Surprising supply-side economics
It will come as a surprise to many that the intellectual origins of supply-side economics can be traced to the 14th-century Muslim philosopher Ibn Khaldun. In his masterwork, 'The Muqaddimah', he wrote about the rise and fall of empires. He argued that high taxes were often a factor in causing empires to collapse, resulting in lower revenues despite higher rates.
As Khaldun wrote: "It should be known that at the beginning of the dynasty, taxation yields large revenue from small assessments. At the end of the dynasty, taxation yields small revenue from large assessments."
Another unlikely influence was Jonathan Swift, the famous satirist and author of 'Gulliver's Travels'. In a 1728 article, he noted the negative effect of high tax rates on government revenue. His catchy phrase, "in the business of heavy impositions, two and two never make more than one," influenced many 18th-century thinkers regarding the deleterious effect of tax rates on revenues, including David Hume, Adam Smith, and Alexander Hamilton.
The 18th-century thinkers were unquestionably influential in the development of supply-side economics. Supply-siders often drew parallels between their views on tax cutting and those of the Founding Fathers of the United States.
Smith's work, in particular, was well known to all supply-siders, as well as to the Founding Fathers. The following quote from The Wealth of Nations is especially apt: "High taxes, sometimes by diminishing the consumption of the taxed commodities, and sometimes by encouraging smuggling, frequently afford a smaller revenue to the government than what might be drawn from more moderate taxes."
Another influence on supply-siders was the 19th-century French economist Jean-Baptiste Say. Say placed supply above demand in importance to the economy. Say's Law "supply creates its own demand" explained that the production of goods and services should take precedence over the stimulation of demand.
As Say put it: "The encouragement of mere consumption is no benefit to commerce; for the difficulty lies in supplying the means, not in stimulating the desire of consumption It is the aim of good government to stimulate production, of bad government to encourage consumption."
John Stuart Mill made much the same point. As he wrote: "Taxation, pushed to the extreme, has the lamentable effect of impoverishing the individual without enriching the state The diminution of demand must be followed by diminution of the supply of production, and consequently, of the articles liable to taxation. Thus, the taxpayer is abridged of his enjoyments, the producer of his profits, and the exchequer of its receipts This is the reason why a tax is not productive to the public exchequer in proportion to its ratio; and why it has become a sort of apophthegm that two and two do not make four in the arithmetic of finance. Excessive taxation extinguishes both production and consumption, and the taxpayer into the bargain."
In the 20th century, several economists wrote about the limits of taxation from a revenue perspective. In the 1930s, no less a personage than John Maynard Keynes argued that lower tax rates can sometimes increase government revenues.
As he wrote in 'The Means to Prosperity': "Nor should the argument seem strange that taxation may be so high as to defeat its object, and that given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget."
In 'Human Action' (1949), Austrian economist Ludwig von Mises pointed out that high taxes can be self-defeating in terms of revenue: "The true crux of the taxation issue is to be seen in the paradox that the more taxes increase, the more they undermine the market economy and concomitantly the system of taxation itself Every specific tax, as well as a nation's whole tax system, becomes self-defeating above a certain height of rates.
The two best-known contemporary academic economists involved in the origins of supply-side economics were Robert Mundell, winner of the 1999 Nobel Prize in economics for his work on international economics, and Arthur Laffer, famed as the originator of the Laffer Curve.
The Laffer Curve has come to represent what supply-side economics is all about in the minds of most people: common sense. It simply makes the indisputably true point that neither a 0% tax rate nor a 100% tax rate collects any revenue – the former because there is no tax, and the latter because no one will earn taxable income if the government confiscates all of it.
The Laffer Curve implies that there is some point between zero and 100 percent that will maximise revenue. If rates are above this point – in the prohibitive range – then a tax rate reduction could theoretically raise revenue. A more important lesson of the Laffer Curve is that there are always two tax rates that will collect the same revenue – a high rate on a small base and a low rate on a large base.
Beyond expanding the tax base and increasing tax revenue, marginal tax rate cuts would also stimulate economic growth, increase investment and labor supply, move some underground economic activity above ground, and discourage tax evasion.
The Laffer Curve remains a frequent topic of discussion in academic journals and has significantly shifted the intellectual climate over the last 50 years. Even critics of supply-side economics concede that tax cuts may produce substantial revenue flows, lowering their net cost, and that tax increases may produce negative reflows, increasing their costs.
A former high-level US politician, not known for praising supply-side economics, once remarked: "The purpose of tax cuts is not just to have a tax cut for a particular time. It is to get the economy to grow. If you can get the economy to grow, you will start having more money coming into the government. It's a synergistic process that moves both the budget forward and the economy forward."
In politics, that's called an endorsement!
THE WRITER IS A PHILANTHROPIST AND AN ECONOMIST BASED IN BELGIUM