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Is Obama Ready to Make the Shift to Supply Side Economics?

The abject failure of Obama demand-side approach to stimulus is evident. Shoveling hundreds of billions of dollars out the door as quickly as possible has both theoretical (see Robert Barro’s analysis of the stimulus effect of government spending) and practical problems (see Sen. Tom Coburn’s list of outrageous projects that have been funded in the mad dash to push out cash.)

But more than that it’s been tried and failed. If government spending could make us rich, the 1930s would have been the Roaring 30s instead of the Great Depression. Japan’s “lost decade” of the 1990s would have been a golden age. And our own economy wouldn’t be mired in an extremely weak recovery with elevated unemployment.

So the demand-side approach has failed. Even Obama kind of gets it. 

This week, for the first time, he rolled out meaningful supply-side proposals that would boost the incentive to save and invest and put capital to work again. The key proposals are a permanent extension of the tax credit for research and experimentation, and the full and immediate expensing of capital investment for businesses. Expensing would alleviate one of the worst features of our income tax system—the multiple-taxation of savings and investment. Obama has proposed it for only two years. It should be permanent, but that’s still a big nod in a supply side direction from a Democratic president.

Supply side tax cuts are the stuff economic booms are made of, as we should have learned from the Kennedy rate cuts of the 1960s, the Reagan rate cuts of the 1980s, and the Clinton capital gains tax cut of 1997. All triggered robust economic expansions.

Obama’s baby steps toward the supply-side would be a real breakthrough if they weren’t shackled to the failed demand-side policies of his previous stimulus bills. In particular, the additional $50 billion in spending on infrastructure projects that we were told would be funded by the last bill. The lag time on these projects, other than repaving projects which are already going on all over the country, can take years. And because, as Barro showed, the multiplier on government spending is less than 1, the short-term stimulus effect is outweighed by the debt burden of paying for the spending. That Obama would even propose even more federal spending in the midst of a national spending revolt is not just economically but politically foolish.

But perhaps the biggest problem with Obama’s supply side proposals is that he continues to stubbornly insist on massive tax hikes on capital gains, dividends, and small business income with the expiration of the current rates at the end of the year. In fact, he would exacerbate these tax hikes with even more tax hikes on foreign-source income of multinationals, making it harder for companies to compete and, perversely, encouraging divestiture of the foreign subsidiaries of American companies.

Obama’s overarching rhetoric is anything but supply side. In fact, he took more potshots at the idea that boosting the after-tax return on work, saving, and investment will get us more of those desirable things, saying of tax cuts, free trade, and cutting back red tape: “For a time, this idea gave us the illusion of prosperity.” Illusion? The Kennedy, Reagan, and Clinton supply-side tax cuts created millions of very real, very productive jobs.

Still, it seems that Obama is finally ready, just a little, just maybe, to put his class warfare politics aside and consider genuine supply-side measures that can unleash capital investment and productivity. Maybe it’s because everything else has failed. 

Whatever the reason, there’s a simple way to put him to the test—if he really wants to make the R&D credit permanent and allow full expensing of capital investment, he should ask his friends Harry Reid and Nancy Pelosi to introduce those proposals as standalone legislation, not shackled to tax hikes or even more spending. Then he could go further, stand down from his insistence on massive tax hikes next year, and embrace a true Kennedy-Reagan style supply-side big-boom of major tax cuts and spending discipline.

Phil Kerpen is vice president for policy at Americans for Prosperity. He can be reached on Twitter, Facebook, and through www.PhilKerpen.com.

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Phil Kerpen is the founder of American Commitment Action Fund, on the web at www.BookerFAIL.com.