Skip to comments.Do Tax Cuts “Starve the Beast”?
Posted on 01/08/2013 9:07:36 AM PST by Kaslin
Theres a debate among policy wonks about whether a no-tax-hike policy is an effective way of restraining the burden of government spending.
At the risk of over-simplifying, the folks who support the starve the beast theory argue that there are political and/or economic limits to government borrowing, so if you dont let politicians tax more, you indirectly impose a cap on total spending (outlays = tax revenue + borrowing limit). Well call this the STB approach, for obvious reasons.
Critics of the theory, by contrast, say that a low-tax policy creates fiscal illusion by making government spending seem artificially cheap. After all, standard microeconomic analysis tells us that people will demand more of something when the perceived price is low (get a $1 of spending for 80 cents of tax = recipe for higher outlays). Well call this the pay for government approach, or PFG.
Theres almost surely some truth to both arguments, but the real issue if whether one effect is dominant particularly in the long run. In other words, should supporters of small government fight tax increases? Or welcome them?
Ive never studied this issue, but my gut instinct has been on the STB side of the debate. Here are a few of the reasons.
Seems like the STB approach makes sense, but not everyone thinks my theoretical musings and generic observations are all thats needed to settle an argument.
Particularly when there are some very sensible people on the other side. The late Bill Niskanen wrote in the 2006 Cato Journal that:
There are three major problems with the starve-the-beast argument: (1) it is not a plausible economic theory; (2) it is inconsistent with the facts; and (3) it has diverted attention away from the political reforms needed to limit government growth.
I fully agree with Bill that there should be much more focus on restraining the growth of government, so theres no disagreement on his third point. I think hes wrong on the first point because half the population no longer pays federal income tax and the top 20 percent pay the lions share, but thats a bit of a judgment call.
What about the facts? Bill does some regression analysis for the 1949-2005 period, where he looks at the change in federal spending as a share of GDP and tests its relationship with the level of tax receipts as a share of GDP, the change in the unemployment rate, and the change in interest payments (the latter two variables are there to hopefully wash out the effects of the business cycle and to limit the analysis to the spending that lawmakers actually can control).
Bill crunches the numbers and concludes:
For no extended period did these estimates reveal a significant positive relation between the change in federal spending as a percent of GDP and the level of federal receipts as a percent of GDP, the necessary condition for the starve-the-beast hypothesis to be confirmed.
Moreover, Bill even found evidence for the PFG approach when he looked solely at the 1981-2005 period.
A 1 percentage point increase in current federal receipts as a share of GDP apparently reduces the change in current federal spending as a share of GDP by about one-seventh of 1 percent a year indefinitely.
I dont doubt that Bills numbers are sound. Indeed, Cato Adjunct Scholar Michael New re-crunched the numbers for the Cato Journal in 2009 and produced similar findings, even when looking only at non-defense discretionary spending.
But I dont find this research very compelling, and its not just because Im from Austrian school, which sometimes has a reputation for being skeptical about empirical analysis.
Here are some reasons why Im not convinced, and even the biggest quant jocks in the world should share these concerns.
To be fair, Bill was breaking some new ground. There was not a lot of empirical analysis to that point, so there was no right or wrong way to test the relationship between taxing and spending. Niskanen picked one approach, and its the role of subsequent researchers to poke and prod the results and contemplate alternatives.
Thats exactly what Christina Romer and David Romer did in their article that appeared in the 2009 Brookings Papers on Economic Activity. They investigated the data from several angles and decided it made the most sense to look at legislated tax changes and look at the long-run impact on spending. And, in an attempt to test the STB hypothesis, they looked solely at major tax bills designed to reduce government revenue.
Thats the good news. The bad news is that this gave them only four pieces of data the Revenue Act of 1948, the Kennedy tax cuts, the Reagan tax cuts, and the 2001/2003 Bush tax cuts.
Setting aside this problem of limited data, what did Romer and Romer discover? Their headline results were similar to Niskanens.
The results provide no support for the hypothesis that tax cuts restrain government spending.
That sounds like bad news for STB advocates. But if you dig into their findings, you find out that the real problem is that politicians cant resist the temptation to feed the beast.
roughly three-quarters of a long-run tax cut is typically undone by legislated tax increases of various sorts within five years. The fact that policymakers have been able to largely reverse tax cuts helps to explain why the cuts have not reduced spending.
In other words, you cant starve the beast if you dont maintain the diet.
