The Pseudo-Psychology of Psupply Pside Economics

by Bruce Webb

In my view you can boil Supply Side down to a simple aphorism: “If you tax something, people will use less of it”. And all things being equal and depending on how you define ‘something’ this seems economically and psychologically plausible, higher prices drive down demand. Unfortunately in the real world all things are not equal and many different incentives bear on demand, meaning we need to take a deeper look.

In Supply Side theory income tax is a tax on work and so serves to have workers do less of it with the easy corollary of less tax, more work, Tax Cut = Increased Productivity. Well I’ll let Spencer and Cactus do the heavy lifting and correlation, I suggest instead that Supply Side is simply caught up in a simple conceptual confusion.

In reality America doesn’t tax work either in its scientific or more normal sense, we don’t tax people at X pennies/Joule, instead we tax consumption or income or property, none of which have any necessary connection to actual amounts of work or for that matter skill, a Trust Fund Baby gains income and consumes things based on income and capital accumulation done by other people. So if the income tax doesn’t tax work, what does it tax? And what are the logical consequences of that? For an impressionistic answer follow me below the fold.

Now the ‘well duh’ answer it clear, an income tax taxes income, and so reduces people’s use of it in favor of the state. But this model while reasonable enough to explain early medieval taxation where tax, tithes and rent were all largely composed of slices taken off the top of income/productivity. later medieval and then modern taxation started building in controls that set taxation levels based on how total income was used and so taxation began to break down into two more distinct categories. One category was a tax on property, which could include real or personal property, together or separate. This is a tax on past consumption. The second category is a tax on current consumption.

And this is what puts the pseudo in supply side psychology. Its governing assumption, which is buried so deep as to be invisible to those trapped by it, that the goal of work is accumulation rather than consumption. In this world-view the governing rule is ROI. But I suggest that historically this hasn’t been the rule at all, humans didn’t come down from the trees with ledger books under our arms, instead humans target levels of consumption and just as importantly the leisure with which to do it.

As I note time and again, I am not an economist and as such not bound by any particular theory, nor by any supposed ‘truth’ of a given ‘Law’, instead my training was in history which for this purpose can be defined as the study of what actually happened. And if you examine world history you see that past civilizations mostly valued the concepts of display and largesse, both mythically and practically the role of the King was to bring peace and abundance, which is to say the possibility for consumption and the leisure to enjoy it. And nobody liked a stingy and miserly King, King Midas was not a sympathetic character. Nor for that matter was simple accumulation valued, the peddler/tinker/money lender being largely restricted to people on the margins or even outside of society (Gypsies/Roma, Jews, Irish Travellers, in ancient times Greeks and Phoenicians).

The ascent of the merchant from its former position outside and/or below the social structure to be ultimately assmililated within that structure and largely between the farmer/artisan and the warrior/aristocrat happened at different paces in different places, for example in Rome you had a distinction between the Senatorial class, the Knights (Equites-originally a military class turned economic one) , and the People from early on while in England it was long understood that gentlemen did not engage in ‘Trade’. But the ultimate result of having the merchant class being elevated to the pinnacle of society and its chosen norms being established as natural ‘Laws of Economics’ to some degree flies in the face of the history of society, the notion that everyone is born with an abacus or calculator in his head busily calculating ROI in the face of all variations is I think rather foreign to human nature as we see that expressed over the last few millennia and longer.

So if we take this cursory historical model and apply it to income taxes what do we see? Interestingly we see a model flipped on its head, rather than being a burden on capitalism, an income tax ends up incentivizing it.

If we regard total income as being a measure of potential consumption, then an income tax is first and foremost a tax on that potential consumption, per our simple aphorism people will do less of it. But this takes us two different directions. If the primary goal of humans is to target a consumption level and not accumulation as such, then the result of taxing consumption would be an intensification of work to get productivity up to the point that it compensated for the additional taking. If we start from consumption the result of more taxation is more work rather than less, or the opposite of what Supply Side psychology suggests. (And for those who are interested in such things there were some classic works by the Russian Chayanov in the early 20th century . In his Theory of Peasant Economy he showed with detailed statistical data how Russian peasants worked outside a capitalist accumulation model and instead on a consumption model where the intensity of the labor input varied over the family life-cycle and so could not be explained with either branch of Liberal Economics, neither the Manchester or the Marxist versions of economic development really fitting the realities of pre-modern rural history.)

But beyond the concept that taxes on income means taxes on consumption means an incentive to boost income to maintain consumption, there are some further wrinkles to explain why higher rates on income promote more economic input. Under our modern tax system, certain types of consumption are privileged over others. For example progressive tax rates and standard deductions are an explicit recognition that everyone has a right to some level of basic subsistence, which equally explains why we generally don’t tax groceries. On the other hand with sufficient progressivity in rates buying that classic Bugatti is going to cost you, in fact in 1958 it would have cost you 10X its sale price if measured in pre-tax income. On the other hand the tax rates were set up in such a way that you could shelter much of that income from taxes if you spent (invested) it in forms that could plausibly be shown to boost productivity overall. Now some of this simply ended up with tax avoidance of various types as consumption simply got shifted to the company ledger (the infamous ‘Unlimited Expense Account’ ) but it did provide incentives for companies to reinvest gains rather than distribute them in the form of salaries which would then be exposed to high effective taxes when converted to consumption. In this model decreases in top rates meant increased pressure for management to expand compensation to take advantage of the reduced tax bite. On the flip side it meant that for any given employee maintaining the same level of consumption meant less work rather than more, or perhaps simply more consumption for the same amount of work.

A model that starts from the standpoint of consumption rather than accumulation as such is a much better fit for the actual social and economic history of the last half-century. As consumption taxes in the form of high marginal rates came down, the tendency of consumption and particularly conspicuous consumption went up. With the result that certain wealthy people couldn’t tell you off the top of their heads how many houses they owned, and Ken Lay thought it reasonable to have multiple mansions in the same ski resort. Both in the 80s and in the 00’s there was a huge boost in the size and extravagence of upper income spending where Supply Side insisted that the reaction should have been in the direction of greater investment. and increasing productivity.

This shouldn’t be a surprise to anyone, look around the world and ask yourself what has historically been the response of ultra-wealthy people who among other things are not exposed to tax: Buckingham Palace, Versailles, the Forbidden City, the Taj Majal, Nero’s Domus Aurea. The ultimate fallacy of Supply Side is first to imagine that everyone has the temperment of a 19th century British Factory owner or Dutch Burgher intent beyond all on boosting the asset line in the ledger (though neither held back from consumption as such) and second to confuse a tax on income for a tax on work.

In Psupply-pside psychology the most rational man in the world, the epitome of Humanity is Ebeneezer Scrooge, Esq, a man so desperate to keep every stray farthing in his Okun Bucket that he would cut himself away from the world of consumption and leisure. If England had had an income tax in Scrooge’s time you might well see him cut back on his business rather than paying an extra pound to the Crown in tax. But then most of us are not sociopaths.

Taxes raise the marginal cost of exposed consumption and so decrease it leaving more income for reinvestment. Psychologically a lot more plausible than the idea that returning to Clinton or Reagan area rates means all the billionaires to go Galt on us. They seem to like their consumption where it is and can be expected to work to maintain it.