Supply Side Policies

In Macroeconimics, there are two major schools of thought: demand side (also termed keynesian ), and supply side.   One supply side policy is control of the marginal tax rate.  The marginal tax rate is the rate on the last dollar of income earned.  The topic of marginal tax rates became the central theme of a revolution in economic policy that swept the globe between the 70s and 90s. (Reynolds, 2008) Supply side economists argue that high marginal tax rates discourage labor output and reduce production.  More than fifty nations significantly reduced their highest marginal tax rates on individual income during that period.  In 1979, the US marginal tax rate was 70%.  In 2002, the marginal tax rate fell to 39%.  By doing so, supply side economists argue that output would be increased.  However, graphing the year on year real GDP growth shows that there is no observable significance in GDP rate change.  Indeed, GDP growth has stayed below 5% after the year 1983, whereas in prior years, a rate of higher than 5% was observed every third year.

Granted, the marginal tax rate is not the only lever on the GDP.  However, the prediction of lower marginal tax rate leads to higher output is not realized, instead, the reverse trend is observable.  This leads me to believe that the marginal tax rate may not be a factor that changes production output.   Indeed, “critics of supply-side economics point out that most estimates of the elasticity of labor supply indicate that a 10 percent change in after-tax wages increases the quantity of labor supplied by only 1 or 2 percent.” (Reynolds, 2008)

References:

Reynolds, A. (2008) Marginal Tax Rates. Liberty Fund, Inc.: http://www.econlib.org/library/Enc/MarginalTaxRates.html

Bureau of Economic Analysis
Bureau of Economic Analysis (2010)  National Economic Accounts, GDP: http://bea.gov/national/index.htm#gdp