Which is basically what other economists concluded when analyzing the work of Romer and Romer. Heres what Steven Davis of the University of Chicago wrote.
if it takes 5 years for a new policymaker to reverse a previous tax cut, so that it remains in effect for 10 years rather than 5, the starve-thebeast effect roughly doubles. In the extreme case where tax cuts cannot be reversed, government spending cuts must eventually absorb the entire adjustment. Clearly, then, tax cuts can produce large starve-the-beast effects if they are sufficiently sticky.
And Jeffrey Miron of Harvard University had a similar interpretation.
concerns over letting children play with matchesthat is, giving politicians access to increased tax revenueare valid. Thus, advocates of small government would seem to have good reason to oppose tax increases.
All things considered, I think that STB is correct.
But Ill close by returning to one of Bill Niskanens points. He warned that the focus on tax limitation was harmful because it diverted attention away from the political reforms needed to limit government growth.
I fully agree. Too many politicians focus on the easy and more politically popular job of fighting tax increases. But then they fail to support measures to restrain the burden of government spending.
Or, as we saw during the Bush years, they cut taxes and then opened the spigot on the spending side of the fiscal equation. No wonder Romer and Romer found that tax cuts generally are reversed. Tax cuts are difficult to maintain and preserve if they are simply gimmicks put in place by feckless politicians.
P.S. Another interesting tidbit is that Romer and Romer acknowledge the Laffer Curve.
We also find that the overall rebound in revenue exceeds the portion due to legislated changes. The key source of the nonlegislated change in revenue is almost certainly the effect of the tax cut on economic activity.
Too bad Christina Romer didnt share that insight with the President when she was at the Council of Economic Advisers.
How would we really know ? When was the last time we ever STB ?
We’re still waiting for the cuts the RATS promised to Pres. Reagan.
Apparently not. esp when the government can create its own money on a computer.
The “cliff deal” just made the code even more progressive.
Nothing is being “starved”, at least not in gubmint.
And certainly not New Jersey Governor Pork Porkie.
Given that the ‘Beast’ owns the printing presses, or food trough if you will, this ‘Beast’ isn’t going to go hungry no matter what you do with the taxes. I believe the intent for raising taxes (now that the Government doesn’t even pretend to try and balance a budget with tax receipts equally the spending) is to impoverish as many people as possible to keep a lid on inflation as long as possible. The ‘Beast’ will continue to spend and spend, no matter what they collect in taxes. Unfortunately, nothing short of a revolution is going to change this process. The established structure in Washington D.C. is not going to change on their own volition. They crave and lust for power, and to reduce their ability to spend would reduce their power. This is not going to happen.
I suppose i could be wrong but to me it is pretty simple, increase in taxes means bigger Government and more Government waste, more Government employees who are not concerned about anything except their position.
Any business person knows that if you spend more than you take in your business will fail so are you going to hire a bunch of employees that do nothing except figure out how to hire more employees so that the first ones can be higher on the totem pole.
As long as we have a congress that does not seem to know what the constitution is for or either don,t care there is no way we can solve anything.
I believe that the constitution gives Congress the authority to collect taxes to pay its debts, government grants, bank bailouts, auto manufacturing bail outs, loans to foreign nations, welfare and about a thousand other things are not debts.
Suggest to anyone that you cut defense, and you’ll see the beast isn’t starving after all.
Perhaps the "starving" which should be considered by lovers of freedom is not a "starving" by refusing to increase tax revenues, by a destruction of the printing presses, or of refusing to approve the borrowing ability. Perhaps the "starving" we should be debating is of a more fundamental and principled approach, and one which the Founders understood to be a need to curb the human tendency to abuse delegated power.
The "formula" for liberty (the Constitution of the United States of America), as explained by Madison, Jay and Hamilton in their 85 essays of THE FEDERALIST starved the human impulse to abuse delegated power by structuring a form of self-government which divided, separated, checked, balanced, and refrained from delegating to elected and appointed individuals any coercive powers not delineated or specified in "the People's" document itself.
In the words of a Texas businessman of the 20th Century, perhaps "the People" must "build a fence between the hog and trough" by reclaiming their Constitution's provisions and protections.
This cartoon, published in the 1980's, illustrates the consequences of the foolish and dangerous policies of so-called "progressives," as they redefined the role of government, turning the Founders' ideas upside-down, and making government officials into masters of "the People," instead holding them to their intended role as servants with strictly limited powers and duties.
Too bad Americans weren't heeding the cautions of Texan Eddie Chiles and other business leaders of that time!
Unfortunately, in subsequent years we found that with few exceptions, Birds fly, fish swim, and politicians spend. There is no constitutional limit on spending, and as long as politicians can buy votes or get their name on something, spending is what we will get.