I've always thought it a little curious that the U.S. Republican party seems to consistently talk about small government, but implement big government. William A. Niskanen, the chairman of the libertarian Cato Institute, thinks he knows why. I'm not normally a fan of the Cato Institute, but I must admit that Niskanen's thesis is appealing and he's got some data to back it up.
Jonathan Rauch discusses Niskanen's theory in the June 2006 Atlantic Monthly:
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.
[...]
Even during the Reagan years, Niskanen 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.
[...]
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.
[...]
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.
25 comments:
Hi Ami,
Sorry to hijack this thread, but you don't have Open Threads.
Have you seen this article?
http://www.washingtonpost.com/wp-dyn/content/article/2006/05/14/AR2006051400806.html
Since Lib has assigned this as the open thread. The US has removed Lybia from the list of terrorist nations and is re-openning relations. I for one welcome this news.
http://www.foxnews.com/story/0,2933,195495,00.html
This is the direct result of the actions Lybia took after we ousted Saddam. I believe Gadhafi feared he would be next if he didn't change.
P.S. Lib, your posting fits right in to the "Nordic" discussion.
Make that the "Sweden" thread rather than "Nordik: thread. We are discussing both medical costs and economic theories.
What you anti tax cut people seem to miss is that we claim revenues will increase after the effects of a tax cut are allowed to work. The Decmocrats claim that federal revenues will drop (that's demonstrably false when you have record revenues).
What jumps out at me from Niskanen's article, Ami, is that Niskanen is stating the libertarian philosophy isn't viable. Since libertarians (and especially Libertarians) call for both a reduction in government's size and a reduction in taxes and Niskanen's argument is that reducing taxes actually increases the size of government then it would folow that the libertarian approach can never become reality.
Fundamentally, I have issues with that assessment. Probably the cause of my discomfort is that Niskanen's sample is only of 25 years or so. Does Niskanen's observation hold also for the Great Society era (1965-1980) or the post-WWII boom or even the Great Depression or the Roaring Twenties? For instance, federal resceipts as a percentage of GDP were below 10% from 1930 (the 1st year I have data for) until 1942, and have never dropped below that point since (they haven't been below 16% since 1950). Did WWII fundamentally change the "neutral" point where taxes don't affect spending to 19% from some earlier threshold?
Indy,
I think the authors point is that reducing spending doesn't automatically follow a reduction in taxes. In other words, congresscritters don't say, "Gee, we don't have as much money as I thought, I guess we won't build that bridge in my district." However, he doesn't address a congresscritter who says, "Let's not build that bridge, and then we don't have to tax as much." I honestly don't think there have been enough of the latter to make a significant sample size.
Brian, that is good news about Libya. Though about going there on my honeymoon a couple months ago, but didn't think the wife would like the idea much.
Stryker, it's Niskanen's second and third implications which lead me to disagree with your assessment of his views:
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.
lib,
one of the papers had this quote: "Because the values of some of these parameters are open to debate, reasonable people can disagree about the magnitude of the feedback effects." However, a static model (10% cut in tax rate = 10% cut in revenue) also seems unlikely.
I would have to agree with anyone who thinks that starving the beast is unlikely. At least as the beast has dad's credit card and the pizza delivery phone number.
Niskanen's time frame is very poor, indeed, and indicative of something other than he's claiming.
Spending went up sharply in the '80's largely because of a Dem Congress in exchange for tax cuts and defense spending from a Rep Pres (defense spending wasn't then, nor is it now, the largest item in the budget). Spending increases slowed dramatically from '94-'00 because a Rep Congress took over and fought with a Dem Pres over spending.
In short, taxes and spending weren't related during those time periods (and maybe not ever), nullifying the analogy. The problem right now is that the Reps currently in Congress aren't the same as in '94 (most self-term-limited out by '00), and they don't share the idea of a fiscally-conservative gov't.
Lib, (one of) the dirty little secret(s) of the Bush Administration is that it took five (5) years for revenues to return to where they were at the end of Clinton's term, and that's *before* taking inflation into account. Gross federal receipts during FY 2000 were $2.03 trillion, and they dropped in each of the following three fiscal years to a low of $1.78 trillion in FY 2003. Gross receipts did not return to the $2 trillion mark until FY 2005 ($2.15 trillion), which admittedly is a record - but only if you don't factor in inflation. If inflation is factored in the FY 2005 revenue in Y2K dollars is $1.90 trillion (a 6% decrease), and Bush's own OMB isn't predicting revenue will return to Y2K levels until FY 2008.
In the meantime of course spending has surged upward. Gross outlays in FY 2000 were $1.79 trillion and in FY 2005 were $2.47 trillion, a 38% increase before inflation. Factoring in inflation leaves gross outlays at $2.18 trillion in FY 2005, a 22% increase in real dollars.
