What Is Supply-Side Economics?

Supply-side economics is a widely held belief that increasing the supply of goods and services powers economic growth. A key tenet of this theory is creating a better climate for businesses—the suppliers. Supply-siders reckon that when companies and the rich are wealthier, everybody prospers, so their policies typically center on tax cuts, deregulation, and lower interest rates.

Evidence suggests that this theory may not always work. In this article, we'll take a look at the background of supply-side economics along with some of its faults.

Understanding Supply-Side Economics

The basic idea behind supply-side economics is that companies reinvest their profits, leading to more jobs, greater productivity, higher tax revenue, and so forth. That is largely how U.S. President Ronald Reagan, and countless politicians since, sold supply-side economics to the public and paved the way for its acceptance.

At the core of supply-side economics is the belief that by reducing tax rates on individuals and businesses, particularly on high-income earners and corporations, it will incentivize them to work harder, invest more, and innovate, leading to increased economic output. Lower taxes are seen as a way to encourage entrepreneurs and businesses to expand, create jobs, and ultimately benefit all members of society through a rising tide that lifts all boats. Advocates argue that reducing government regulations and intervention in the economy can also spur growth by allowing the market to operate more freely. Critics of supply-side economics argue that it disproportionately benefits the wealthy and exacerbates income inequality. Those opposed contend that it can lead to budget deficits and reduced government revenue.

History of Supply-Side Economics

Supply-side economics was first presented as an economic theory by Arthur Laffer in the 1970s. Laffer argued that tax cuts stimulate demand, resulting in more job opportunities and wealth circulating in the economy.

It didn’t take long for Laffer’s theory to enter the mainstream. In the 1980s, President Reagan and British Prime Minister Margaret Thatcher ran with the idea that the money high-earners saved by paying less tax would be pumped back into the economy to everyone’s benefit, and adopted supply-side economics in their respective countries.

Tax cuts for the rich is an economic policy that’s been championed by several leading politicians since, including former U.S. Presidents George W. Bush and Donald Trump. More recently, it was also a feature of Liz Truss’ disastrously short stint as U.K. prime minister.

Truss lasted just six weeks in office after her bold call to tax Britain’s wealthiest less during an unprecedented cost-of-living crisis backfired. The move spooked investors, destroyed the value of the local currency, and was abandoned, much to Truss’ humiliation, within less than a month.

5 Flaws of Supply-Side Economics

Few topics divide economists quite like the supply-side one. For every expert who swears that this economic approach works, another one vehemently disputes it. Like other theories, supply-side economics isn’t flawless and does have some holes. Here are five key reasons why the theory has been disproven.

1. Tax Cuts Don’t Create More Jobs

If companies are taxed less, they’ll use their excess savings to employ more staff, supply-siders argue. The problem is that there isn’t a lot of evidence to back that up. From 1982 to 1989, when the United States was governed by Reagan and taxes were cut substantially, the labor force didn’t grow anymore than previously. A similar thing happened under George W. Bush’s watch. In 2001 and 2003, Congress passed two generous tax cuts for the wealthy, and the slowest job growth in half a century followed.

There's a number of reasons why this may happen. When individuals or businesses receive tax cuts, they may not necessarily use all the extra money to create jobs. The effects of tax cuts on job creation may not be immediate. The impact of tax cuts can vary by industry. In any case, supply-side economics may have flaws in terms of tangible, short-term job creation.

2. Supply-Side Policies Weakened Investment

Data supporting the popular opinion that lower taxes on the rich spur more investment is also hard to come by. In fact, the Center for American Progress, citing figures from the U.S. Bureau of Economic Analysis, said that average annual growth in nonresidential fixed investment was significantly higher in the non-supply-side 1990s than in the Reagan and Bush decades. Ironically, in the 1990s, the tax rate for higher earners was raised.

3. Supply-Side Economics Is Not Synonymous With Productivity Growth

Another thing supply-side advocates often talk about is productivity growth. In an essay published in 2017, Republican economists John Cogan, Glenn Hubbard, John Taylor, and Kevin Warsh claimed that productivity growth “rose markedly” through the 1980s and 1990s after taxes were slashed and regulation was done away with.

Other economists, including the University of California-Berkeley’s Brad DeLong and the New York University Stern School of Business’ Nouriel Roubini, quickly proved that this statement isn’t based on factual data and that productivity growth actually had been in decline since World War II. According to Roubini, the annual growth rate of productivity hovered around 1.1% from 1973 to 1997 and didn’t change course during the 1980s.

4. Tax Cuts Don’t Spur Stronger Economic Growth

All of the above serves as a reminder that supply-side economics doesn’t always achieve what its advocates say it does and is by no means a guarantee for economic growth. Often, supply-siders point to the 1980s as evidence that these policies engineer economic turnarounds. However, as Roubini points out, the pickup in growth exhibited from 1983 to 1989 came after a severe recession and was nothing out of the ordinary.

More evidence that traditional supply-side policies don’t lift economies was discovered in Kansas. In 2012 and 2013, lawmakers there cut the top rate of the state’s income tax by almost 30% and the tax rate on certain business profits to zero in a desperate bid to energize the local economy. That experiment lasted about five years and didn’t go well, with Kansas’ economy underperforming most neighboring states and the rest of the nation during that period.

5. Tax Cuts Don’t Pay for Themselves

A key selling point of supply-side economics is that tax cuts actually increase overall tax revenue by boosting employment and the incomes of the population and, therefore, don’t leave the country in more debt. This view has gained political currency but isn’t backed by much concrete evidence.

In fact, data shows that budget deficits exploded during Reagan’s era of tax cuts. According to the New York University Stern School of Business, the public debt-to-gross domestic product (GDP) ratio rose to 50.6% in 1992 from 26.1% in 1979.

The National Bureau of Economic Research (NBER) similarly shot down talk of tax cuts paying for themselves. Based on its estimates, for each dollar of income tax cuts, only 17 cents will be recovered from greater spending.

The Bottom Line

Supply-side economics, which posits that everyone prospers when companies have more money at their disposal, has reshaped how most of the world’s major economies operate. The thing is, not all economists agree with the trickle-down theory. Abundant evidence has been presented to support the view that supply-side economics doesn’t deliver as advertised. According to those findings, this economic model does not create more jobs and lift the economy or result in similar overall tax revenues.