SUPPLY SIDE ECONOMICS In view of the failure of demand management policy of Keynesianism, the rise of the theory of rational

expectations combined with a Natural Rate of Unemployment focused attention on the supply side economics. Neo Classical Economists totally rejected the premises and implications of Keynesian economics. Following global crisis in 1970s oil crisis in 1973 and in the aftermath of the war of Vietnam, the Keynesian propositions no longer useful.

The propagandists of Supply Side Economics argue that large cuts in taxes are essential to provide incentives to work save and invest. This in turn is expected to boost the output and employment and decrease in inflation.

Most of the SSE measures, especially the tax cuts and deregulation of the economy are currently being pursued to give a push to the recession ridden economics including India. SSE gained prominence in the early 1980s with the election of Regan as President of USA. The ideas, thus follows have been labeled as Reagonomics. These ideas represent a revival of classical economics and its latest form called Neo Classical Economics. Reagonomics based on the four pillars: they are: Lower taxes

Reduction in Government Spending

Encouragement of monetary restraint Easing of regulatory burden on business

Laffer Curve: One of the important prescriptions of SSE takes the form of lowering of tax rates and its impact on tax revenue. The orthodox view was that the reduction in taxes leads to decline in the tax revenue. However, then American Economist, Arthur Laffer and others have argued that the reduction may actually raise tax revenue by providing incentives which lead to much higher levels of economic growth.

It explains the relationship between tax rates and tax revenue. The relation shows that there exists some optimal tax rate shown as t* in the diagram, which maximizes government tax revenue. At O rate, no tax revenue is possible and hence the curve starts at the origin. With a tax of 100% persons have no incentives to engage in economic activities so they will not do so and tax revenue is again zero. Between, zero tax and 100% tax, the curve has an inverted U shape indicating that tax revenue rises as tax rates increase over some range, to tax rate t and then fall. Over the O to t range, the effect of the increases in tax rates dominates the disincentive effect. From t to 100%, the opposite is true.

Thus, at tax rates greater than t a tax increase actually reduces tax revenue. Which implies that the appropriate way to increase tax revenue is to reduce tax rates?
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