Evidence-Based Economics

Edmund Phelps, recent Nobel Prize winner in Economics, writes about Evidence-Based Economics,

… the supply-siders jumped to the daring conclusion that a permanent cut in tax rates on labor would encourage more work permanently – with no diminution of effectiveness.

In my view, this core tenet of supply-side economics rests on a simple blunder…

We must proceed cautiously, however. In standard analyses, the tax cut brings a reduction in government purchases of goods and services, like defense. But a tax cut could instead contract the welfare state – social assistance and social insurance, which constitute social wealth. In that case, the tax cut, while gradually increasing private wealth, would decrease social wealth. The issue is an empirical one…

Neoliberals are now telling continental Europe that tax cuts on labor can dissolve high unemployment. But the effectiveness of such tax cuts would be largely, if not wholly, transitory – especially if the welfare state was spared. In two decades’ time, high unemployment would creep back. The false hopes raised by cutting taxes would have diverted policy makers away from fundamental reforms that are necessary if the Continent is to achieve the dynamism on which high rates of innovation, abundant job creation, and world-class productivity depend.

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