It was the best of times. It was the worst of times.
It was the era of low taxes. It was the age of high
deficits. Prices were up. Wages were down. Oil and
gold soared. Housing and big cars cratered. Foreign
powers threatened. Foreign currencies beckoned. Some
saw a new Jerusalem in the nation’s future. Others
saw only the glaucoma of gluttonous greed. It was the
summer of economic hope. It was the winter of
In short, the early eighties were an economic time not
unlike our own—a time that scared the Dickens out of
most sober observers.
The common thread that unites the two times is Supply
Side Economics. In the eighties it was new and
promising. In the aughts it is recycled and damaging.
In both eras, it stood against Demand Side Economics
in its prescription for how to manage the economy.
But it is in their outcomes that the two theories
present such stark and measurable differences.
In the late seventies, the U.S. economy was falling to
pieces. Johnson’s Great Society programs and the
Vietnam War had produced enormous inflationary
pressures. But these were only the beginning. In
1973, Arab oil sheikdoms tripled the price of oil and
in 1978, they tripled it again. Inflation soared,
interest rates skyrocketed, and the economy tanked.
Higher prices cut into corporate profits, forcing
employers to cut back production. The higher prices
also reduced the purchasing power of workers, causing
a slowdown in the economy. It was the worst of both
worlds: a stagnant economy with rampant inflation.
Economists called it “stagflation.” They were at a
loss for a cure.
Traditionally, to fight inflation, governments raise
interest rates and cut spending, tampening down
demand. To fight unemployment, they do the opposite:
cut interest rates and raise spending, increasing
demand. But now they had both problems at the same
time. The cure for stagnant growth (lower interest
rates and higher spending) would only aggravate the
inflation. And the cure for inflation (higher
interest rates and lower spending) would only
aggravate the stagnation. The problem seemed
insoluble. Enter Supply Side Economics.
Supply Side Economics claimed that if the government
cut taxes on the wealthy, it would jump-start the
economy as the wealthy plowed their tax savings back
into investments. New factories fitted with new
technologies would produce goods at lower cost, taming inflation. And the newly hired workers would tame unemployment. It would, in effect, square the economic circle, fixing both inflation and
unemployment at the same time.
Even better, more output meant government tax receipts
would grow. The government could continue to spend
money without having to raise taxes — it would simply materialize as a byproduct of higher levels of production! The economy would bootstrap itself in an ever-expanding, virtuous circle of tax cuts, investment, productivity, employment, and rising tax revenues. It was the proverbial “something for nothing” story. It seemed too good to be true.
In 1980, Ronald Reagan promised that, if elected, he
would cut taxes, raise military spending AND balance
the budget—all at the same time. His opponent, George
H.W. Bush called it “voodoo economics”. But Reagan
won the election and kept his promise. He cut the
marginal tax rate on the highest income earners from
75% to 38%. What happened?
In 1982, the first full year for Reagan’s policies,
the economy shrank by 2%, the worst performance since
the Great Depression. Investment — the magic
transmission belt through which all other Supply Side
benefits were supposed to flow — actually declined as
a percent of GDP over the 1980s. Worse, Reagan’s
Supply Side policies created the biggest budget
deficits in history. The numbers tell the story.
Jimmy Carter’s last budget produced a deficit of $77
billion. At the time, it seemed huge. But Reagan’s
first budget swelled the deficit to $128 billion. By
the next year, 1983, it had exploded to $208 billion
and was creating severe problems for the economy. By
1992, at the end of the “Reagan Revolution,” (under
Reagan’s Vice President and successor, Bush, Sr.) the
deficit was approaching $300 billion a year.
Annual deficits, of course, accumulate to the national
debt. In 1980, the national debt amounted to less
than $1 trillion. By the end of 1992, it had reached
$4.35 trillion. In other words, the debt, which had
taken over 200 years to reach $1 trillion, quadrupled
in the 12 years of Supply Side Economics. A more
complete, definitive repudiation of Supply Side’s
claims could not be imagined. What went wrong?
According to Supply Side “theory,” tax cuts should go
to the wealthy for only they can afford to use the
extra income to invest in the economy — to increase
its capacity to “supply” goods. But there is nothing
to make sure they actually invest, especially in the
The new money might simply sit in the bank, or be
spent on expensive foreign imports. It might be
wasted in misdirected speculation, or invested in fast
growing markets like southeast Asia. Without the
ability to ensure that tax cuts are, in fact, invested
in new productive assets, Supply Side Economics cannot
ensure any real linkage between tax cuts and the
hoped-for economic boom.
Revealingly, Supply-Siders strenuously resisted calls
to tie tax cuts to actual productive investments, that
is, give the tax cut only after the investment had
been made. This led critics to suspect the real
motives behind the “theory.” The only thing that was
certain was that the rich would become richer and
revenues to the government would be lower. Beyond
that, it is all just wishful thinking.
Contrast this wishful thinking with Demand Side
economics. Demand Side Economics, says that if taxes
are to be cut, they should go to those who earn the
least amount of money. The reason is that low-income
workers spend virtually all of their incomes. Money
given to them goes right back into circulation,
fueling a boom in consumer spending. This is
essentially the policy that rescued the U.S. economy
from the Great Depression. This, say the Demand Side economists, is the real foundation for an expanding economy. How has this theory held up in practice?