IV,
How much of the federal revenues were from cap. gains taxes on trading of internet stocks in 1999 and Early Y2K? These gains were 99% speculation and represented phantom valuations. How long did it take the general stock market to recover from the collapse of this wild speculation? (hint: the market recovery co-incided with the return of revenue to the feds.)
How much of a hit did the economy take due to the attacks on 9/11?
At what level would unemployment, GDP and federal revenue be were it not for the stimulus provided by the tax cuts?
I decided to answer some of my own questions. I could only find total capital gains data up to year 2003...
http://www.irs.gov/pub/irs-soi/03indtr.pdf
Figure K has the total reported capital gains. The record for reported net Cap Gains was $630 billion in 2000. That dropped to $326 billion in 2001 (mostly due to the bursting internet bubble) and to $238 billion in 2002 (mostly the after effects of 9/11). Revenue (assuming 28% rate) would have been $176 billion in 2000 and $66 billion in 2002 (actually less due to a rate cut) for a change of at least $110 billion due to a drop in the capital gains revenue. That alone is nearly half the total change in revenue.
Lib: Thanks for the link. Interesting article, and actually I think it fits in nicely with this topic.
I'll start adding open threads though. I figured there weren't really enough visitors here to warrent them, but I'm happy to give you guys a place a talk, especially when I don't always have time to put something more substantive up.
... Ami.
Indy: I think the crux of Libertarian philosophy is small government. Cuts in taxes are simply a means to this end. So in that sense I don't think Niskanen is contradicting himself.
... Ami.
Stryker: The argument further than saying that lowering taxes doesn't automatically reduce the size of government. He's arguing that lowering taxes beyond (in the U.S.) 19% of GDP actively increases the size of government. That's what makes the theory so interesting.
I'm not necessarily buying into it myself, but the idea is neat and makes some sense at least at first blush. If citizens don't have to pay for bigger government then they might naturally demand more of it - after all they're getting something for free. So the way to get citizens to demand smaller government is to make sure they're paying the full cost.
... Ami.
Brian: The idea that fiscal stimulus can increase growth in the short term has been accepted since (at least) Keynes. The controversy is whether or not this is enough to make tax cuts pay for themselves. The evidence suggests that it's possible in very extreme cases (early '80s Sweden, like I mentioned), but not in general.
I could make an equally valid claim that increases in government spending pay for themselves. After all, they stimulate the economy in the same way as tax cuts, so it's reasonable to expect this to cause higher tax revenue. There are probably cases where my theory would be true: social security in China might turn out to be such a case.
But even a hopeless lefty like myself is forced to admit that, in general, higher spending doesn't pay for itself. Since the mechanism for my theory and the Laffer theory are the same, it's quite difficult to support (or deny) one and not the other.
... Ami.
Ami,
I think one reason tax cuts work better than spending increases for improving economic conditions is efficiency. Many of us believe that government bureaucracies cause too much waste and inefficiency in nearly everything they do.
Allowing people to spend the money where they choose rather than having the government make the decisions improves the efficiency of money use. This extra efficiency provides extra stimulus.
Ami, the libertarian philosophy does call for small government, both on economic issues (they tend to be well to the right fiscally) and social issues (they tend to be well to the left socially). The Libertarian Party repeatedly calls for directly limiting the government's ability to raise revenue, which is why I find Niskanen's 2nd and 3rd implications to run counter to libertarian philosophy. Granted, there are differences between libertarians and Libertarians, so maybe jacking taxes as a means of reducing spending (or spending growth) can be reconciled with libertarianism, but I just don't see it from my layman's viewpoint.
BH, you're overstating revenue from capital gains, probably by about 50%. First, you've ignored the capital gains exclusion which individuals or couples can claim for selling their principal residence (and I believe secondary residences also): that's $250,000 per individual per sale. Second, according to wikipedia, capital gains tax rates averaged only about 20% before 2003, not 28% as you note. Your estimate that 50% of the revenue loss between 2000 and 2003 is due to this one factor appears to be a significant overstatement.
No president since Harding has overseen a revenue loss in three consecutive years, as Bush has. Hoover, at the onset of the Great Depression, saw revenue drop for only two years. Roosevelt, during the Great Depression, saw revenue drop only once, in 1939. In the 40 years prior to Bush's election revenue dropped only twice: in 1971 and in 1983. Bush's "achievement" at having revenues fall in three consecutive years is truly historic, and matched only by Harding - one of the worst presidents ever - in the post-1900 period (the period I have data for).
Indy, would you mind reposting the link for federal revenues and expenditures you have? You gave it out long ago, and I've managed to lose it.
