I argued, correctly as it turned out, that inflation would come in lower than Stockman's figures and that our opponents would place the blame for the budget deficits on the tax rate reductions instead of blaming the faulty inflation forecasts. However, the argument that the Republican Senate could not be trusted to vote for a budget that projected deficits carried the day and brought the consequences that I predicted.
What produced the un-equitable distribution of income in the 21st century was not the Reagan marginal tax rate reductions, but the offshoring of high-productivity, high value-added, high wage jobs by global US corporations. When a country moves its middle class manufacturing and professional skill jobs abroad, it decapitates itself by reducing both personal income and personal income tax revenues.
What is Supply-Side economics? Supply-Side economics is a correction to Keynesian demand-side economics. In Keynesian theory, the supply function is fixed and changes only very slowly with technology and discovery of new resources. Supply is passive and aggregate demand, the summation of consumer demand, investment demand, and government demand, determine employment and economic growth.
If consumer and investor demand are insufficient to maintain full employment, the Keynesians say that the government can add to demand by running a deficit in its budget. The government can create a deficit by holding spending constant and cutting taxes, or it can hold taxes constant and overspend the revenues. The Keynesian policymakers preferred the latter fiscal policy, because it let them expand the size and responsibilities of government. In other words, Keynesians could use their employment policy also for social engineering. Content in this role, they didn't think about the supply-side of the economy.
It was the neglect of the supply-side of the economy that had produced stagflation, which required a rising rate of inflation in order to maintain full employment. Supply-Side economics showed that the Keynesian picture was incomplete and corrected it. Keynesians emphasized that fiscal policy impacted aggregate demand. Supply-Side economists showed that fiscal policy directly impacts aggregate supply.
The Keynesian policy of pumping up consumer demand with easy monetary policy while suppressing the response of output with high marginal tax rates resulted in prices rising more than output. This is the explanation of stagflation. As Assistant Secretary of the US Treasury in charge of US domestic economic policy, this was my challenge.
Supply-side economics says that the aggregate supply schedule is not dependent merely on technology and discovery of new resources. The ability to produce is also determined by the incentive effects of tax rates. The supply of labor is dependent on choices on the margin between work and leisure, and the supply of savings is dependent on choices between current consumption and future income.
Supply-side economics introduced into macro-economic policy the valid point that the cost of leisure is the foregone income from not working and that the cost of current consumption or immediate enjoyment is foregone future income from not saving and investing.
In other words, taxation is a cost of production. A high marginal tax rate on labor makes leisure inexpensive in terms of after-tax foregone income from not working A high tax rate on saving makes current consumption cheap in terms of foregone future income.
In other words, Supply-Side economics introduced microeconomics into macroeconomics and should have won a Nobel prize.
Keynesian demand management relied on easy monetary policy to stimulate consumer demand and relied on high tax rates to reduce purchasing power and restrain inflation. The result was that the high tax rates curtailed output while the easy monetary policy pushed up consumer demand. The result was that prices rose.
The Supply-Side policy was a tremendous success. The US economy has not experienced worsening "Phillips curve" trade offs between inflation and employment since the Reagan economic program went into effect. Stagflation is a problem of the past until new policy errors revive it.
Yet, this entire story is totally missing in the Wikipedia account of Supply-Side economics.
In 1989 I wrote an assessment published by the Institute for Political Economy of the results of Reagan's supply-side policy. It was republished in The Public Interest, by a think tank in England, and in peer-reviewed premier economic publications in Germany and Italy, such as Zeitschrift fur Wirtschaftspolitik and Rivista Di Politica Economica.
Despite the abandance of factual information, propaganda has prevailed.
Here is my assessment of the Reagan Administration's Supply-Side policy as I wrote it in 1989:
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