Conservative Delusions on Tax Cuts
May 10th, 2010 . by economistmom
There are two main delusions ideological-but-not-thoughtful conservatives have about tax cuts: (i) they pay for themselves (supply side to the extreme, known as the “Laffer Curve” effect); or (ii) they don’t pay for themselves and so they restrain spending (the “starve the beast” argument). They obviously can’t both be right, and it turns out that neither are right.
A very thoughtful and brutally honest article by Kevin Williamson in the May 3rd issue of the National Review declares “Goodbye Supply Side”–because there’s just no evidence that at today’s marginal tax rates, cutting rates could spur so much economic growth that revenues would actually rise. Williamson quotes Arthur Laffer himself confessing:
Arthur Laffer, whose famous (and possibly apocryphal) back-of-the-napkin diagram launched supply-side tax policy, readily concedes that the growth effects of tax cuts are oversold in the political debate. “Does every tax cut pay for itself? No. I think Irving Kristol wrote that, once — and then did a pretty good job of arguing for it. But if some guy running for Congress in Clayton County, Texas, says all tax cuts pay for themselves, what do we want to do? Go after him with a shotgun? Sure, they’re going to cite me, and there’s very little I can do about it. But there’s the same amount of ignorance on the other side, ignoring the economic feedback effects of tax cuts.”
…and Williamson goes on to explain the difference between recognizing that marginal tax rates do affect economic decisions and being delusional about how large those responses are:
[S]uch magical thinking is not the exclusive domain of back-benchers from the hinterlands. The exaggeration of supply-side effects — the belief that tax-rate cuts pay for themselves or more than pay for themselves over some measurable period — is more an article of faith than an economic fact. But it’s a widespread faith: George W. Bush argued that tax cuts would serve to increase tax revenues. So did John McCain. Rush Limbaugh talks this way. Even Steve Forbes has stepped into this rhetorical stinker from time to time…
[I]n truth, nobody really should run for office on the supply-side revenue effects of tax cuts, either. As it turns out, they present a dry and technical question of limited interest to the general electorate. It is true that tax cuts can promote growth, and that the growth they promote can help generate tax revenue that offsets some of the losses from the cuts. When the Reagan tax cuts were being designed, the original supply-side crew thought that subsequent growth might offset 30 percent of the revenue losses. That’s on the high side of the current consensus, but it’s not preposterous. There is, however, a world of difference between tax cuts that only lose only 70 cents on the dollar and tax cuts that pay back 100 cents on the dollar and then some…
And when conservatives can’t rely on the myth that tax cuts raise revenue, they turn to the argument that if they lose revenue, then all the better(!)–to “starve the beast” of government spending. Kevin Williamson also dismisses that as another delusion about tax cuts:
[T]hat’s one thing the gentleman from Clayton has right: Tax cuts aren’t really the problem. The hot action is on the spending side of the ledger, and nobody wants to touch it. The problem with magical supply-siderism is that it gives Republicans a rhetorical and intellectual framework in which to ignore spending — just keep cutting taxes, the argument goes, and somebody else will eventually have to cut spending. The results speak for themselves: Tom DeLay and Dennis Hastert and Trent Lott and Bill Frist all know how to count, but, under their leadership, Republicans spent all the money the country had and then some. Deficits boomed, and Republicans’ claim to being the responsible britches-wearing adults when it comes to spending got unpantsed. Cutting taxes is easy. Cutting spending is hard.
Bruce Bartlett points out in his latest Forbes column that the “starve the beast” theory is so wrong in practice that tax cuts in fact have had just the opposite effect, ironically feeding the beast of government spending as well as the uglier beast of budget deficits:
["Starve the Beast"] remains a critical part of Republican dogma. On April 8 Rep. Michele Bachmann, R-Minn., told right-wing talk show host Sean Hannity that the Republican response to health care reform would be to “starve the beast” by refusing to fund it. On April 14 Sarah Palin begged her followers in Boston to “please starve the beast” by resisting any tax increase, no matter how large the budget deficit.
Despite its continuing popularity among Republican politicians, at least a few conservative intellectuals are starting to have misgivings about STB. In 2005 free-market economist Arnold Kling admitted he had been wrong. “Cutting taxes did not help to reduce the size of government,” he conceded.
