Criticisms of the Supply Side Disinflation Proposal

There are several immediate criticisms of the Supply Side idea, some of which the Supply Siders have recognized and responded to, and some not.

A tax cut would cause a large government deficit and increasing federal debt.

This is the most widely discussed issue and will be taken up on the next page.

A cut in taxes would itself stimulate aggregate demand, frustrating the purpose of the policy.

Ideally, this might be offset by reductions in overall government spending. That is, the right mix of cuts in government spending and in taxes could hold aggregate demand steady, or even reduce it a little bit, without the pain of high interest rates and tax increases. As we recall, a balanced budget cut would reduce aggregate demand, with a Balanced Budget Multiplier of one. In practice, though, the stimulating effect of the tax cut is a complication. It particularly makes it difficult to judge whether Supply Side policies have been successful, as we will see in a few pages.

Because it neglects the short run, the proposal is not really practical.

In the past, practical politicians often accused economic theorists of concentrating too much on the long run, and ignoring the questions of whether we can get from here to the long run equilibrium and, if so, how. Now we theorists can turn the criticism around. The problem is the that inflationary spiral, fueled by inflationary expectations and by input-market contracts with inflation built in, could go on despite the increase in Long Run Aggregate Supply. Proponents of supply side policies have never really discussed the long-run -- short run problem, so we can only guess how they might answer it. They would probably reject the underlying assumption that increasing labor productivity only affects Long Run Supply. They could say that increasing productivity is also a powerful stimulus to increasing production in the short run, and that the productivity increases would overwhelm the inflationary spiral so that the economy moves smoothly and rapidly to the long run equilibrium. We have some experience that backs them up -- the evidence suggests that productivity growth can be a strong stimulus to production even in the short run. But there is also evidence and experience on the other side of the issue. No-one has ever yet succeeded in doing what the Supply Siders would have to do: eliminate inflationary expectations without a period of increased unemployment.

There is plenty of room for controversy, here -- but let's focus on the key issue, the effect on the Federal Deficit.

Here's Your Tax Cut!