Henry Paulson to Supply-Side Economics: Drop Dead

In his 1984 book, The Supply-Side Revolution, Paul Craig Roberts wrote of England’s gasping late ‘70s economy. Despite the country’s dire economic outlook, London’s streets were full of Rolls-Royces.

Many would consider the above to have been a sign of economic prosperity, but thanks to the country’s at-the-time 98 percent tax on investment income, the plentiful existence of those luxury autos was a sign of economic decline. With taxes high on investment success, those with capital had no reason to offer it up to the next generation of entrepreneurs.

Across the Atlantic in the United States, something similar was at work. Decrying the consumer culture which prevailed during his presidency, President Jimmy Carter noted that “too many of us now tend to worship self-indulgence and consumption.” But with the dollar in freefall alongside high capital-gains rates, Americans were understandably consuming at a manic pace. Fully aware that inflation and taxes would erode any investment profits, Americans had little incentive to save, and the Carter economy’s actual health was much worse than what unreliable GDP numbers suggested at the time.

To the supply-side revolutionaries of the late ‘70s who so expertly changed the economic debate, the economic situations in England and the U.S. were no surprise at all. Indeed, supply-side economics was never about “putting money in people’s pockets” as George W. Bush once stated, nor was it ever about consumption.

Instead, supply-siders resumed the arguments made by classical liberals such as Adam Smith and Jean-Baptiste Say in the 18th and 19th centuries. Both recognized that an economy never lacks consumption so long as individuals possess incentives to produce.

Productive work effort in the classical liberal model was what constituted economic growth, and as such, it was essential to reduce the tax penalties on work and investment so that the efforts of enterprising individuals would be met with intrepid capital eager to fund economy-enhancing innovations.

So while conventional economic thinkers see rampant consumption and “stimulus” as something that accrues to our economic health, supply-siders then and now understood that heavy consumption at the expense of saving could only last so long. Eventually the prodigal consumer runs out of capital.

Conversely, the prodigious saver, far from harming the economy, actually facilitates economic growth for those savings serving as capital for existing and new business concepts. As Adam Smith noted, savers are society’s ultimate benefactors. They are because in any economy products are traded for products. Savings fund economic creativity that leads to economic productivity by individuals eager to exchange their surplus for that of others. In short, we’ll always have consumption so long as the economy is growing.

All of which brings us to Treasury Secretary Henry Paulson’s announcement last week that the latest version of Treasury’s $700 billion Troubled Asset Relief Program will focus on the consumer. In an administration that has sought to deify the presidency of Ronald Reagan and the supply-side revolution that he was often associated with, Paulson’s latest move speaks to an administration that either never understood supply-side theory, or understood it but views it as unworthy of emulation. With regard to Paulson, we’re all Keynesians now, and supply-side economics can drop dead.

Paulson’s reasons for “aiding” the consumer have to do with his view that consumer finance “is currently in distress, costs of funding have skyrocketed and new issue activity has come to a halt.” As such, his plan according to a Wall Street Journal account is to use TARP money to “increase the availability of student loans, auto loans and credit cards.” Adam Smith is doubtless spinning in his grave.

Indeed, if we try to forget for a moment that the proliferation of federally-backed student loans has necessitated more student loan money for driving up education costs, Paulson’s newest attempt to “fix” the economy is surely inimical to our economic health. In times of economic distress, when capital is in short supply, the last thing an economy needs is for more capital to be consumed as opposed to being supplied to future entrepreneurs.

Indeed, in times of economic weakness the best economic “stimulant” absent a stabilized dollar or tax cuts is paradoxically the very consumer pullback that Paulson and his minions are trying to avoid. That is so because when individuals choose to save rather than consume, their capital, far from vanishing, funds the growth of job-creating business concepts. To the extent that Paulson’s activities foist more credit on an already tapped consumer, there will be even less capital available for tomorrow’s ideas. Recovery will be pushed back even further.

So while many fear the looming presidential transition that perhaps foretells an even greater lurch toward statism, it would be hard to find in history a presidential administration more interventionist than this one. At this point, GOP partisans should be giddily counting the days until Paulson et al move on. The latter have overseen an impressive destruction of the GOP brand, and as evidenced by Paulson’s latest policy maneuvers, their departure will be a positive for limiting any further damage.

As for supply-side economics, conventional historians will sadly use George W. Bush’s presidency as evidence that classical thinking is a hoax. But in truth, other than the 2003 tax cuts that were blunted by dollar debasement and heavy spending that are merely other forms of taxation, the Bush presidency had very little to do with supply-side thought. In short, historians will critique a classical liberal administration that never was.