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Saturday, May 08, 2010

"Tax Cuts And 'Starving The Beast'"

Bruce Bartlett argues that "starve the beast" doesn't work, and may even lead to the opposite of the intended effect:

Tax Cuts And 'Starving The Beast', by Bruce Bartlett, Commentary, Forbes: I believe that to a large extent our current budgetary problems stem from the widespread adoption of an idea by Republicans in the 1970s called "starve the beast." It says that the best, perhaps only, way of reducing government spending is by reducing taxes. While a plausible strategy at the time it was formulated, STB became a substitute for serious budget control efforts, reduced the political cost of deficits, encouraged fiscally irresponsible tax cutting and ultimately made both spending and deficits larger.
Once upon a time Republicans thought that budget deficits were bad, that it was immoral to live for the present and pass the debt onto our children. ... Republicans also thought that deficits had a cost over and above the spending that they financed and that it was possible for this cost to be so high that tax increases were justified if spending could not be cut.
Dwight Eisenhower kept in place the high Korean War tax rates throughout his presidency, which is partly why the national debt fell from 74.3% of gross domestic product to 56% on his watch. Most Republicans in the House of Representatives voted against the Kennedy tax cut in 1963. Richard Nixon supported extension of the Vietnam War surtax instituted by Lyndon Johnson... And Gerald Ford opposed a permanent tax cut in 1974 because he feared its long-term impact on the deficit.
By 1977, however, Jack Kemp, Dave Stockman and a few other House Republicans concluded that the economy was desperately in need of a permanent tax rate reduction. Kemp believed that such a tax cut would so expand the economy that the revenue loss would be minimal. He also thought that much government spending was driven by slow economic growth--welfare, unemployment benefits and so on--that would fall automatically if growth increased.
But the Republican Party's economic gurus--Alan Greenspan and Herb Stein, in particular--were not comfortable supporting a tax cut without stronger assurances that the deficit would not increase too much. ...
After enactment of California's Proposition 13--a big property tax cut with no offsetting spending cuts or tax increases--on June 6, 1978, there was an immediate change in attitude among Republican economists who were previously skeptical of a permanent cut in federal income tax rates. They could see that a tax revolt was in the making and that Republicans could very possibly ride it all the way back into the White House in 1980.
On July 14, 1978, a few weeks after the Prop. 13 vote,... Greenspan ... was the first Republican to articulate what came to be called "starve the beast" theory. ... Citing Greenspan's testimony, conservative columnist George Will endorsed Kemp-Roth and STB in a column on July 27, 1978. ...
On Aug. 7, 1978, economist Milton Friedman added his powerful voice to the discussion. Writing in Newsweek magazine, he said, "the only effective way to restrain government spending is by limiting government's explicit tax revenue--just as a limited income is the only effective restraint on any individual's or family's spending."
By 1981 STB was well-established Republican doctrine. In his first major address on the economy as president on Feb. 5, Ronald Reagan articulated the idea perfectly. ... Unfortunately there is no evidence that the big 1981 tax cut enacted by Reagan did anything whatsoever to restrain spending. ...
Rather than view this as refutation of starve the beast theory, however, Republicans concluded that Reagan's true mistake was acquiescing to tax increases... By the end of his presidency, Reagan signed into law tax increases that took back half the 1981 tax cut. His hand-picked successor, George H.W. Bush, compounded the error, Republicans believe, by supporting a tax increase in 1990.
When Bill Clinton became president in 1993, one of his first acts in office was to push through Congress--with no Republican support--a big tax increase. Starve the beast theory predicted a big increase in spending as a consequence. But in fact, federal outlays fell...
Although all of evidence of the previous 20 years clearly refuted starve the beast theory, George W. Bush was an enthusiastic supporter, using it to justify liquidation of the budget surpluses he inherited from Clinton on massive tax cuts year after year. Bush called them "a fiscal straightjacket for Congress" that would prevent an increase in spending. Of course nothing of the kind occurred. Spending rose throughout his administration... Nevertheless STB remains a critical part of Republican dogma. ...
Despite its continuing popularity among Republican politicians, at least a few conservative intellectuals are starting to have misgivings about STB. ... By eliminating tax increases as a necessary consequence of deficits, it also reduced the implicit cost of spending. Thus, ironically, STB led to higher spending rather than lower spending as the theory posits.
In the latest study of STB, political scientist Michael New of the University of Alabama ... concluded. "The evidence suggests that lower levels of federal revenue may actually lead to greater increases in spending."
In effect STB became a substitute for spending restraint among Republicans. They talked themselves into believing that cutting taxes was the only thing necessary to control the size of government. Thus, rather than being a means to an end--the end being lower spending--tax cuts became an end in themselves, completely disconnected from any meaningful effort to reduce spending or deficits.
Starve the beast was a theory that seemed plausible when it was first formulated. But more than 30 years later it must be pronounced a total failure. There is not one iota of empirical evidence that it works the way it was supposed to, and there is growing evidence that its impact has been perverse--raising spending and making deficits worse. In short, STB is a completely bankrupt notion that belongs in the museum of discredited ideas, along with things like alchemy.

Starve the beast was always backwards. There is some simultaneity in the choice of spending and taxes, and causal lines likely run in both directions, but the main causal effect is that tax rates adjust to spending over time, causality from taxes to spending in not as strong.

However, I don't want to say that starve the beast has been a complete failure. I believe our response to the crisis would have been different - hopefully it would have been considerably larger -- if we had been running a large surplus rather than a large deficit. Tax cuts weren't the only factor that put pressure on the budget, spending on the war mattered too, but I believe the tax cuts did reduce the magnitude of the response to the crisis. The tax cut portion of the stimulus package was smaller than it might have been if taxes hadn't been cut so much already, and spending would have been larger if surplus monies were present. I also think that discussions over spending on Social Security and other social programs would be different if the government's finances were in better shape, i.e. if taxes had not been cut. There would still be issues to resolve in the long-run, but there wouldn't be as much pressure to solve the problem immediately through drastic cuts in benefits.

So while I do believe that the strongest causal effects run from spending to taxes, I don't think we can say that causality in the other direction -- from say tax cuts to spending during an economic crisis -- is insignificant. It mattered.

    Posted by on Saturday, May 8, 2010 at 01:17 AM in Budget Deficit, Economics, Politics | Permalink  Comments (74)

          


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