In the past few years, the world has witnessed potent wave of protectionism rising in free market economies. The election win of Donald Trump displays the rage and dismay of white middle-class Americans whose wages had remained stagnant due to influx of immigrants. Trump’s administration is expected to come out with “America First” policies for foreign trade and “Mundell-Laffer” policies which are famously called as Reaganomics.
Supply side economics has been inspired by Say’s Law which states that supply creates its own demand. It is contradictory to Keynesian theory according to which demand is driving force. The theory reckons cut in personal tax, corporate tax and deregulation to boost economic growth. The cut in personal taxes provide incentive for workers to work hard and ultimately increases output per worker. A corporate tax cut gives businesses more money to hire workers, invest in capital equipment and produce more goods and services. Thus economic benefits will trickle down into overall economy. Ronald Reagan was the first president to put this theory into practice and the results were quite rosy. During the Reagan administration, the American economy went from a GDP growth of -0.3% in 1980 to 4.1% in 1988. This reduced the unemployment rate by 1.6%, from 7.1% in 1980 to 5.5% in 1988.
Trump’s campaign pledges already include tax cuts, increased government spending on infrastructure, and regulatory reform. Trump has proposed to simplify tax code to just three brackets from current seven-12, 25 and 33. He is also planning to invest 550 billion dollars in new infrastructure. He says he wants to deeply cut taxes by some $10-12 trillion over a decade, while also balancing the budget without cutting projected entitlement spending. To meet all those goals, Trumponomics would have to generate growth of more than 10 percent annually over a decade, according to the Committee for Responsible Federal Budget. It is difficult to assess whether contemporary tax cuts will generate same results as were generated in 1980-89 as economic scenario now is different. The tax rate in 1980 was considered to be on right hand side of the “Laffer Curve” so possibility of cut in tax rate leading to higher tax revenues was high. The present tax rate is high but is not as higher as that was in 1980 so chances of tax rate being on left side of curve are higher. If latter is true then tax cuts will reduce the revenue. According to an analysis by the Tax Policy Centre, a think-tank, the plan would reduce annual federal-tax revenue by about 4% of GDP. Rising public expenditure and low tax collections will exacerbate fiscal deficit which will compel the government to resort to borrowings. High inflation and public debt will raise the yields which will further attract foreign investment causing appreciation in dollar. Many domestic companies will get benefitted by cut in corporate tax at same time companies whose profits rely upon exports will get affected due to appreciation of dollar. The countries to whom dollar denominated loans are issued by U.S.A will find it difficult to repay the loans which can make American banks vulnerable to debt-defaults especially shadow banking system. Inequality in U.S.A is already high due to stagnant growth of wages amongst middle class. Adoption of regressive tax cuts can further widen the wealth gap to an unprecedented and toxic level.
Reagan policies only make sense when tax rates are unnecessarily elevated (on right side of Laffer curve), low inequality and currency is pegged to gold (Bretton Woods System). U.S.A needs more realistic tax structure to boost economic growth. The cons of moving back to trickle-down policies appear to overweigh the pros.
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