At a generation’s distance, it is clear to me that we, the original supply-siders, bear some responsibility for the failure to persuade. We were not radical enough — we allowed our own arguments to be ensnared by the mechanical economics of Adam Smith and his heirs. Even Arthur Laffer’s original and brilliant graph, after all, functioned almost entirely in the realm of rational expectations, stimulus and response applied to poor passive Homo economicus. Let him keep more of the fruits of his labor and he will labor harder, we proclaimed; increase the after-tax rewards of investment and more investment there will be.
By focusing on incentives rather than on information and creativity, free-market economists have encouraged the idea that capitalism is based on greed, although entrepreneurs cannot in general revel in their wealth, because most of it is not liquid. Greed, in fact, only motivates capitalists to seek government guarantees and subsidies that denature and stultify the works of entrepreneurs. The financial crash of 2007 and beyond reflected orgies of greed among crony capitalists awash in government guarantees and subsidies, sitting on their Fannies and Freddies, feeding in the troughs of Treasury privileges and government-insurance scams. Greed leads as by an invisible hand to an ever-growing welfare and plutocratic state — to socialism and near-fascist corporatism.
The secret of supply-side economics is not merely to incentivize people to work harder or accept more risk in order to gain a greater reward. That could be done under socialism. The reason lower marginal tax rates produce more revenues than higher ones is that the lower rates release the creativity of employers, allowing them to garner more information. They can move more rapidly down the curves of learning and experience. They can learn more because they command more capital to use in their trade. With more capital they can attract more highly skilled labor from around the globe. They can reduce time and effort devoted to avoiding taxes and interpreting regulations and consulting lawyers and accountants. With fewer resources diverted to government bureaucracy, they can conduct more undetermined experiments, test more falsifiable hypotheses, try more business plans, generate more productive knowledge.
It is not the enlargement of incentives and rewards that generates growth and progress, profits and capital gains for the entrepreneur and revenues for the government, but the combination of new knowledge with the power to test and extend it. Volatile and shifting ideas, not heavy and entrenched establishments, constitute the source of wealth. There is no bureaucratic net or tax web that can catch the fleeting thoughts of Eric Schmidt of Google, Jules Urbach of Otoy, or Chris Cooper of Seldon Technologies.
The key issue in economics is not aligning incentives with some putative public good but aligning power with knowledge. Business investments bring both a financial and an epistemic yield. Capitalism catalytically joins the two. Capitalist economies grow because they award wealth to its creators, who have already proven that they can increase it. Their proof was always the service of others rather than themselves.
As Peter Drucker has written, within companies there are no profit centers, only cost centers. Whether a particular cost yields a profit is determined voluntarily by customers and investors. Capitalism feeds on information that is outside of the company itself and therefore under the control of others. Only an altruistic orientation can tap the outside incandescence of information and learning that determine the success of capitalism’s gifts.
– Mr. Gilder is the author of 15 books, a venture investor, and a co-founder of the Discovery Institute. This article is adapted from the prologue to his Wealth and Poverty: A New Edition for the Twenty-First Century(Regnery).