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Thursday, November 08, 2007
Deficit/Spending
Here's an interesting paper on the "starve the beast" school of government reduction by tax cut (via Inclusion). The abstract:
The hypothesis that decreases in taxes reduce future government spending is often cited as a reason for cutting taxes. However, because taxes change for many reasons, examinations of the relationship between overall measures of taxation and subsequent spending are plagued by problems of reverse causation and omitted variable bias. To deal with these problems, this paper examines the behavior of government expenditures following legislated tax changes that narrative sources suggest are largely uncorrelated with other factors affecting spending. The results provide no support for the hypothesis that tax cuts restrain government spending; indeed, they suggest that tax cuts may actually increase spending. The results also indicate that the main effect of tax cuts on the government budget is to induce subsequent legislated tax increases. Examination of four episodes of major tax cuts reinforces these conclusions.
Its conclusion casts doubt on Jason Furman's paper on the distributive impact of the 2001-5 tax cuts. If the pattern holds, those tax cuts will not be paid for with spending cuts, as Furman predicted, but with more tax revenue. What's undetermined is who will be taxed, not whether taxes will go up. Indeed, it is increasing tax revenue caused by a growing and unequal economy that's already closing the deficit the Bush tax cuts opened.
This begs the question: does deficit-financed spending "starve the beast," so to speak? The deficit-financed war in Iraq, for example, will ultimately be paid for. Again, if the pattern holds, taxes will go up in the long run. Spending won't decline to make room for it in the budget.
Regardless, the paper does raise powerful questions about deficits. Do they not have the tremendously harmful impact on spending that most reasonable people, in good faith, think they do? For the vice-grip this notion has on policymakers, it's remarkably untested empirically. Hopefully papers like this will get a full discussion going.
Posted by Matt Lewis
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