Bill Clinton reversed Reagan’s Supply Side policies,
raising taxes on the wealthy and lowering them on the
working and middle class. This Demand Side formula
was fiercely resisted by Republican leaders in
Congress who predicted a stock market crash and
another Great Depression. Indeed, every single
Republican member of Congress voted against it. It
took a tie-breaking vote by Al Gore in the Senate to
get the bill passed. What happened?
The economy produced the longest sustained expansion
in U.S. history. It created more than 22 million new
jobs, the highest level of job creation ever recorded. Unemployment fell to its lowest level in over 30 years. Inflation fell to 2.5% per year compared to the 4.7% average over the prior 12 years. And overall economic growth averaged 4.0% per year compared to 2.8% average growth over the 12 years of the Reagan/Bush administrations.
It wasn’t even close. The economy performed
dramatically better in almost every way once Supply
Side policies were replaced with Demand Side policies.
The most dramatic outcome was the reversal of the
Reagan-era Supply Side deficits. Clinton’s Demand
Side policies not only paid down the Reagan/Bush
deficits, they produced the first budgetary surpluses
since 1969. By the time Clinton left office, the
government was running surpluses of almost $140
billion per year. This is what he turned over to
George W. Bush in January of 2001.
Bush, of course, returned to the Supply Side policies
of Reagan and his father. He lowered taxes on the
very rich — his “base” as he calls them. His $1.6
trillion in tax cuts give 45% of the benefits to the
top 1% of the population. It is classic Supply Side
economics. What happened?
According to the Economic Policy Institute, "By
virtually every measure, the economy has performed
worse in this business cycle than was typical of past
ones." GDP growth since the bottom of the 2001
recession has averaged 2.8%. But it grew at an average
rate of 3.5% over the prior six recoveries dating back
to World War II. Or consider jobs: 1.3% more jobs
under Bush versus 8.8% more during earlier upswings.
Private sector jobs — an especially telling measure of
economic health — are up only 1% since 2001 versus an
average of 8.6% for past recoveries. Investment? That
Holy Grail of Supply Side orthodoxy? Up 3.6% compared
to the 8.2% average for the six earlier rebounds.
Pick your measure: growth, jobs, income, spending,
investment. The recovery based on the Bush II Supply
Side tax cuts is one of the weakest ever recorded.
The one thing the Supply Side revival did excel at —
not surprisingly — is debt. Bush turned a $136
billion surplus from Bill Clinton into a $158 billion
deficit in his first year. When he took office, the
national debt stood at $5.8 trillion. It now stands at
$8.1 trillion and is projected to hit $10 trillion by
2008 when Bush’s second term is over. The ten-year
cumulative deficit forecast by the non-partisan
Congressional Budget Office has changed from a $5.6
trillion surplus in January 2001 to a $3.4 trillion
deficit in March of this year—an almost inconceivable
swing of $9 trillion to the worse in only six years.
After more than 17 years of experience with Supply
Side economics, we now know beyond doubt that this is
not an accident.
These mammoth debts are a huge boon to that rich
“base” that Bush loves to coddle. It is they, the
very rich, who loan the money to the government to
fund its debts. And since more borrowing drives up
interest rates, they get to do so at higher and higher
rates of return. This is simple supply and demand.
By increasing the demand for borrowed money in the
economy as a whole, Supply Side deficits drive up the
cost, not just of government borrowing, but of ALL borrowing—everything from credit cards and mortgages to car loans and municipal bonds.
In other words, Supply Side economics rewards the rich
both coming and going. Higher government debt leads
to higher interest rates for all borrowing — or in
their case, lending. And then, they get to pay lower
and lower taxes on their higher and higher earnings.
It is a magical two-fer worth hundreds of billions of
dollars a year.
This is the real reason Bill Clinton was so
relentlessly hounded while in office. It wasn’t that
he was being serviced by an intern or that he was a particularly radical president. Indeed, Clinton himself described himself as “an Eisenhower Republican.” His big faux pas was that by paying down the Republican debts, he lowered interest rates, the basis of Republican earnings. In fact, real interest rates declined 40% while Clinton was in office. You can see why he simply had to go.
This is the real magic of Supply Side economics:
for the rich. It is one of the reasons the top 20% of
income earners has raised its share of national income
from 44% in 1980 when Supply Side policies began, to
50.1% last year. They now earn more than all of the
rest of the people in the economy combined.
But it only works for the rich. If you’re not rich,
it is you who are paying those higher and higher
interest rates and it will be you — or perhaps, more
precisely, your children — who will be stuck with the
bill for the higher government debts. Paying off
those debts can only come at the expense of future
economic growth for income spent paying off inflated
debts is money that is not available for college
tuitions, job retraining, repairing infrastructure,
Rarely in matters of public policy do we have the
luxury of such starkly clear, repeatedly proven,
empirically founded contrasts. Demand Side economics,
as we saw in the 1990s, while far from perfect,
produces robust growth, budgetary surpluses, and broad
based prosperity. Supply Side economics produces
middling growth, soaring deficits, and broad based
debt. Mountains of debt. And the mountains are
If we are to salvage any kind of economic sanity and
prevent the bankruptcy of the nation, the next
Congress must reverse the Supply Side agenda and
return the country to a responsible fiscal course.
Robert Freeman writes on history, economics, and
education. He can be reached at email@example.com.