Obama’s Flirtation With Supply-Side Economics

Here he extends the Bush tax cuts. (Photo by Alex Wong/Getty Images)

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In his first term as president, Barack Obama extended the reduction in the top rate of the income tax to 35 percent through 2012, two years past the 2010 expiration date that his predecessor, President George W. Bush, had set. Obama presided over the lowest estate tax rate since Herbert Hoover’s time, 35 percent in 2010 and 2011. (In one year, 2010, the estate tax rate was zero for those who elected to take it.) And Obama temporarily cut the payroll tax rate by about fifteen percent.

In our new book Free Money: Bitcoin and the American Monetary Tradition, we ask why gold peaked after a phenomenal rise, as Obama got going, and why Bitcoin, though founded in 2009, took into Obama’s second term to sport extreme price appreciation. We ask why the Great Recession bottomed early in 2009 and never came back (though the recovery was slow). A big reason for these things is that Obama was coquettish, 2009-12, toward supply-side economics.

The marginal rate of the income tax, the top estate tax rate, and the payroll tax are three classic targets of supply-side economic policy. These tax rates are to be cut as the top priorities of supply-side economics. The theory is that each of these tax rates distinctly discourages the production and the seizing of initiative in the economy; therefore, cutting them enhances economic activity to an uncommon degree.

The primus inter pares of supply-side economics is the marginal rate of the income tax. In a graduated tax system, the marginal rate is that which hits only earners of highest income. Cutting this rate encourages economic activity in two distinct ways.

First, a cut in the top rate is the most powerful among all possible rate cuts in a graduated scale, on a simple percentage basis. A cut of 4.6 points from 39.6 to 35 percent (that of the W. years), for example, increases marginal after-tax “take-home” income from 60.1 cents to 65 cents on the dollar—an increase of 8.2 percent. In comparison, a cut in the bottom rate of 10 percent (that of the W. years) by 4.6 percentage points to 5.4 percent increases marginal take-home income from 90 to 94.6 cents on the dollar—an increase of 5.1 percent. Given progressive income taxes, equal rate cuts mean more at the top than at the bottom.

Second, those who are subject to the highest graduated rates—the highest earners—by definition have the most ability and desire to avoid, legally, those rates. High earners do not even need the money. They can decline to earn, change the way they earn (taking advantage of lower rates elsewhere in the tax code), the timing, shelter the stuff, whatever. The highest earners are most adept when it comes to making money. They can slip the top rate because they have the savvy and inclination to do so, and because the tax code gives them ample opportunity to represent income beyond declaring it ordinary. (Forget about closing these loopholes without lowering rates—an inevitable lesson of tax history.)

Obama maintained a cut in the marginal rate of the income tax through the entirety of his first term in office. Undoubtedly, this was a central component of this president’s strategy to get re-elected. When the Republican opponent in the 2012 election, Mitt Romney, made his gaffe about 47 percent of the electorate’s not having to pay any income tax, Obama must have smiled. Obama had ensured that by keeping the top earners’ tax rate reduced, top earners paid an outsized share of income taxes. Low top tax rates, high top-earner tax revenue—he knew the verity would hold. Let us be clear: keeping top tax rates down got Obama to a second term.

The estate tax is another classic supply-side target. Work and earn your whole life, have the government take it away: a major disincentive to acquire. A reduction in the estate tax prompts, once again, precisely those who are capable of succeeding greatly at enterprise to do just that. Lots of people succeeding at enterprise spells a good economy. Obama took the estate tax to zero. If one took the zero rate, heirs did not get the step-up basis in capital gains. If one did not take the zero, again Obama’s rate (of 35 percent) was the lowest since 1932. Supply-side essence, from President Obama.

Obama cut the employee portion of the social security tax. For decades, supply-siders have identified the social security tax as one of the best illustrations of the problem facing modern tax-heavy economies. Social security taxes, paid by employer and employee, are a “wedge” that interposes itself at the place where employee and employer would normally meet to contract labor. Cutting the rate leads to greater employment, and greater returns to both parties, employer and employee.

The Obama cut would have been more purely supply-side if it had included the employer side as well (and been permanent), but a rate cut is a rate cut. More people contracted to work because their take-home pay was greater because of the policy. And employers could settle at slightly lower wage rates because their employees were taking more home after-tax. Barack Obama giving a clinic on supply-side economics!

One can say that tax cuts are Keynesian. It is true that every tax cut makes the beneficiary spend more than before. But the effect is the absolute least at the marginal rate, and the least in general when the cuts are in rates of a progressive tax system. The JFK tax cut of 1964 that reduced progressive tax rates remains an exemplar of Keynesianism—actually it doesn’t, thanks to Kudlow and Domitrovic, JFK and the Reagan Revolution—because of misinterpretation. A cut in progressive rates disproportionately has supply-side, not demand-side effects. Obama maintained cuts in progressive tax rates.

Obama did much of this without Republicans forcing his hand. The Tea Party sweep of 2010 brought in a new Congress in 2011, after Obama had settled on most of his accommodations of supply-side economics. Politicians in foxholes—which is to say facing re-election—may talk a Keynesian game (it soothes the chattering classes). But when they act, they take supply-side economics into their confidence.