T-Bone on Supply Side Economics

Reader T-Bone sends along something he posted on a gaming-clan forum (go figure!) forum. (I took the liberty of editing it slightly.)

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I believe supply-side economic policies that we have now are not effective in increasing growth or potential growth. It doesn’t work as advertised. Bush’s tax cuts for the wealthiest people was maybe the worst policy we could have. Some have suggested they would like to see the cuts geared more towards the middle class. But I would go further. I think we’re probably could do better, long-term growth-wise with some level of higher taxes for the richest. BTW, I’ll use the words rich/poor for simplicity and lack of a better word…

1a. Basics
Look at how it works. If you cut taxes for the largest incomes, you give the richest more money. They invest (save) a much larger portion of the additional money than the lower classes would with the same total amount of money. Lower income people would spend a larger percentage, saving less than the rich do. Also, some of their savings (investment) would be like the same investment as the rich, while some would be to pay off debt, which is freeing up some investment for the rich (so would be essentially the same as the rich having more to invest).

1b. Basic summary
So with tax cuts to the rich, you get more investment, some demand.
With tax cuts to the poor, you get more spending (demand), some investment in their hands, and some investment put into the hands of the rich (when they pay off debt).

2.a Supply-side basic
Now the idea behind supply side economics is that more investment money will lead to more long-term investments (ability to create better products, or more efficient products, or to increase output).

2.b Futility of supply-side
However, there is not exactly a lack of investment. If there is something to be invested into, then whether it will get the investment depends on some things. First is the expected rate of return, considering risk and alternative investments (opportunity cost). High risk investments with only a promise of small rewards if successful won’t get much investment. The best investments get the first money.

2.c Effects of increasing investment (assuming no change in demand)
When you increase the amount of investment money, more of the investments with lower rates-of-return get investment money. Investors are more-or-less spreading investments around equally to the best investment. For example as one stock gets bought and pushes up the price, the return on that stock decreases compared to the price paid for that stock (that why your mutual funds can be value/equity focused, expecting a stock is undervalued and will rise in price with more investment, or your mutual fund can be growth focused, expecting a company will grow and increase profits, increasing the value that way). But also anything that will grow in value is an investment, including homes. With an increase in the investment money, as other investments become more saturated, homes as an asset become a better investment, increasing their value. Investments are not just in the USA either. More investment money in American hands also increases the investment in stocks abroad, as well as other investments abroad. Wherever the best return is, that’s where the money goes.

2.d Summed up idea behind supply-side.
So that’s where the supply side comes in. You give more money for investment, and so people are looking for more places to put it. Investment is cheaper/easier to come by.

3.a Demand is real driver
But in my opinion, the demand side is much more important. What makes an investment give a higher rate of return (and thus get investment money more readily) is demand. In fact, low demand can actually cause a loss on investment (nobody wants to invest in that and would rather hold the money).

3.b Economies of scale (efficency)
More demand also allows more economy-of-scale efficiency increases, which is that the cost per-person of providing a product or service decreases as you serve more and more people. This increases the profits, which can be reinvested or distributed as pay or to stockholders.

3.c Quality of spending (also regarding efficiency)
I would also argue there is a difference in the quality of GDP or quality of spending that comes from the rich versus the poor. Lower income people spend the money on “better quality” or “more efficiently produced” goods/services than the wealthy. I mean, the satellite radio companies (XM and Sirius now merging) will do better with money in the hands of lower incomes than on higher incomes because they need lots of customers, not a few rich customers. There is great economy of scale in that type of business, as well as many more technology related businesses. The only cost of adding a new customer is the cost of creating their satellite radio for them to use. They don’t need to add new programming to accomodate the new customer, etc.. But when a rich person exhausts their collection of efficient goods and services, they start using money for inefficient things, things that give little value for a lot of cost (or a high GDP contribution but little real value). One good example in mind is a guy who had a custom luxury car built for just himself for a couple million (or was is 10+ million?), and took like 15 people working for some decent amount of time to create it. There no efficiency gained by building that car. It’s not produced on an assembly line and there’s no incentive from it to improve the efficiency of the assembly line. Imagine what those 15 workers could have created in that time for average people. That was an extreme example, but the same applies for other jobs being done that quite unnecessary. Hiring a full time crew to take care of a your mansion, of which 3 rooms are ever used, etc.

3.d Increasing Capacity
When talking about production capacity, a company isn’t going to expand unless demand warrants it. If for some reason there is no investment to be had (is that possible?) or if the investment is too expensive to obtain compared to the added return on expanding, then the shortage of product could allow prices to be raised in order to accumulate the investment needed simply from profit. If there isn’t increased demand, then any additional investment is useless.

3.e Improving processes
When improving processes (improving production efficiency) the costs are weighed against the savings. Again, if there is no money on hand, the money needs to come from outside investment. The cost of the outside investment is weighed against savings gained from the improved processes. But adding a ton of money to the global pool of available investment only lowers the costs of investment marginally, compared to the gain a business gets from higher profits (internal investment money) and a bigger return on the improvement because of the larger demand.

3.f R&D
When investing in R&D the same is true, but instead of improved processes, you have improved product.

3.g New Business (demand vs investment)
When talking about investing in new business, again demand is the driving factor. More demand makes new business a better investment.

3.h New Business (motivation to use investment)
I would also argue that each dollar being saved by a lower income person is more likely to be used for new business than each dollar being saved by a rich person. A rich person who already has such large income will have less motivation to venture into something new in addition to whatever is currently earning them a large income. Spread that amount of investment into the hands of lower income individuals, and they have more motivation and dedication to improving their status by starting something.

4. Paying for tax breaks (or increased spending)
When you give a tax break, you also need a way to pay for it. You could cut spending, or raise taxes elsewhere. You could also pay for it with borrowing (debt). It does no good to borrow from US citizens, since you just take their investment money. So in the overall scheme of things, you need to get foreign loans to actually increase investment. Likewise, any debt incurred by a lower class citizen is actually investment money being used by someone else (the money loaned is no longer available for investment).

5. Bush 43
The current Bush has lowered taxes, increased debt, increased some spending while cutting other spending. I believe some of the spending cuts were funding to programs where the state and local (or the individual taxpayers) had to pick up the slack. This meant raising taxes or adjusting funding at the state and local levels, or causing people to have to pay more for something that was covered by the gov. So cutting taxes at the federal level to force tax increases at the local and state levels or causing higher expenses on the individual level aren’t exactly tax cuts, but tax shifting.

6. Quick conclusion.
Anyway, main point was that supply-side economics slows us down more than it helps. If you want to maximize growth, we are currently at a point where our best growth would come from more tax on the richest to pay for either debt-reduction, gov spending, or tax cut targeted at the lower incomes.