Supply-Side Failure from Theory, to Outcomes, to Danger of Citizens United Decision

Summary: Republican tax cut/deregulation (supply-side) policy assumes the United States to be a closed economic system where the benefit remains in America when in fact we invest in a global economy.  A critical break occurred in supply-side theory when enhanced savings from tax cuts was not followed by increased US capital investment.  The failure of this policy to stimulate US business investment contributes to its underperformance in jobs creation, job recovery following recession, GDP growth, real annual median household income growth and wage levels.  Without economic stimulative effects from this policy, the loss of tax revenue from tax cuts was not offset by increased tax receipts from economic growth and our national debt has substantially increased as a fraction of our economy under all five complete 4-year periods where this policy has been in effect since 1981. With no control over where the wealthy and corporations deploy their capital, the money we borrowed to support tax cuts largely favoring the wealthy has supported job creation and business growth abroad while our job creation has lagged at home.  The unreliably of tax cut policy to direct money into the US economy lends credence to government-supported investment as a way to stimulate private sector job creation at home, as we have done in the defense industry for decades.  Additionally, the tenacious defense of the pro-business tax cut policy by the Republican Party highlights the ideological battle between ‘Main Street’ and ‘Wall Street’ and shows the danger of the Citizens United Supreme Court ruling where a limited number of the wealthy and corporations can now influence the outcome of elections.

Introductory Remarks

As I study and write about tax policy and its effects, one thing has become quite clear to me.  And that is the government must play an important role in US private sector jobs growth during this recovery.  Tax cut policy as a means to grow our economy and create jobs growth at home assumes that the US is a closed economic system and that the benefit remains here to spur investment.  However, where that policy fails, in both theory and actual outcomes, is that we participate in global investment and can not dictate to the wealthy (who receive the largest benefit) and corporations where they deploy their capital.   There is a serious disconnect in supply-side theory, and that disconnect has been reflected in actual outcomes.

Economic vs. Personal ‘Investment’

‘Investment’ is central to the success of tax cut policy.  It is important to understand the difference between the economic and colloquial use of the term.  The generally accepted measure of our economy is our Gross Domestic Product (GDP) which is the market value of all final goods and services produced by our country in a given period of time.  GDP can be calculated a few different ways (ref), but a frequently used method is the Expenditure Approach which has 4 components:  private consumption (the largest, about 70% of our economy); ‘investment’; government spending; and, net exports.

Investment, in terms of our economy, includes the money that companies spend to expand business operations (digging a new mine, purchasing new equipment, etc), inventory, as well as the money that households spend on new homes.  Although the term investment is also used to describe the purchase of stock by individuals, that activity is considered to be savings. From an economic perspective the money a corporation receives from ‘personal investors’ is not counted as investment until it actually spends it on equipment, expansion, etc.

So when you hear politicians saying that tax cut policy is good for investment, they are speaking in economic terms, not in terms of personal savings.

Tax Cut Policy: How It Is Supposed to Work

Tax cut policy (called supply-side) basically argues that by lowering taxes on income and capital gains, along with reduced regulation, barriers are lowered that would permit a larger supply of goods and services to be available that consumers could buy at lower cost (ref).   Essentially, tax cuts largely favoring those with high savings rates (the wealthy), would lead to higher ‘savings’, would result in capital accumulation by business that would be used for ‘investment’, that would result in greater economic growth (ref).  Thus the term ‘trickle down’ that has been used to describe the policy.

A Break in the Theory: Tax Cut Money Went into Savings, But Not US Capital Investment

The first part of the theory worked.  Tax policy did affect savings rates as shown by a study conducted by Moody’s Analytics Inc. and published in Bloomberg (ref).  When Clinton raised the top tax rate to 39.6% from 31% in 1993, saving rates fell from 12.1% in the second quarter to 9.5% in the first quarter of 1994.  When the Bush tax cuts were signed into law in June 2001 pushing the top rate down to 35%, the savings rate climbed to 2.8% in the first quarter of 2002 from a minus 2% in the second quarter of 2001.  So tax policy did affect savings in the direction that was anticipated.

However, the tax cut benefit to the wealthiest did not translate into increased US capital ‘investment’.  Bernstein reported last September in the Financial Times (ref) that ‘investment’ during the decade following the GW Bush tax cuts was by far the weakest in the Post WWII as reflected in such measures as real gross non-residential investment, investment in equipment and software, and non-residential structures.  Yet, during this period there were record flows to high growth emerging market (foreign) debt and equity funds.  Between December 2003 and August 2010, the MSCI Emerging Market Index appreciated 120% while the S&P500 (our broader market index) declined 6%.  The paper concludes that the enhanced savings from tax cut policy leaked abroad to the benefit of non-US groups rather than into our own economy.

