The writer is director of economic policy studies at the American Enterprise Institute
Despite losing her grip on power after chancellor Jeremy Hunt reversed the tax cuts announced in Kwasi Kwarteng’s “mini” Budget, former UK prime minister Liz Truss continued to argue for her vision of a high-growth economy during her final days in office. She was right to do so.
For conservatives on both sides of the Atlantic, the wrong conclusion to draw from this episode would be to abandon supply-side economics. The correct lesson is that the supply-side agenda needs to be updated from the days of Ronald Reagan and Margaret Thatcher.
Truss and Kwarteng were mistaken to give such a prominent place to individual income tax cuts. And ahead of the midterm elections in the US, the Republicans risk making the same error.
Tax cuts are not as important today as they were four decades ago, when rates of taxation were much higher and more damaging to the economy. In the US, an optimistic analysis finds that reducing the top income tax rate from 37 per cent to 35 per cent — which some free-market conservatives would enthusiastically support — would increase the level of economic output by 0.2 per cent over the long run, an amount that would surely leave many tax-cut advocates disappointed.
A 2005 analysis by the non-partisan Congressional Budget Office suggests that a 10 per cent reduction in all federal individual income tax rates would boost the level of economic output by less than 1 per cent over a 10-year period. The economy would grow because the cuts would increase incentives to work and save, but the analysis also assumes that the tax cuts would eventually be paid for. Since rising debt crowds out private investment, deficit-financed tax cuts deliver even less economic growth over the longer term.
Even an aggressive and laudable revenue-neutral tax reform — lowering marginal tax rates and broadening the tax base by repealing tax deductions, exclusions and credits — would be likely to increase the size of the economy by 1 or 2 per cent, according to an analysis by the Joint Committee on Taxation.
Rather than focus on individual income tax cuts, conservatives should look at other ways to boost the supply side of the economy. In the US, declining labour supply deserves much more attention than it gets. Boosting employment will grow the economy. Conservatives should champion an expansion of earnings subsidies to increase employment, along with supply-side reforms to the childcare sector, making care more available while reducing its price and helping more parents to hold down jobs.
Modern supply siders should also recapture immigration policy from culture warriors. Over the long run, more immigrants mean more workers, more entrepreneurs and a more dynamic, faster-growing economy. They would bring immediate benefits as well, by easing the current labour shortage.
Improving skills through well-designed training programmes would spur economic growth by increasing productivity, along with boosting workers’ wages. The American education system fails too many children. It should be clear that the US needs a longer school day and a longer school year. Better-educated students become more productive, higher-wage workers.
Conservatives should continue to push for reducing tax rates on corporate income and encouraging the full deductibility of new business investment, which would lead to faster productivity and wage growth. Policy should also increase incentives for research and development spending, and provide additional support for basic research. New inventions and innovations fuel longer-term, lasting prosperity.
Some of these policies were in the UK’s ill-fated “mini” Budget, and conservatives in the US and Britain should not overlearn the lessons from Truss’s failed premiership. Uncertainty driven by tactical errors and poor communication from the prime minister, the government’s decision to cut out the Office for Budget Responsibility, a failure to specify spending reductions to balance tax cuts and missteps by the Bank of England all led to a credibility crisis that saw the pound fall while gilt yields rose.
American conservatives, who have become increasingly enamoured with protectionism and industrial policy, should not be persuaded by Truss’s fall to move even further from their supply-side roots. Giving select industries special treatment is a lose-lose, reducing employment in those industries and lowering the overall growth rate. But the correct alternative isn’t additional deficit-financed individual income tax cuts either.
Instead, conservatives should pursue a growth-and-participation agenda that would increase the size of the workforce, boost investment, make workers more productive and increase innovation and dynamism. This agenda would lead to more output and higher incomes — and would give more Americans the dignity, purpose and identity that come from earned success.
