It may be noted that in order to get out of recession and to reduce unemployment, if Government seeks to raise aggregate demand to the higher level ADThus in this context of stagflation in the economy attempts by the Government to raise aggre­gate demand to get out of recession and reduce unemployment result in further rise in the inflation rate. They recommended expansionary fiscal and monetary policies to raise aggregate demand to pull the economy out of depression or recession and thereby to reduce unemployment.

The second basic proposition of supply-side economics is that reduction in marginal tax rates will increase the incentives to save and invest more. In the early seventies workers with expectations of inflation to continue pressed for higher wages to compensate for accelerating inflation. In the period of 1973-75, removal of wage and price controls which had been imposed earlier also produced a supply stock to the American economy.

She writes about the U.S. Economy for The Balance.The Effect of Presidential Economic Policy on the EconomyPaul Volcker and How He Got a Shock and a Rule Named After HimHow Carter Created Jobs, Fought Stagflation, and Brokered World PeaceHow Every President Since Hoover Has Affected the Economy By combining the tax cuts with reduction in Government expenditure of the right magnitude aggregate demand curve could be held constant which would make it possible to retain the favourable impact of tax cuts on aggregate supply. To sum up, it follows from above that supply-side theorists have too optimistic view of the favourable effect of tax cuts on inflation. This massive increase in global liquidity prevented deflation, a far greater risk. Keynesian economics was born during the great depression of the 1930s, when a large percent­age of labour force (about 25%) was rendered unemployed and also a good deal of productive capacity (i.e., capital stock) lay idle resulting in a huge decline in Gross National Product (GNP) of the economies.

Second, the removal of the dollar from the gold standard was a once-in-a-lifetime event. Real GNP fell at a rapid rate during 1979-81.

Another important contention of supply-siders is that higher mar­ginal tax rates encourage people to work in the underground economy (which in India is popularly called black or parallel economy) where their income cannot be traced by the income tax depart­ment. It follows from above those tax cuts of supply-side economics which was originally propounded to cure both inflation and stagnation, could be expected to make not more than a small dent in the inflation rate because of the demand-side effects they create. Therefore, these higher tax rates reduce national output and income. This simultaneous oc­currence of high inflation and high unemployment was also seen in case of other free market devel­oped countries such as Britain, France and Germany. Third, the wage-price controls that constrained supply wouldn't even be considered today. The higher tax rates after a certain point prove to be counter-productive as they reduce supply of labour and capital accumulation through provid­ing disincentives to work, save and in­vest. Tax cuts have both supply-side and demand-side effects. Suppose an individual saves Rs. First, as explained earlier, the reduction in tax increases tax compliance and tends to reduce tax evasion and tendency to indulge in underground or black market activities. With more capital per worker, labour productivity will rise which will tend to reduce unit labour cost and lower the rate of inflation. An important graphic concept called as Laffer curve was developed to prove that reduction in taxes would increase tax revenue and help in reducing budget deficits. This virtually lowered the tax-burden on the companies which increased their incentives to invest in capital accumulation. The fourth measure was adopted by Reagan to control inflation as a supplementary measure to supply-side approach to control stagflation.

Similarly, the cuts in business taxes will raise the profitabil­ity of investment and thereby induce the firms to invest in expanding productive capacity. However, in case of tax cut made by President Reagan during 1981-83 in the United States, the supply-side view proved wrong. As seen above, a central idea of supply-side economics is that the reduction in rates of certain type of taxes will increase aggregate supply of output by increasing both the supply of labour and capital. According to the Phillips curve,-a high rate of inflation is accompanied by a low rate of unemployment or a low rate of inflation is accompanied by higher unemployment which shows that the goal of reduced inflation conflicts with the objective of reduced unemployment. An eminent supply-side economist, Arthur Laffer has argued that lower tax rates are quite consistent with the increase in tax revenue. It may be noted that in 1981 when on the advice of supply-side economists Reagan made large tax cuts, his critics argued that these would further increase the budget deficits, as he had made only small cuts in Government spending. There was a four times increase in the oil prices. This also increases the aggregate labour supply in the market. The first three measures are features of supply-side economics. According to them, Government regulation of some industries such as transport and communication created monopolies and thus protected them from competition by rivals. If marginal tax rate is 60 per cent, his after-tax interest income will be Rs. Stagflation can only occur if government policies disrupt normal market functioning. In the United States during 1973-75 the higher costs of fuel-oil and other petroleum products brought about a sharp increase in the prices of manufactured goods. Tax base refers to the real GNP or national income.


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