Supply Side Economic in United States Economic Policy
Namal Balasoooriya, Assistant Lecturer, Department of Economics, University of Kelaniya, Sri Lanka
namalbalasooriya@yahoo.com
Introduction
The United States of America is a federal
constitutional republic with fifty states at 3.7
million square miles and with 300 million
people. USA (United States of America) is
the third or fourth largest Country by total
area third largest by land area and
population. Its national economy is the
world's largest with a nominal 2006 gross
domestic product (GDP) of more than $ 13
trillion.
USA is fueled by abundant natural
resources, a well developed infrastructure
and high productivity. According to
International Monetary Fund, the USA GDP
of more than $ 13 trillion constitutes 20 per
cent of the gross world product. Only the
collective GDP of the European Union is
greater. The USA is the largest importer of
goods and second largest exporter. The
private sector constitutes the bulk of the
economy, with government activity
accounting for 12.4 per cent of GDP,
Agriculture accounts for only 1 percent of
GDP but 60 per cent of the world's
agricultural production.
Supply side economics provided the
political and theoretical foundation for a
Remarkable number of tax cut in the United
States. President George W Bush's proposal
to reduce taxes has reignited the economics
debate in USA, Specifically, in his budget
address before congress in February 2001;
President Bush cited the tax cuts of
president john F Kennedy and President
Ronald Reagan to support his argument for
tax relief. Forty years ago President
Kennedy and then twenty years ago
President Ronald Reagan advocated and
introduced tax cut for there economic
policy. Interestingly, the Kennedy and
Reagan tax cuts were firmly rooted in
supply side economics. As for the Bush tax
plan offers two fundamental supply side
ingredients are replacing the current five -
rate personal income tax structure of 15 per
cent, 28 per cent, 31 per cent, 36 per cent,
and 39.6 per cent, with four lower rates of
10 per cent, 15 per cent, 25 per cent, and 33
per cent and killing death taxes. (Raymond,
2001)
1
Supply side Economics
Supply side economics focuses basically on
the marginal tax rate. The supply siders say
that high marginal tax rates decrease
aggregate supply and lower marginal tax
rates increase aggregate Supply that is the
summaries idea of supply side economics.
This means that the goal of lowering the
marginal tax rate is to increase production
(Real GDP) According to say's law, if more
goods and services are produced, more
goods and services will be bought, and it
means "supply creates its own demand"
Supply side economics is a school of
macroeconomic thought which emphasizes
the importance of tax cuts and business
incentives in encouraging economic growth,
in the belief that businesses and individuals
will use their tax savings to create new
business and expand old businesses, which
in turn will increase productivity,
employment and general wellbeing. While
all macroeconomics involves both supply
and demand, supply side economics
emphasizes the importance of encouraging
increases in supply. It was popularized in the
1970s by the ideas of Robert Mundell,
Arthur Laffer and Jude Wanniski. The term
was coined by Wanniski in 1975. In 1978
Wanniski published "the way the world
works" in which he laid the central thesis of
Supply - Side economic and detailed the
supposed merits of low taxation and a gold
standard.
In 1983 economist Victor Conto, a disciple
of Aruthur Laffer, published the foundation
of Supply - Side Economics. This theory
focuses on the effects of marginal tax rates
on the incentive to work and save, which
effect the growth of the Supply Side.
In the middle of the 1970s, Laffer developed
his famous Laffer curve is clearly accurate
at both extremes of taxation zero per cent
and one hundred percent where the
government collects, no revenue. At one
extreme, a 0 percent tax rate means the
government's revenue is of course zero. At
the other where there is a 100 percent tax
rate, the government collects zero revenue
because taxpayers have no incentive to work
or earn. Some where between 0 per cent and
100 per cent, therefore lays a tax percentage
rate that will maximize revenue, an idea
central to the Supply Side Economics.
Total tax revenue
0 t* tax rate
2
t* represents the rate of taxation at which
revenue is generated.
Let us examine the conclusions of supply
side economic theory using Aggregate
Demand - Aggregate Supply graph. The
argument is that lowering marginal tax rates
will cause a significant increase in supply.
On the graph an increase in aggregate
supply is shown as a shift to the right
GDP Deflator
S1
The Supply side Economic theory guided
the policies of the administration of
President Reagan. The Most significant
economic policies of his first term come
with the Economic Responsibility and Tax
Act of 1981. There were two main
provisions of this Low. First, and most
important, was the lowering of the marginal
tax rates. President Regan’s reasoning for
this provision should be clear after the
discussion of the ideas of Supply- Side
economics. The Economic Recovery and tax

