Here Comes Supply-Side Economics and the Laffer Curve
Increases in government regulation, taxes, environmental regulations, and ObamaCare on businesses, shifted the aggregate supply (AS) curve inward and thus reduced aggregate demand (AD).
With the explosion higher in the cost of doing business, businesses hired fewer workers. In fact, many small businesses reduced the size of their workforce in response to ObamaCare. Less hiring means a weaker consumer with less discretionary income.
Typically, in stage three of an economic recovery, the supply curve (AS) shifts out to AS2, as firms hire more workers, and expand output. Together, these price and wage adjustments drive the economy back to full employment at Q1 and close the recessionary gap, but at a new and lower price of P2.
Increases in government regulation, taxes, environmental regulations, and ObamaCare on businesses, shifted the aggregate supply (AS) curve inward and thus prevented the outward shift of the AS curve that was needed to get the US economy firing on all cylinders.
You will soon be reading about policy decisions from the Trump administration that are aiming at shifting the supply curve outward. An attempt to shift the AS curve outward means that Donald Trump’s economic team will end things like Dodd-Frank and Federal fracking regulations. The media will correctly call this supply-side economics.
Donald Trump will lower taxes for businesses and consumers in an attempt to reduce deadweight loss as discussed here.
Higher taxes also negatively impact the number of people willing to work as illustrated by the Laffer Curve.
The marginal tax rate is measured on the vertical axis, and total tax revenues are measured on the horizontal axis. Note that the Laffer Curve is backward-bending, reflecting the behavioral notion that at some point, people will work less the more they are taxed. This backward bend means that above a certain tax rate, “m” in the figure, an increase in the tax rate will cause overall tax revenues to fall.
Now here is the important point that Dr. Peter Navarro will likely be advising Trump on, for a supply-side tax cut to increase tax revenues, the existing tax rate before the tax cut must be above “m,” perhaps at a rate associated with point “n” on the curve. The tax rate being above “m” is an important point because, in the early 1980s, the Reagan Administration’s economists believed that the economy was on the backward-bending portion of the Laffer curve (above “m”) and that a tax cut would increase total tax revenues. Based on this assumption, it moved forward with one of the largest tax cuts in American history.
Policies which can successfully shift the economy’s supply curve out, do so with the twin advantages of both lower unemployment and lower inflation.