Another paper by Ettlinger and Irons (ref) revealed that yearly real investment growth during the GW Bush years was 2.7% versus 10.2% during the Clinton years where supply-side tax cut policy was reversed.  The authors conclude that without better investment growth associated with supply-side tax cut policy, that “a critical link in the theory…is broken – and it is difficult to draw any plausible connection between supply-side tax cuts and any observed positive economic performance”.

So, a significant break occurred in the chain of events that describe supply-side (tax cut/deregulation) theory; the benefit largely weighted to the wealthiest did not result in greater growth in US business investment.

Break in Chain Supported by Weak Economic Outcomes

To avoid redundancy, the reader is referred to recently posted referenced article entitled, Policy and the Economy: The Good, The Bad, and the Ugly (ref) that supports what follows.

The failure of higher savings from tax cut policy to find its way into the US economy is reflected in important economic measures.  Since the mid-1970’s median job creation during 5 different 4-year periods with tax cut policy in place was 2.6 million (0.0 – 10.8) versus 11.2 million (10.3 – 11.5) during the three four-year periods having progressive tax policy that extended into the wealthiest.  Job creation during the GW Bush years was the lowest since the presidency of Hoover.  Return to sustained job growth following the recessions of 1990-1991 and 2001 (both periods employed tax cut policy) was 12 months and 22 months, respectively; time to sustained job growth following this recent severe economic downturn was just 6 months and followed passage of the stimulus package.  GDP (the standard measure of our economy) between 1978-2005 experienced greater growth during progressive tax periods than during tax cut periods.  Average annual real median household income growth, wage levels, and as mentioned above real investment growth, all did better during the Clinton years that employed progressive tax policy as opposed to either of the supply-side tax cut periods (Reagan/Bush 41 and Bush 43).


I will reproduce one graph from the above referenced article that displays national gross debt as a fraction of our economy over 4-year periods since the mid-1970’s.

We have had eight different complete 4-year periods since the mid-1970’s that employed varying tax/economic policy.  In 5 of those periods supply-side tax cut policy was employed (all Republican presidential terms) and in 3 progressive tax rate policy was employed (all Democratic presidential terms).  In all five periods where tax cut policy was in place, our national debt substantially increased when expressed as a fraction of our economy (this is unsustainable debt accumulation) and in all 3 periods where progressive tax policy was in place our national debt decreased as a fraction of our economy.  (A question I posed to Speaker Boehner and Senator McConnell in a letter I sent to their attention (ref), is why Washington seems to have a spending problem only when their tax policy is in place).

Retiring a Couple of Partisan-Based Arguments

It is time to retire a couple of partisan-based arguments regarding deficits and surpluses.  First, it has been argued by some that it is the party controlling Congress that is responsible for deficits or surpluses.  I would ask those who support such a position to explain how our country went from record surpluses in 2000 to record deficits in 2005 when the Republican Party controlled both houses of Congress in both instances.  The party didn’t change – the policy did.  And secondly, for those who claim the Clinton surpluses were due to counting Social Security, those surpluses existed whether or not Social Security is counted (ref).  In the year 2000 we balanced the books for the first time since 1965 without borrowing from entitlement programs.

Connecting the Dots: Pro-Business Policy and the Citizens United Supreme Court Decision

Republican tax cut policy is a pro-business policy.  It provides business additional capital through the wealthy that was supposed to increase and diversify supply and thus drop cost to the benefit of the public. Although this policy has greatly benefitted the wealthiest, Wall Street, and corporations, it has not been to the benefit of the general public as shown by multiple economic outcomes.  However the tenacious defense of this policy by the Republican Party in the face of documented debt increase, the failure to stimulate jobs growth at home, the borrowing of money to finance business and jobs growth abroad while ours lagged is troubling; especially as that party is discussing the need to cut social programs such as Medicare, repeal Healthcare Reform, and privatize Social Security (would be a plum for ‘Wall Street’) while supporting continuation of the policy.  The defense of this policy defines the ideological battle between ‘Main Street’ and ‘Wall Street’.  And pro-business lobbying is supporting the funding of political campaigns so that policies are enacted or kept in place that benefit their industries.  And herein lies the danger of the Citizens United Supreme Court decision.

