Mundell on Supply-Side Economics
Robert A. Mundell, a Columbia University economist, won the Nobel economics prize yesterday. Following are excerpts from an article he published in the July-August 1990 issue of the Rivista di Politica Economica, an Italian economics journal. (Reprinted with permission.)</br></br>Supply-side economics emerged as a political force partly as a reaction against the steep progressivity of personal and corporate income taxes and partly as a result of the breakdown of the international monetary system in 1971. The principal features of the supply-side program were a reform of the tax system, featuring a drastic slashing of marginal tax rates, and a reform of the international monetary system to one based on stable exchange rates anchored by gold or some alternative international asset.</br></br>The United States had enacted high income tax rates after it entered World War I, and they were only gradually lowered, to a maximum rate of 25% under {Treasury} Secretary {Andrew} Mellon. But in June 1932, during the last year of the Hoover administration, marginal income tax rates were suddenly raised again to a maximum level of 60%. They remained at or (frequently) considerably above this level for half a century. The grand bargain entered into by both Democratic and Republican administrations up to 1981 was the exchange of punitive marginal income tax rates to satisfy the political left in exchange for sweeping tax loopholes to placate the political right.</br></br>The collapse of monetary discipline with flexible exchange rates in 1973 and the subsequent oil embargo and increase in oil prices led to an inflation that further exacerbated the progressivity of the tax system. At the same time the absence of a stable monetary environment led to rising interest rates and exchange rate fluctuations that, almost arbitrarily, altered relative labor costs and international competitiveness. The exchange rate was determined increasingly by volatile international capital movements rather than the requirements of international trade. Reform of the international monetary system was therefore the second pillar in the platform of supply-side economics.</br></br>Supply-side economics addressed itself directly to policy considerations rather than theoretical abstractions. It would be a mistake, however, to believe that it lacks any less of a scientific foundation than the older demand-side schools of monetarism and Keynesianism, or the new classical school. Its own academic credentials lie in the solid allocation-theoretic literature of neo-classical economics and the policy-oriented models of global monetarism and macroeconomics.