For some years Bill Niskanen of the libertarian Cato Institute has argued that STB actually increased spending and made deficits worse. His argument is that the cost of spending is ultimately the taxes that will have to be raised to pay for it. Thus fear of future tax increases was the principal brake on spending until STB came along. 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 confirms Niskanen’s analysis. “Revenue reductions by themselves are not an effective mechanism for limiting expenditure growth,” New 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.
Why didn’t “starve the beast” work as Bruce explains Milton Friedman and Ronald Reagan once claimed it would? (emphasis added):
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. As he told a nationwide audience that night, “Over the past decades we’ve talked of curtailing spending so that we can then lower the tax burden. … But there were always those who told us that taxes couldn’t be cut until spending was reduced. Well, you know, we can lecture our children about extravagance until we run out of voice and breath. Or we can cure their extravagance by simply reducing their allowance.“
Well, maybe because when you reduce a kid’s allowance, he doesn’t normally just turn around and max out his credit card…
Or as Kevin Williamson puts it (emphasis added):
This we know: Tax cuts don’t get us out of the spending pickle, and growth isn’t going to make the debt irrelevant. Legislative mandates and gimmicks like spending caps and the like will not constrain the spendthrift habits of appropriators — because, if they do, they will be repealed, just like Gramm-Rudman was. You can’t starve the beast if the Chinese and the bond markets keep lending him bon-bons by the ton. And the prospect of enacting a balanced-budget amendment to the Constitution is a castle in the sky.
So these Laffer-curve and “starve the beast” theories are both delusions that only encourage us to keep feeding the debt monster, while our revenue base continues to waste away.
Note well that the leading conservative and free market political thinker and economist — Friedrich Hayek — opposed the fantasy of restraining oppressive government via tax cut without spending and regulatory reform from the very beginning of the Reagan Presidency.
One more instance were Hayek got it right and Friedman botched it — and not without coincidence the deep issue is capital theory which Hayek understood and Friedman, well, didn’t.
You’ve grossly mischaracterized Laffer’s view .. Just for the record.
STB didn’t work? Why did President Obama promise to freeze spending and why hasn’t another stimulus bill been passed yet despite all the clamor for one? Do you really think there would be hesitation to spend more if the budget was in balance today?
I’ve read a few of your posts EconomistMom, and there seems to be many many programs and services you’d like the government to start providing. Without the budget constraint imposed by record high deficits, what would stop these proposals from being passed? We only need to look at state budgets to see that STB is the only thing that keeps states from spending even more. Despite tax and fee increases and revenue growth that has outpaced population growth for the last decade even with this recession, states governments around the country are now asking for even more tax increases instead of a cut to spending. There is no end to the cycle of tax, spend until broke and a crisis comes, then ask for more tax increases.
With all the upcoming liabilities that will have to be paid, I don’t understand how you can advocate more spending. It will be a miracle just to borrow and tax enough to pay for the trillions that Social Security, Medicare, and the new Health Care bill will cost.
There always will be someone who needs something, that’s the harsh truth of reality–we live in a world of scarcity, not everyone can be provided everything. Is there a point where you would say that there is enough being spent by government? If so, please make a post about it so people like me can be clear on your position. At what point would you say, I will support no more spending. I’m guessing that will be when some unrealistic utopia where everyone has a middle class lifestyle is established. Of course, not everyone can have a middle class lifestyle since it is a relative standard. I hope you’ll post about what your limits are, at what point would you finally be content, content enough to allow people to keep what they earn?
But here’s the rub. It isn’t really about STB. It’s about whether the beast’s appetite is unaffected by how much food he gets. Here the evidence depends on the timeline by which you look at the data. Over short periods of time, you might say it’s uncertain. Over long periods of time, the best seems to eat about 2 to 3% of GDP more than you feed it, regardless of how much you feed it.
I think it likely true that starving the beast does not produce a short run response of restraint; however, it does produce a long run response. Let’s do a thought experiment. Let’s say with no policy changes, tax revenues suddenly increased to 22% of GDP. Do you think changes on the spending side would be more likely or less likely than today?
Let’s do another. Let’s say now that tax revenues increased to 25% of GDP, do you think government would me more likely or less likely to create expensive new programs than it is today?
In my world view, it’s not starve the beast, it’s please don’t feed the bear. I fully accept that simply depriving the beast of revenue will not curb its appetite once the appetite has been established; however, I do believe that providing the bear with more revenue will make its appetite even larger. All of the critiques of STB fail to deal with this issue and it is this issue that is most germane to our current budgetary woes.