As for the 3 years of revenue decreases and its historic nature, I'll give you that. However, 9-11 was also historic, and the loss of assets, coupled with the reduced economic activity that happened because of it (for instance, the sharp reduction in hotel and airline services), certainly had a real impact. I don't remember what the actual dollar figure of losses were to the economy, but I seem to remember somewhere in the $1 trillion range (could be wrong, feel free to correct).
Taking that into account, I think it reasonable that 9-11 caused a 2 year slump in revenues. Add in that tax cuts tend to lower revenues in the 3rd year (as your figure of '83 declining in revenues seems to support), and I can understand why it happened.
There are certainly things that Pres Bush has done wrong (spending, for one), but I don't think those 3 years of revenue drops was particularly avoidable given the circumstances.
Richard, all of the federal revenue and expense numbers I used came from the Historical Tables included in the president's own FY 2007 budget request, specifically tables 1.1, 1.2, and 1.3. I don't have a direct link, but it's available on the OMB page of the white house's web site. It's a pretty large pdf file; you may want to download it and open it locally rather than try and open and read it on the net.
My view is - and has always been - that the primary culprit for the loss of revenues was the games Bush and the Congress played with the tax code in 2001 and 2002 (and 2003, though this should not have affected revenue much in 2003 itself). The economic distress of 2001-2002 paled compared to that of 1990-1992, 1982-1983, or 1973-1975, yet federal revenues continued to rise in all of those years except one (1983).
Remember, after inflation is factored in, Bush isn't predicting that revenues will equal what they were in FY 2000 until FY 2008 - a full 8 years of less-than-record real revenue. We're still not out of the woods on the damage caused by the Bush tax cuts. And spending increases.
The economic distress of 2001-2002 paled compared to that of 1990-1992, 1982-1983, or 1973-1975, yet federal revenues continued to rise in all of those years except one (1983).
That's an interesting claim, Indy. I'm curious on what you base that, because I'd think 9-11 would have a more significant impact than Pres Nixon's resignation or the tail end of Pres Carter's impact on the economy.
Thanks for the general info on where to find those tables, Indy!
IV,
The numbers I gave were the net capital gains claimed on schedule D. That is the taxable capital gains after deducting capital losses and would not include the amounts excluded for the sale of a principal residence. Those are the amounts used to compute individual taxes.
I'll defer to your research and accept that capital gains were taxed at 20% prior to 2003. It's still a significant piece of the difference in collections. The $630 billion taxes at 20% would be $126 billion in revenue. The $238 billion taxed at the same 20% would have been $47.6 billion for a difference of $78.4 billion. That's closer to 1/3 of the drop in revenue rather than 1/2 but that's just 1 piece of the change in income attributable to the internet bubble and 9/11.
There were significant losses of high paying tech sector jobs when people discovered that all those internet companies didn't really have any value. There were additional significiant job losses in nearly all sectors after 9/11. It's a good bet that most of the additional $172 billion in lost revenue was due to these factors.
Most of the recovery in jobs and return of federal income was due to the economic growth we've experienced since Bush's tax cuts. You can argue wether Bush's tax cuts or Fed action were more responsible for this growth, but the growth did occur. I'd argue it was a combined effect and it's difficult (impossible?) to tell how much growth was due to each type of stimulus.
IV, Brian:
You guys aren't using the same facts to come to your respective conclusions. IV's focused on tax cuts (which certainly decrease revenues short-term) and Brian on 9/11. I, for one, want to know what the basis is for saying 9/11 didn't have the most significant impact in this argument. Didn't economic output significantly drop the next year?
Hi Richard,
I'm suggesting that the internet bubble and 9/11 were a large portion of the drop in revenue and that drop would have occurred regardless of the tax cuts. Any critique of the effects of the tax cuts should also include the effects of those events.
Of course the cuts caused an initial drop in revenue. That's expected and is the primary engine of the stimulus. After a while, the tax cuts actually cause an increase in revenues. That's also expected. Did the tax cuts cause enough of an increase to match the increase that would have come anyway? That's more difficult to know, possibly not (depends on your prediction of economic activity without the tax cuts).
But I really don't care. The fact is that we ARE collecting more revenue now than in 2000, AND we have higher employment and an economy that's built on real businesses rather than a phantom industry. I prefer a slightly lower rate of gain if it gives me higher employment and less misery.
I agree with you on the cause, Brian, but I don't think you effectively communicating it to Indy, nor did you address short-term revenue declines due to tax cuts until I mentioned it (I know you know it, but it wasn't mentioned).
As per the bubble, it started collapsing in mid to late '00, and that's long before Pres Bush's tax cuts were even signed, much less had an impact on revenues. Something that always gets me in these tax debates is that you can't realistically include the 1st year a tax cut is signed into law, because they typically don't go into effect until the next fiscal year.
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