Supply-Side Economics By J.A. SACCO

Supply-Side Economics – Up to this point we have looked at fiscal policy to shift the AD curve (Keynesian economics) – What about changing AS to fix the economy!

3 Supply-Side Economics – Creating incentives for individuals and firms to increase productivity will shift the aggregate supply curve to the right – Reduce regulation of business to allow them to expand production

4 Supply-Side Economics The Supply-Side Effects of Changes in Taxes – Expansionary fiscal policy involving reducing marginal tax rates to: increase productivity since individuals will work harder and longer, save more, and invest more increase productivity which will lead to more economic growth

5 Supply-Side Economics Real GDP per Year Price Level AD SRAS 1 SRAS 2 With lower marginal taxes and more business incentives, the AS will shift right resulting in greater GDP, lower inflation and increased employment. E1E1 P1P1 GDP 1 E2E2 P2P2 GDP 2

6 Offsets to Supply Side Economics Tax Rates and Tax Revenues – Will an increase in tax rates always raise tax revenue? – What is the effect of this increase in taxes on the economy? – Would a tax increase cause you to work more or less? – Answer- The Laffer Curve

7 The Laffer Curve Named after Supply-side economist Arthur Laffer Shows a hypothetical relationship between the marginal tax rate (dollars paid on the last dollar of taxable income) and tax revenues

8 The Laffer Curve Tax Rate Tax Revenues Normal Range Tax Revenue up As Tax Rate up Optimum Tax Rate Prohibitive Range Tax Rate up, Tax Revenue down as they prohibit more work and productivity by firms and workers. As the tax rate increases from 0 to 100%, tax revenues rise from 0 to some maximum level and then decline again to 0. Maximum tax and revenue reached What does the Laffer Curve suggest?

9 The Laffer Curve Therefore, when the tax rate is in the prohibitive range, a reduction in taxes are needed to provide incentives, stimulate production, and bring higher, not lower tax revenues. Remember with greater production comes greater employment, a larger tax base and higher taxes.