I don’t think any serious analyst believe that tax cuts are the way to solve the budget problem; however, I think the counter position that we should just raise taxes to give the government what it “needs” ignores the fact that government needs expand.
Reality,
Although I disagree with many of EM’s posts about taxes, I think you are misrepresenting her position (perhaps because you have not read enough of her posts). She favors spending restraint as well as revenue increases. She has a bee in her bonnet about what she perceives as Republican idiocy on tax increases and, on that front, I happen to agree with her. The no new taxes ever view is not going to generate a reasonable solution to the budget crisis.
Having said that, I suspect out of 100 percent of the problem to be solved, she and others who post here would probably argue that taxes should bear the lion’s share of the burden since they seem to believe that absent the military (and the lovely waste fraud and abuse), there isn’t a lot of cutting that can be done.
Comparing states and the Feds is comparing apples and oranges. Most states have constitutional balanced budget requirements. The Feds do not. STB can’t work directly without some requirement for balance. And, we should remember that, even in the states, the Feds are borrowing money on their behalf and giving it to them, undermining even the state level STB approach.
Diane, that was an excellent exposition. I doubt that these myths are widely believed by conservatives, but they deserve debunking.
Starve the beast is clearly false as long as the borrowking window stays open, but it has a germ of truth, as stated above “please don’t feed the bear”.
What will actually starve the beast is a sudden end to the government’s ability to borrow at reasonable rates. The end will be sudden, arriving over a matter of days, not months, as it did for Greece.
When that happens, the starvation will be so extreme that even conservatives will agree to a VAT. At the same time, all those formerly unthinkable spending cuts will be unavoidable.
I think it is valuable to understand the main themes of the arguments about taxes and EM has done a good job of examining the tax cut arguments: STB and Laffer. Laffer is treated better than STB in EM’s post. Yes, some take his argument too far, but that is how we conduct public debate today, straw men and exaggeration. EM points out that Laffer doesn’t agree with all of what is attributed to him. Tax policy, however, does affect behavior, and some tax increases won’t raise as much as thought and some tax decreases won’t cost as much as thought, which should help us create more effective and less painful taxes.
STB isn’t treated as well in EM’s post. STB isn’t working because the Federal government can still borrow and devalue the currency. Eventually this will end (Stein’s law: If something cannot go on forever, it will stop.) The question for us should be how will it stop? EM argues for a rational policy of spending reduction and tax increases. Without change we will end up in some sort of very ugly crash. Sometimes we need to see the edge of the cliff before we decide to turn and STB is a little like driving towards the edge. Is a crash event that happens sooner (or reaching the edge sooner and changing) better than a deferred crash event (and later change)? EM is right, STB hasn’t worked in the short term, we’ve taken the cash, left the Visa card.
At the state level, STB is alive and well. The only error was in thinking that it would be effective in the short term. Colorado’s legislature has passed a bill requiring the institutions of higher ed to submit reports on how they will respond to a 50% cut in state funding. Arizona has dropped its SCHIP program and substantially restricted its Medicaid program.
Many, perhaps most, states are up against the political limits on state and local tax rates. The cost of programs like education and Medicaid are growing faster than state revenues. Within state legislatures, the idea that dropping programs and doing the remaining programs well, rather than keeping all the programs and doing them all badly, is beginning to gain some traction.
STB is starting to work at the state level precisely because and only because states’ borrowing ability is beginning to end. Diane is correct that STB does not work when governments are free to borrow the deficit at low rates.
Republicans aren’t stupid. They win votes by promising lower tax rates. Democrats win votes by getting high income earners to pay taxes for lower-income earners who vote Democrat. Who wins votes by promising lower deficits?
The people who are stupid are the donors to the think tanks like Concord Coalition and other so-called responsible budget watchdog groups. They pay policy wonks like D. Rodgers and B. Bartlett and other moralizers to write the same old stuff I’ve read since 1981, only with a different spin or data set. What a waste of money.
The voters are responsible for deficit spending for the same reason that good girls like to fool around with bad boys that play guitars in bands, drink heavily, and ride motorcycles. It’s bad in the long-run, but they only see the short-run fun.