Having met several times with an experienced and successful political consulting group when I considered entering the NC-D primary for the US Senate, elections are won and lost in the living rooms of high probability voters through TV messaging.  And buying primetime is expensive (they spoke in terms of shows like Oprah and Wheel of Fortune).  Just as in military operations, those who control the air win the war.  With the Supreme Court ruling allowing unlimited corporate contributions, it has opened the door for a small number of the wealthy and corporate America to markedly control the outcome of our elections.  The ‘voice’ of the singular wealthy and corporate ‘citizen’ has become much louder than the voice of the average citizen.  Take for example the case of a Wall Street hedge fund operator in NYC and a business owner in the Washington DC area pumping hundreds of thousand of dollars (through and entity called Concerned Taxpayers of America) into attack adds against a Democratic incumbent in Oregon (Rep. DeFazio) (ref).  Or the revelation that a small circle of exceptionally wealthy Wall Street hedge fund and private equity moguls, who were ‘bitterly opposed’ to Democratic proposals to increase taxes on compensation that hedge funds pay their partners, provided substantial funding for GPS Crossroads that worked in conjunction with other special interests in supporting Republican political campaigns around the country (ref).

A system now exists where a limited number of special interests, driven by greed and their own interest, can stack the deck in our elections to their own benefit without regard to the public.  The same special interests that contribute to political campaigns.  I believe it important that the attendance by Supreme Court justices Thomas and Scalia at a bi-annual closed-door Koch brother meeting be investigated.  It is not unusual for political figures to attend conferences.  However, the meeting they attended was billed as a forum ‘to review strategies for combating the multitude of public policies that threaten to destroy America as we know it’  (ref).  If our Supreme Court justices attended strategy sessions that would raise ethical questions as to whether they should have recused themselves from the Citizens United vote that opened the door for the Koch brothers and other special interests to heavily contribute to political campaigns. Common Cause has sent a letter to Attorney General Eric Holder requesting that DOJ investigate the matter (ref).

Point Summary

First, with our country involved in global investment, and with no control over where the wealthy and corporations deploy their capital, it can be strongly argued that targeted investment by the government into private sector jobs creation is a much more reliable way of stimulating our economy than tax cuts to the wealthiest during this current recovery.  I believe tax payers would support the use of taxpayer dollars to support jobs creation at home rather than borrowing to support job creation abroad.  Regarding free-market purists, our government has been supporting and creating private sector jobs for decades in the defense industries.  Why not in alternative energy, as but one example, if our dependence on foreign oil has been considered a national security issue (ref).

Second, the tenacious defense of tax cut policy by the Republican Party, a policy that has failed both in theory and hard outcomes, must be questioned from the perspective of political self-interest versus the health of our economy, job creation at home, and the well-being of our citizenry.

One comment

  1. Insanity: doing the same thing over and over again and expecting different results. – Albert Einstein
    As long as the United States continues to allow China to manipulate the U.S. Dollar and therefore manipulate our trade with ALL our trading partners, free trade agreements will work to our disadvantage and we should halt entering into new ones.

    Mark Twain is credited with an early use of the cliché “more than one way to skin a cat” in A Connecticut Yankee in King Arthur’s Court, as follows: “she was wise, subtle, and knew more than one way to skin a cat, that is, more than one way to get what she wanted”. defines beggar-thy-neighbor as: an international trade policy of competitive devaluations and increased protective barriers that one country institutes to gain at the expense of its trading partners. Under the guise of fostering ‘indigenous innovation’, the Chinese government has creatively used a non-conventional, subtle version of beggar-thy-neighbor. Its version doesn’t entail the competitive devaluation of its own currency, which would enhance China’s exports and inhibits its trading partners’ exports to China. China’s version perpetrates an over-valuation of the currencies of one or more of its trading partners. This negatively affects all the trade of the pegged trading partner(s), not just trade with China. During the recent period China pegged its currency to the U.S. Dollar, its version of beggar-thy-neighbor was 8 times as damaging to the U.S. economy as what the media refers to as “China keeping it currency undervalued”.

    In November 2003, Warren Buffett in his Fortune, Squanderville versus Thriftville article recommended that America adopt a balanced trade model. The fact that advice advocating balance and sustainability, from a sage the caliber of Warren Buffett, could be virtually ignored for over seven years is unfathomable. Until action is taken on Buffett’s or a similar balanced trade model, America will continue to squander time, treasure and talent in pursuit of an illusionary recovery.


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