Republicans still dogmatically hold onto the idea of supply-side economics. While they don't use the term anymore, they still implement the policy of cutting taxes for the wealthiest Americans. Here is the basic theory. Supply-side states the upper class' retained money will be reinvested in the US in the form of new business investment or consumer spending. This increase in domestic spending from the upper class will ripple through the economy creating new jobs. The sum total of this increased domestic spending will be an increase in overall GDP to pay for the tax cut. Here's the basic problem. The government pays for the tax cut with increased borrowing. Hence, we have a primary reason for the mammoth amount of debt the Republicans are responsible for, currently totaling a little below 8 trillion dollars and growing. In short, their ideas are a complete failure. Instead of the promised prosperity, the Republicans have put the US remarkably close to national bankruptcy.
Here's a simple example of the scheme. Joe Millionaire makes $250,000 year and is taxed at 35%. Therefore, he pays $87,500 in taxes. The Republicans cut his taxes by 10% to 25%. This lowers Joe's taxes to $62,500 or a decrease of $25,000. Joe now feels richer. He either spends the extra $25,000 on new stuff or invests it in the market helping other companies build new products that will employ more people. This in turn will increase the total US GDP because more businesses are created, employing more people at higher wages who now pay more overall taxes. Historical facts clearly demonstrate three holes in this theory.
Here's the first problem with Supply-side economics. It assumes the government will make a proportionate cut in spending -- for every tax-dollar lost, the government will cut spending. Good luck with this one. Politicians - regardless of their party affiliation - will never proportionately cut spending. In addition, Republicans love overspending on the military. Every time a new Republican takes office, they give the pentagon a blank check. Reagan and Bush II are classic examples of this. How quickly they forget Eisenhower's warning about the military industrial complex.
This is why Reagan's great economic expansion increased the US debt from a little under 1 trillion to 2.6 trillion. Yes, he cut taxes. He also increased defense spending from 134 billion in 1980 to 290.9 billion in 1988 an increase of 117% (from the CBO). "But we won the cold war!" Yes, we did. When are we going to pay for it?!?!?!?!" This leads nicely to the second problem with supply-side economics.
Here's the second problem. The government now has a revenue shortfall. Instead of receiving $87,500 it receives $62,500. Therefore, the government borrows money by selling Treasury bonds. According to supply side economics, the revenue shortfall will eventually be eliminated by the increased revenue from an expanding economy created by the upper class spending more of their money.
When will the US GDP actually increase to a level where the tax cuts pay for themselves with a large enough increase in GDP to pay for the increased level of government debt? The Republicans started implementing massive tax-cuts for the rich in 1980 when our total deficit was a little under 1 trillion. 25 years later, our total debt is 7.8 trillion. In other words - 25 years later, supply-side economics has not paid for itself. But, it has taken the US to the brink of financial ruin. And it appears ruin will occur before the supply-side ponzi scheme pays for itself
Clinton's economic team provides the proper blueprint for dealing with this problem. His efforts are illustrative of how the Democrats tackle this problem.
Clinton began the process of deficit reduction when he took office. Right-wing pundits always state Clinton was simply in the right place at the right time. This is absolutely wrong. Leon Panetta -- Clinton's budget chief -- was very hawkish on the deficit. He was the one who really pushed for a move toward resolution. The Clinton administration communicated through Lloyd Bentson with the Federal Reserve, essentially stating "If we start to really get the deficit under control, will you quietly start to calm the financial markets." Greenspan agreed. The result was a slow and disciplined approach to deficit reduction, eventually ending up with surplus in Clinton's last few years.
Part of Clinton's solution was increasing tax rates on upper-income taxpayers. The Republicans screamed this would lead to a recession. However, an expansion ensued for the following reason. As the markets saw the US was reducing its deficit, they started to bid down interest rates. This rippled through the markets lowering the overall cost of capital. The effect was economically simulative, leading to a large expansion and the tech boom of the 1990s. And yes, I am well aware of the bubble because I was a broker shorting the market when it happened. I will remind you there are still 3 3/4 years for Bush's real estate bubble to come crashing down.
In conclusion, supply-side economics has failed because it does not pay for itself. The only way to solve the problem is raising taxes on upper income taxpayers, asking them to pay for their fair share of the national debt. This will in effect calm the financial markets allowing market participants to bid down rates.