Force voters to confront their folly by making them accountable for deficit spending. A Debt Limit Referendum (see http://www.thepeoplesdebt.com ) would end the careers of the politicians who cannot mathematically reconcile their tax and spending policies. That’s what we should be working to achieve, instead of pretending that warnings about the dangers of bad boys will be heeded by good girls.
BTW, the STB crowd is just as phony and divorced from reality as the Obamacare advocates who pose as deficit hawks. I’m not naming any names, but you know who you are.
From the article:
Some people are more sensible about that Laffer Curve talk. Laffer, for instance…“Does every tax cut pay for itself? No. I think Irving Kristol wrote that, once — and then did a pretty good job of arguing for it. But if some guy running for Congress in Clayton County, Texas, says all tax cuts pay for themselves, what do we want to do? Go after him with a shotgun? Sure, they’re going to cite me, and there’s very little I can do about it. But there’s the same amount of ignorance on the other side, ignoring the economic feedback effects of tax cuts.”
No, that’s not Laffer being “sensible”. That’s the typical straw man combined with sleight of hand practiced by hyperpartisan conservative economists who want to sound respectable while still bullsh*tting in a way that enables their ignorant hyperpartisan followers to maintain their beliefs, and enables him to save face. No, Art Laffer, it’s not just that not all tax cuts pay for themselves, it is that it is rare that they do and it would be highly unlikely, in general, for this to result from income tax rate cuts from where they are today, particularly from broad based rate cuts*. And no, there is no comparable “amount of ignorance on the other side, ignoring the economic feedback effects of tax cuts.” Sure, there is CBO’s practice of static scoring, but CBO acknowledges that static assumptions are probably not realistic, and no economists nor anyone with a clue makes such assumptions, ruling out (or even considering unlikely or vastly underestimating) dynamic effects and thus revenue feedback effects.
* For another example of this nifty trick, see this Cato video in which Dan Mitchell, although he explains that it is “very rare” that tax cuts pay for themselves, puts as the recap bullent point, “Not all tax cuts pay for themselves” http://www.youtube.com/watch?v=fIqyCpCPrvU
Well if tax cuts don’t pay for themselves, then I wonder why the Keynesians claim that deficit financed government spending increases always pay for themselves? You’ve got to wonder about the logical consistency of the ecnomic reasoning that could arrive at those divergent conclusions.
The Laffer Curve is simple a restatement of Rolle’s Theorem from your introduction to Calculus class. Apply to a reduced form equation in 2 dimensions (tax rates, and tax revenues) taken from a muti-variable world.
How about instead of viewing taxes as income for the government (talking federal here) we view taxes as just a regulator of inflation?
If the government took no money in would it be out of money? Does the government ever have money or even need money?
Of course not. They own the printing press. What’s that you say? What about the debt? What debt? If the government can create a debit it can create the credit. What do you mean the government can only create debt? Why can’t it create the money to pay the debt? Really? Why not?
So, forget the debt and forget STB. It doesn’t matter. But, perhaps we’re not talking about the right beast.
Please don’t feed the troll.
Is that your Starve The Troll theory?
So these Laffer-curve and “starve the beast” theories are both delusions that only encourage us to keep feeding the debt monster, while our revenue base continues to waste away.
As an example to show that the Laffer-curve delusion is still alive and well, I ran across an article at this link. Following is an excerpt:
If you do the math, it is clear that the only way out of a debt crisis is to cut taxes in order to increase economic growth. As an example, let’s take the case where we eliminate the corporate income tax, thereby reducing the Federal “tax take” to 16% of GDP. It would take only a 0.11 percentage point increase in economic growth (to 2.11%) to “pay for” this enormous tax cut, and only an additional 0.2 percentage points of growth (to 2.20%) to raise U.S. debt capacity to 103% of GDP.
Further on, the author states:
At an average real economic growth rate of 3.0% annually, the debt capacity of the U.S. government becomes infinite.
Hence, if we can just get our average real economic growth rate up to 3 percent, we can borrow all of the money in the world and then some! In any event, the above wisdom comes to us from our friends at the Club for Growth.
I hope it works ; )
B Davis,
Thanks for a very out of context couple of quotes. The quotes all simply reflect math assuming a real interest rate of 2.9%. That’s what people call an assumption. It’s an assumption that might or might not be correct. And by the way, his math is correct, if you are simply looking at debt service ratios over very long periods of time and using simplistic models where debt service is the only concern.
