Supply Side Economics & Laffer Curve

Supply Side Economics - The belief that the AS curve will determine levels of inflation, unemployment, and economic growth.

• To increase the economy, shift AS curve to the right

• Supply side economists focus on marginal tax rate (the amount paid on the last dollar earned or on each additional dollar earned)

Supply Side Economists:

• Believe that lower taxes are an incentive for a business to invest in the economy

• Believe that lower taxes are incentive for workers to work hard, thereby becoming more productive

• Also believe lower taxes are incentives for ppl to increase savings and therefore create lower interest rates which causes an increase in business investment

• They support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments such as unemployment compensation or welfare programs provide disincentives to work, invest, innovate, and undertake entrepreneurial ventures

• Coined as 'Reaganomics' - lower marginal tax rate to get out of recession, which worked, but it resulted in a deficit

Laffer Curve

• Trade-off between tax rates and government revenue

• Used to support supply side arguments

• As tax rates increase from zero, tax revenues increase from 0 to some max level, then decline

Three Criticisms of Laffer Curve

• Research suggests that the impact of tax rates on incentives to work, save and invest are small

• Tax cuts also increase demand which can fuel inflation, thus creating a situation where demand exceeds supply

• Where the economy is actually located on the curve is difficult to determine