SUPPLY-SIDE ECONOMICS: AN ANALYTICAL REVIEW

Abstract

Introduction WHEN I left graduate school, in 1963, I believed that the single most desirable change in the U.S. tax structure would be the taxation of capital gains as ordinary income. I now believe that neither capital gains nor any of the income from capital should be taxed at all. My earlier view was based on what I viewed as the best available economic analysis, but of course I think my current view is based on better analysis. I thought the story of this transformation, which is by no means mine alone, would make an interesting subject for a lecture. Indeed, I think it makes a particularly suitable subject for the Hicks Lecture, for the theoretical point of view advanced in Value and Capital plays the central role in this story, as it has in so many other chapters of our intellectual history. The framework most of us used, or at least had in the back of our minds, for thinking about taxation, capital accumulation and economic growth in the 1960s was the Solow (1956)-Swan (1956) model in which an economy's savings rate was assumed to be a fixed fraction of income. In this framework, returns to capital are pure rents, so taxing these returns should have no allocative consequences.' With progressive schedules and without preferential treatment of returns arbitrarily classified as capital gains, wealthier capitalists could be singled out for the heaviest taxation. Who could ask for a better tax base than this?