Saturday, May 06, 2006

Why Conservatives Should Support Higher Taxes

From an interesting article in this months Atlantic. (Subscribers only.)

Reagan and his supply-side vanguard saw a way to break the jam—or, more precisely, two ways. First, some argued that tax cuts would so energize the economy as to pay for themselves. That claim was widely controversial, even among Republicans (Reagan’s then-rival George H. W. Bush called it “voodoo economics”), and it proved mostly wrong. Less controversial, but in the end more important, was the claim Reagan lobbed at Anderson. Often called the Starve the Beast hypothesis, it held that tax cuts shrink the federal Leviathan by starving it of funds. Tax cuts need not await spending cuts because they would cause spending cuts.

For modern conservatism and the country, the importance of Starve the Beast is impossible to overstate. Suddenly Republicans could offer both lower taxes and smaller government without any need for fiscal dentistry. Suddenly it was the Democrats who were trapped. From then to now, tax cutting has been the lodestar of conservatism, rising to its apogee under the current President Bush. But there have always been dissenting voices, of which perhaps the most prominent speaks from within the conservative movement.

...

Even during the Reagan years, Niskanen [chairman of the libertarian Cato Institute) was suspicious of Starve the Beast. He thought it more likely that tax cuts, when unmatched with spending cuts, would reduce the apparent cost of government, thus stimulating rather than stunting Washington’s growth. “You make government look cheaper than it would otherwise be,” he said recently.

Suppose the federal budget is balanced at $1 trillion. Now suppose Congress reduces taxes by $200 billion without reducing spending. One result is a $200 billion deficit. Another result is that voters pay for only 80 percent of what government actually costs. Think of this as a 20 percent discount on government. As everyone knows, when you put something on sale, people buy more of it. Logically, then, tax cuts might increase the demand for government instead of reducing the supply of it. Or they might do some of each.

Which is it? To the naked eye, Starve the Beast looks suspiciously counterproductive. After all, spending (as a share of the gross domestic product, the standard way to measure it) went up, not down, after Reagan cut taxes in the early 1980s; it went down, not up, after the first President Bush and President Clinton raised taxes in the early 1990s; and it went up, not down, following the Bush tax cuts early in this decade.

Niskanen recently analyzed data from 1981 to 2005 and found his hunch strongly confirmed. When he performed a statistical regression that controlled for unemployment (which independently influences spending and taxes), he found, he says, “no sign that deficits have ever acted as a constraint on spending.” To the contrary: judging by the last twenty-five years (plenty of time for a fair test), a tax cut of 1 percent of the GDP increases the rate of spending growth by about 0.15 percent of the GDP a year. A comparable tax hike reduces spending growth by the same amount.

Again looking at 1981 to 2005, Niskanen then asked at what level taxes neither increase nor decrease spending. The answer: about 19 percent of the GDP. In other words, taxation above that level shrinks government, and taxation below it makes government grow. Thanks to the Bush tax cuts, revenues have been well below 19 percent since 2002 (17.8 percent last year). Perhaps not surprisingly, government spending has risen under Bush.

“I would like to be proven wrong,” says Niskanen. No wonder: for the modern conservative coalition, the implications of his findings are discomfiting, and in a sense tragic.

First, the root-canal economics of pre-Reagan conservatism was right all along: the way to limit the growth of government is to force politicians, and therefore voters, to pay for all the government they use—not to give them a discount.

Second, conservatives who are serious about halting or reversing the dizzying Bush-era expansion of government—if there are any such conservatives, something of an open question these days—should stop defending Bush’s tax cuts. Instead, they should be talking about raising taxes to at least 19 percent of the GDP.
Voters will not shrink Big Government until they feel the pinch of its true cost.

Third, the most effective constraint of all is to raise taxes and cut spending: exactly the sort of anti-deficit package that anti-tax conservatives pummeled the first President Bush and President Clinton for approving, and exactly the sort of package that the current President Bush and his anti-tax allies are sworn to block.

The conservative movement is in no position to accept or even acknowledge those implications, now that tax cutting has become the long pole in the Republican tent. Therein lies the element of tragedy. By turning a limited-government movement into an anti-tax movement, conservatism has effectively gone into business with the Big Government that it claims to oppose. It is not starving the beast. It is fueling the beast’s appetite. And the beast has a credit card.

5 comments:

Benjamin said...

Yes. Unfortunately people forget that
(taxes)(size of government)=k, where k is a constant. Otherwise, the nation goes into debt. I would love to see lower taxes, but only so that it fits within the bounds of k.

Unfortunately, Atlantic Monthly is right at the moment.

Random said...

"Another result is that voters pay for only 80 percent of what government actually costs. Think of this as a 20 percent discount on government. "

Erm, no. What's actually happening is that you're paying for 80% of government in cash and putting the other 20% on your credit card, at a non-trivial rate of interest. Then repeating the performance the following year without paying off last year's card bill (except, maybe, the interest) and so on until your economy collapses.

But yes, to continue the original analogy, people have been known to use credit to buy things they couldn't otherwise afford.

"After all, spending (as a share of the gross domestic product, the standard way to measure it) went up, not down, after Reagan cut taxes in the early 1980s; it went down, not up, after the first President Bush and President Clinton raised taxes in the early 1990s; and it went up, not down, following the Bush tax cuts early in this decade."

I am not an economist, but this looks like a rather dubious way of doing comparisons to me. All it is saying is that GDP grew faster than spending during the Bush I/Clinton years and vice versa in the Reagan/Bush II years. It isn't saying anything about the actual rate of spending growth. I'd have thought the cash figure adjusted for inflation would be a better way of doing that.

And finally, I have to say that any analysis that ignores the fact that Reagan/Bush II were both spending on the military at wartime levels (literally so in the case of Bush II, and spending the USSR into the ground on defence in order to win the cold war for Reagan) and the other two presidents weren't isn't worth the paper it's written on.

"Second, conservatives who are serious about halting or reversing the dizzying Bush-era expansion of government—if there are any such conservatives, something of an open question these days"

I obviously read different Conservative commenters than the author, but I've read plenty who loathe what Bush is doing to the federal budget. The balanced budget movement is by no means dead on the right.

Jewish Atheist said...

Erm, no. What's actually happening is that you're paying for 80% of government in cash and putting the other 20% on your credit card, at a non-trivial rate of interest.

He's not talking about what's "actually happening" -- he's talking about what taxpayers perceive. Sort of like with credit cards for a lot of people, where it doesn't feel like spending so people spend more. I think you're basically saying the same thing actually.

I can't speak about the other stuff because I'm not informed enough. :-)

Ezzie said...

Again looking at 1981 to 2005, Niskanen then asked at what level taxes neither increase nor decrease spending. The answer: about 19 percent of the GDP. In other words, taxation above that level shrinks government, and taxation below it makes government grow. Thanks to the Bush tax cuts, revenues have been well below 19 percent since 2002 (17.8 percent last year). Perhaps not surprisingly, government spending has risen under Bush.

No time for whole thing now, but this shows one of the major flaws here: Revenues as a % of GDP is meaningless; the revenues as a % of GDP have gone down simply because of the strong GDP growth; but in reality, revenues themselves are way up.

The article also fails to take into account quality of life issues which is one of the main drives of increased GDP...

asher said...

Didn't Reagan pass the biggest tax hike in the history of the country..a fact most people don't remember. Prior to Reagan, social security payments were not taxed and you could deduct the interest on your credit cards.

Also, doesn't it take at least 12 months for any economic plan to take effect in a country as large as this one?