or stringent zoning rules—also limits labor mobility and, with it,economic growth. Arguably, these two categories of regulations are the pre-eminent supply-side issue of the current era, at least for younger generations. An America First supply-side agenda should be aimed squarely at removing these shackles.

An America First supply-side agenda should permeate other economic policy areas as well, from education and health care to trade and energy. Conservatives must abandon their reluctance to tackle certain issues out of a fear of accidentally committing an act of ideological heresy. There is freedom—and a much more expansive set of policy solutions to explore—once one sheds the burden of rigid dogma in favor of a more principled pragmatism rooted in the Constitution and American ideals of experimentation.

For instance, both the health care and education sectors suffer from severe incentive problems and broken mechanisms for conveying underlying costs to guide resource allocation. Moreover, functioning in society requires reasonable access to both without the risk of financial devastation. Conservatives have embraced committing the public purse to K–12 education—ideally in ways that fund students instead of systems—but making a similar commitment to providing a financial backstop in a reformed, patient-centric, and choice-driven health care system creates tension in the movement. It has proven easier to avoid such an overt commitment—despite its striking parallels with the school choice movement—and focus only on further (often laudable) deregulatory efforts. The reluctance comes not from supply-side thinking per se, but rather from the lingering vestiges of libertarian notions that taxation is theft, and that government acts legitimately only as a nightwatchman state. An America First supply-side agenda for health care and education would prioritize fixing incentives through transparent pricing and greater patient choice, providing a reasonable safety net so that lack of education or health care does not hold people back from their full potential, and balancing the financial exposure to taxpayers.

Likewise, consider trade. From the 1980s until President Trump, supply-side doctrine held that the only good form of trade policy is no trade policy—that is, get the government out of the way and pursue unrestricted free trade. Such was the theory, anyway, even if not the real-world implementation. Economics textbooks rightly explained the model of comparative advantage, in which trade caused the economic pie to grow. The problem was not with the models, but that too many people misunderstand the nature of a model, which is based on a series of “if…then” statements. If a certain set of assumptions or conditions holds, then the model applies. Models are not supposed to be universal statements of truth. The assumptions and conditions under which pure free trade is the optimal policy are not the conditions present in the world today given the rise of China and its manipulative practices. Numerous published and reputable economics papers consider the question of what optimal tariffs or trade barriers are under different modeling frameworks.

In some supply-side circles, considering an optimal tariff is pointless, because every trade barrier is axiomatically bad. As a starting point, the instinct is defensible and even laudable. When someone calls for government intervention, the wise policymaker insists first on articulating the market failure or externality and making the case that the proposed intervention will not lead to even worse government failure. But allowing this instinct to transform into a dogmatic refusal to acknowledge market failures or a knee-jerk rejection of all proposed interventions is not supply-side economics, and certainly is not conservative. Supply-siders ought to view free trade as a launching point to examine the evidence and tradeoffs instead of an automatic landing point. Even if a tariff in isolation causes economic losses, using its revenue to reduce more damaging taxes or to help dislocated workers retool or find good employment may have a positive net effect. The supply-sider holds one’s principles close but always allows a bona fide evaluation of the evidence to guide their application.