E1 S2
Act was fully implemented by 1985
P2 (Raymond, 2001)
P1 E2
The tax rate schedules for a single person in
1980 and in 1985 are repeated below. Notice
that the marginal tax rates are lower in 1985
than they were in 1980. Notice that the
0 Q1 Q2 Real GDP
highest marginal tax rate fell from 70 per
Accounting to above graph, first the Real cent to 50 per cent.
GDP rises from Q1 to Q2 this is a Table 1: the tax rates schedules (1980, 1985)
1980 1985
expansion. During an expansion, the Income $ Tax rate % Income $ Tax rate
0-2300 0 0-2390 0%
unemployment rate falls. All of this is good 2301 - 3400 14% 2391 - 3540 11%
3401 - 4400 16% 3541 - 4580 12%
second the GDP deflator falls from P2 to P1. 4401 - 6500 18% 4581 - 6760 13%
6501 - 8500 19% 6761 - 8850 14%
This is a deflation. Again this is good. 8501 - 10800 21% 8851 - 11240 15%
10801 - 12900 24% 11241 - 13430 16%
Finally, if the Laffer curve assertion is 12901 - 15000 26% 13431 - 15610 18%
15001 - 18200 30% 15611 - 18940 20%
correct, tax revenues will also rise and the 18201 - 23500 34% 18941 - 24460 23%
23501 - 28800 39% 24461 - 29970 26%
budget deficit will be reduce or eliminated.
28801 - 34100 44% 29971 - 35490 30%
34101 - 41500 49% 35491 - 43190 34%
41501 - 55300 55% 43191 - 57550 38%

Supply Side Economics in USA 55301 - 81800 63% 57551 - 85130 42%
81801 - 108300 68% 85131 + 48%

Economic Policy up to 108301 70% 50%

Sources: http://daphne.palomar.edu/llee

3

President Reagan proposed a more sweeping
reform of the federal income tax low in
1986. Again, his proposal was enacted into
low. The main provision this low, as with
the 1981 low, was to lower the marginal tax
rates. The number of tax brackets was
reduced the new tax rate schedule for a
single person in 1986 is repeated below.
Table 2: Reduced tax rate schedule - 1986
Adjusted cross Income $ Marginal Tax rate
George W Bush became president in 2001.
A major part of his campaign had involved a
proposed reduction in marginal tax rates. In
May 2001, President Bush's Tax reduction
Proposal was enacted into low called the
"Economic Growth and Tax Relief
Reconciliation Act of 2001", it created a
new tax bracket of 10 per cent, effctive
January 1st of 2004. This was estimated to
lower tax payments by $300 for a single
person and $ 600 for a married couple. This

0 - 19450 15%
tax reduction was sent to people as checks in
19451 - 47050 28%
2001.
47051 - 97620 33%
Table 4:The marginal tax rates for a single person for-
up to97621 28%
2002.
Sources: http://daphne.palomar.edu/llee
Adjusted Gross income $ Marginal Tax rate

0 - 6000 10%

6001 - 27950 15%

Notice how much lower the highest
27951 - 67700 27%

marginal tax rates were compared to the 67701 - 141250 30%

141251 - 307050 35%

highest marginal tax rates of 1980. The up to 307050 38.6%

reason for this change should be clear in Source: http://daphne.palomar.edu/llee

1991, the 33 per cent marginal tax rate and

the top 28 per cent marginal tax rate were George W Bush Sought and Obtained

combined into are 31 per cent marginal tax another congressional approval for tax cuts

rate. So for 1992 the tax rate schedule for are the job creation and worker Assistance

single person looked as shown below. Act of 2002 and the jobs and Growth tax
Table 3: Tax schedule for a single person - 1992 Relief Reconciliation Act of 2003. In 2003
Adjusted Gross Income $ Marginal tax rate further changes to the tax low were posed
0 - 21,450 15%
under the influence of President Bush. So
21451 - 51900 28%

up to 51901 31% the marginal tax rates were reduced once

Sources: http://daphne.palomar.edu/llee again, as shown below. There were several
other tax changes passed in the 2003 low.

4
Table 5 Tax schedule for 2003 for a single person higher than they have been for this effect to
Income $ Marginal tax rate
operate. In fact, the lowering of marginal tax
0 - 7000 0%
rates in 1981 and 1986 coincided with a
7001 - 28400 15%
large increase in federal government budget
28401 - 68800 25%

deficits. From having federal government

68801 - 143500 28%

143501 - 131950 33%

budget deficits of about $ 60 billion in 1981,

war 311950 35%

the USA experienced federal government
budget deficits of more than $ 100 billion in
Source: http://daphne.palomar.edu/llee
1982 and then more than $ 200 billion in
Criticism of Supply Side Economics 1983. These federal government budget
via the USA Economic Policy deficits stayed at very high levels, reaching a
Among economists, there is several criticism peak of $ 290 billion in 1992.
of supply side Economics. The first one is a A third important criticism involves the fact
view like that of supply side economics is that the view of the supply. By doing so, it
very controversial. This criticism is that, ignored the effects of decreases in marginal
even though the conclusions of supply side tax rates on aggregate demand. Lowering
view validity the effect is exaggerated. marginal tax rates may indeed increase the
Lowering marginal tax rates will likely incentives for people to work and to save.
provide people with greater incentives to But doing so also provides greater
work and to save. But these effects are likely disposable income. This increase in
to be very small and too small to create any disposable income increases costumer
significant improvement in economic spending. Many economists argue that the
behavior. benefits of the decrease in the marginal tax
A second important criticism involves the rates come more as a result of the effect on
Laffer curve. This curve argued that consumer spending than on incentives to
lowering marginal tax rates would increase produce.
production so much that tax revenues would A last important criticism involves the
actually increase. The 1981 and 1986 tax distributional effect of the policy of
changes were justified by this argument. But lowering the marginal tax rates. An across
subsequent research has shown that the board decrease in marginal tax rates
marginal tax rates would have to be much provides great benefit to richer people are

