As we have seen, the supply side tax cut will work only if tax cuts lead to very large increases in investment. The following figure shows Gross Private Domestic Investment in 1992 dollars (based on a chain index).
In the figure, investment is shown by the blue-green curve. Years from 1960-2000 are on the horizontal axis and the scale on the vertical axis is hundreds of billions of dollars. The vertical scale is logarithmic, so that when the height on the vertical axis doubles investment increases by ten times. The logarithmic scale makes it easier to compare changes in investment at different times.
When we look at the period around 1963, we see that it was a period of vigorous growth in investment both before and after the tax cut. There seems to be some slight acceleration of the growth of investment after 1963, although only for a few years. It is difficult to say whether this is any more than a random fluctuation, and, if it is, whether it might be a result of the tax cut or of something else. After the 1981 "Supply-Side" tax cut, we see a considerable drop in investment, followed by a recovery in the mid-eighties; but the performance for the decade of the eighties as a whole was quite disappointing. Again, the drop in investment in the early eighties probably should not be blamed on the tax cut. Many other things were going wrong. While the tax cut might have discouraged investment, by increasing the deficit and so driving up interest rates, it seems likely that the high interest rates at that time were largely a result of monetary policy and inflationary expectations. We should remember that a careful statistical analysis might give different results, but, on balance, these figures seem to give little evidence that tax cuts stimulate (or discourage) investment.
All in all, most economists believe that tax cuts do stimulate investment to some extent, despite the ambiguity of the evidence. However, cutting taxes to increase revenues looks like a gamble at long odds. Simply in terms of the logic of the AS/AD model, it is possible for a Supply Side tax cut to work, but it seems very improbable that the policy would work in fact.
The Bottom Line
