SUPPLY-SIDE ECONOMICS AND THE LAFFER CURVE
Laffer curve
Supply-Side economics is widely misinterpreted as the Laffer curve. Arthur Laffer, an economics Professor at University of Southern California claimed that an important feature of supply-side economics is that tax cuts will pay for themselves. Laffer became famous after he illustrated this idea on a napkin in a restaurant in Washington in 1974. But the question is not whether tax cuts pay for themselves, but whether they are more effective in creating economic growth and welfare, compared to a Keynesian policy of increasing government spending. The difference between Keynesianism and the supply side school centers on fiscal policy. Does a successful fiscal policy work by incentives (tax cuts) or by increasing demand (spending)? The important question is not whether such a fiscal policy will pay for itself. The Keynesians stress demand, supply-siders stress incentives. Changing fiscal policy by creating incentives will change the behaviour of people. If tax rates rise, people will reduce their participation in taxed economic activities, such as working, risk-taking, investment and saving. When tax rates go down, people are motivated to increase their economic activity. The economic expansion that will follow a tax cut is far more important than the fact that tax cuts should pay for themselves. Most politicians in Western Europe have not yet understood this very important distinction. Even worse: the media in Europe have killed Reaganomics because they do not understand this difference.