5
that to poor people. Richer people are those
in the highest tax brackets and are the people
who pay most of taxes. Poor people may pay
no federal income tax at all and therefore
would receive no benefit from the policy of
lowering marginal tax rates.
Actually the 1980s tax cuts did not increase
the rate of growth of GDP and productivity,
nor the investment and savings rates. The
unemployment rate went above 10 per cent
in 1982. The private saving rate continued to
decline slowly in the 1980s. In the 1973 -
1980, private saving averaged 7.8 per cent
of the economy, and dropped to 6.9 per cent
in 1986 and 4.8 per cent in 1989. In other
words, the saving rate was significantly
lower after the 1981 tax cut than before it,
The labor force are at an average rate of 1.6
per cent over the 1982 - 89 period, about
the same as during the previous four years,
Overall labor productivity grew rapidly
before 1973 and less rapidly since then. In
the entire period after 1973, the annual
growth rate of productivity has been very
close to 1.1 percent. It average around 1.1
percent also in the 1980s, Budget deficits
that were equal to 40b $ in 1979 (-1.7 per
cent of GDP) and 74b $ in 1980 (-2.7 per
cent of GDP) increased to 221b $ by 1986
(5.2 per cent of GDP), The public debt to
GDP ratio increased from 26.1 pre cent in
1979 to 41.2 per cent in 1986.
Considering the George W Bush
administration Economic growth of USA is
going up slowing that can be seen
comparing the data between averages of
economic indicates of 1949 - 2000 and 2001
- 2005
Graph 1: Economic growth for the 2001 to 2005
business cycle compared to the average for business
cycles 1949 to 2000.
Source: Bureau of Economic Analysis USA, 2008
While the Economy has grown under the
Bush administration, growth was below
average in comparison to the average for
business cycles between 1949 and 2000
Overall real GDP has grown at an average
annual rate of 2.5 per cent (Bureau of
Economic Analysis, 2008) Between 2001
and 2005, GDP growth was clocked at 2.8
per cent, 17.6 per cent below the average of
3.4 per cent while GDI (Gross Domestic
Income) growth was 36 per cent below
average. The number of jobs created grew
by only 6.5 per cent, 28.5 per cent below the
6
growth rate of 9.1 per cent. The growth in developed his famous Laffer curve. Under
average salaries was less than half as usual; presidents Ragan and Bush, fiscal policy
1.2 per cent versus 2.7 per cent, was based largely on the views of supply
respectively. While growth in consumer side economists.
spending was 72 per cent faster than growth
in income, it too has "failed to keep pace References
with the... average of previous cycles." Only Alan Greenspan(2007),The Age of
investment residential real - estate soared, Turbulence, Penguin Press.
growing 26 per cent faster than average.
(Price L, 2005) Boskin Michael J. (1987) Reagan and the
US Economy. The Successes, Failures, and
Unfinished Agenda, ICEG
Conclusion
Supply side economics focuses basically on
Bureau of economic Analysis (2008),Gross
the marginal tax rate. High marginal tax
Domestic Product: Percent change from
rates decrease aggregate supply and lower
pervious period.
marginal tax rates in order to increase
aggregate supply. This means that the goal
Chait, J.(2007), Feast of the Wingnuts:
of lowering the marginal tax rate is to
How economic crackpots devoured
increase production (Real GDP) by
American politics, The New Republic,
providing incentives to produce more.
The 1980 was a decade of conclusion
Daniel J. Mitchell(1996),The Historical
Political conservatism in United States and
Lessons of Lower Tax Rates, The Heritage
else where. In reaction to the high rates of
Foundation.
inflation is prevailing in the late 1970s and
early 1980s. the views of the monetarist
Department of Labor US (2008), Labor
economist gained prominence much
Force Statistics from the current
monitory policy was made with their views
Population Survey,
in mind meanwhile the most formal part of
the Supply Side Economist's argument is
John Maynard Keynes(1972),The Collected
associated with an economist named Arther
Writings of john Maynard Keynes
Laffer in the middle of the 1970s, Laffer

7
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Press. pays price for Bush's tax cuts.
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Supply-SideEconomics:The Principles,
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Niskanen W.A. (1988) Reaganomics: An Tobin J. (1992) Voodoo Curse, Harvard

Insider's Account of the Policies and the International Review.
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http://www.nytimes.com/2005/08/31/busine
The economy has little to show for $860
ss/31wannisk.html Jude Wanniski, 69,
billion in tax cuts.
Journalist Who Coined the Term 'Supply -
Side Economics,' Dies
http://www.wikipiedia. com.