The concept of supply-side economics has all but been forgotten in Washington, and many of its principles have been abandoned by U.S. policymakers. Paradoxically, it is alive and well in the heartland of the old Soviet Empire, Central and Eastern Europe. Congress illustrated this sorry state of affairs by failing to take action to prevent tax rates from increasing two years from now by 33 percent on capital gains and 133 percent on dividends. Just when investments being contemplated in the coming months will begin to bear fruit and increase our tax base, the Congress has planted seeds of a tax increase and a future economic slowdown.
A great paradox grew out of the supply-side revolution that occurred during the Reagan presidency. On the one hand, the revival of this neoclassical economic thinking provided the solution that pulled us out of the economic malaise of unemployment and inflation rising simultaneously, which demand-side Keynesianism could neither explain nor remedy. On the other hand, supply-side economics failed to replace Keynesianism as the reigning economic orthodoxy. To this day, supply-side economics, its tenets and prescriptions are resisted or misrepresented by the Washington establishment, including the think-tank community and the media.
Meanwhile, many of our competitors in the global economy increasingly embrace supply-side principles, reform their tax codes, get their monetary policy right and eliminate mercantilist-protectionist policies that stunt economic growth. Unless the supply-side precepts that drove the Reagan economic revolution are rediscovered and reapplied here at home, the United States will confront a crisis of unsustainable big government and a declining economy in the future. America could become less able to compete in the global economy with countries that have learned and applied the supply-side lessons, including China, India and Eastern Europe. Economic growth will slow, and our standard of living will be imperiled.
Washington Post columnist E.J. Dionne Jr. made it clear in a recent screed against supply-side economics that discussions of economic policy have degenerated again into agitprop for class warfare and overheated rhetoric about economic snake oil, Scrooge, old folks and orphans. Dionne perpetuates the myth that it was the Clinton tax increases rather than the Republican Congress’ supply-side tax rate reductions that restored economic vitality after the Clinton recession.
Even more alarming was Alfred Tella’s Washington Times column quoting the new chairman of the Federal Reserve Board, Ben S. Bernanke, paying homage to the idea that there is a trade-off between unemployment and inflation. The discredited Phillips Curve — which assumed economic growth causes inflation and that inflation can only be reduced by increasing unemployment — has come back into fashion relabeled the "sacrifice ratio," which, according to Tella, purports to "measure the short-term economic cost of reducing inflation, that is, the amount of employment or output that is lost, or has to be ‘sacrificed,’ in order to reduce the inflation rate. The sacrifice ratio is also defined in terms of joblessness, measured by the amount of unemployment required to lower the inflation rate."
Tella reports that the Fed’s staff estimates the so-called unemployment sacrifice ratio has risen sharply since the mid-1980s, a view Tella says is embraced by Bernanke. In other words, the resurrected Phillips Curve demands more sacrifice from the economy today, i.e., the economic cost of lowering the inflation rate has increased.
Given the Fed’s penchant for overshooting the mark and holding monetary policy too tight for too long, there is now a high probability that this economic quackery — the danger that Congress will administer an unwarranted sedative of tax rate increases and a potential Fed decision to bleed the patient with excessively tight monetary policy in the name of the sacrifice ratio — could put the economy flat on its back just in time for the 2008 presidential campaign.
So notwithstanding a decade of Republican control of the Congress and five years in the White House, and despite the fact that Republican policymakers give constant lip service to Reagan’s economic policies, the supply-side revolution has failed to regenerate itself with younger scholars and activists and has been largely halted in Washington by a neo-mutant-Keynesian counterrevolution that threatens to unleash a crisis of big government interventionism and mercantilism that will make the 1970s repeat itself.