What the author actually says is “if the real interest rate is pegged at 2.9%, debt service ratios (the thing that bond traders tend to look at) cannot become an issue if the real growth rate is higher than 2.9% in the long term.” That’s a bit different than your concluding paragraph but whatever.
Note, I’m not defending STB. I think it’s wrong. However, I do think that Don’t Feed the Bear (DFB) is correct. Namely, the more you feed the bear, the more he is likely to eat. Note that it is entirely logically consistent for STB to be wrong and DFB to be correct. A statement and it’s converse do not need to be both true or false.
Where’s the long list of proof points about why we should give the government more money and expect it not to increase spending from the baseline. Oh yeah, we don’t have any such evidence and I’m pretty sure that PAYGO isn’t going to stop the problem.
SteveinCH wrote:
Thanks for a very out of context couple of quotes.
You’re very welcome! Of course, I did provide a link to the article for anyone who wishes to see the full context.
The quotes all simply reflect math assuming a real interest rate of 2.9%. That’s what people call an assumption. It’s an assumption that might or might not be correct. And by the way, his math is correct,…
If you know the math is correct, then please reply to the following questions that I have about the author’s numbers. I truly want to understand his numbers so that I can better judge the validity of his arguments.
The author states:
The present value methodology makes it possible to calculate a country’s debt capacity, as a percentage of current GDP. Let’s take the U.S. as an example. The Social Security Trustees assume that from here “to the infinite horizon”, the U.S. economy will grow at a real average annual rate of about 2.0%, and that the Federal government will pay a real interest rate of 2.9% on its debt. Further assuming that Federal revenues will average 18% of GDP and that the government can devote 5% of its revenues to debt service, the maximum “debt capacity” of the Federal government would be 93% of GDP. In other words, lenders would be confident that the U.S. government would be able to service debt equal to about 93% of GDP.
Where does the 93% of GDP figure come from? If “revenues will average 18% of GDP and the government can devote 5% of its revenues to debt service”, then the government can devote 0.9% of GDP (0.05 * 18% of GDP) to debt service. This 0.9% of GDP is 0.97 percent of 93% of GDP. Is the author referring to the 0.9 percent difference between the real interest rate and GDP growth? In any event, by precisely what formula does one obtain the 93% result?
Further on, the author states:
Using the U.S. as an example, increasing the Federal Government’s “tax take” to 20% of GDP from 18% of GDP (say, by letting the 2001 and 2003 tax cuts expire) would increase the nation’s debt capacity to 103% of GDP. However, if these massive tax increases reduced GDP growth by just 0.11 percentage points, debt capacity would not increase at all. The Federal government would be back to where it started from, and the rest of the nation would be worse off.
Starting with the 93% of GDP figure, the 103% is correct since 93 multiplied by the increased take of (20/18) equals about 103% of GDP. However, where does the 0.11 figure come from? The one-year decrease in GDP necessary to counteract a (20/18) gain in “tax take” would be an (18/20) decrease in GDP. (18/20) multiplied by the prior assumed real increase of 2.0 percent in GDP would be real increase of 1.8 percent. That’s a reduction of 0.2% of GDP, not 0.11% of GDP. Is the author looking at an increased growth over more than one year? In any case, by what formula does the author obtain the 0.11 result?
The author continues:
If you do the math, it is clear that the only way out of a debt crisis is to cut taxes in order to increase economic growth. As an example, let’s take the case where we eliminate the corporate income tax, thereby reducing the Federal “tax take” to 16% of GDP. It would take only a 0.11 percentage point increase in economic growth (to 2.11%) to “pay for” this enormous tax cut, and only an additional 0.2 percentage points of growth (to 2.20%) to raise U.S. debt capacity to 103% of GDP.
A (16/18) decrease in take would require an (18/16) increase in the one-year GDP growth. (18/16) multiplied by the prior assumed real increase of 2.0 percent in GDP would be real increase of 2.25 percent. That’s an increase of 0.25% of GDP, not 0.11% of GDP. Once again, is the author looking at an increased growth over more than one year? And again, by what precise formula does the author obtain the 0.11 result?
The author continues:
Now, eliminating the corporate income tax would produce a seismic shift in the economy. Investment and employment would skyrocket. Let’s look at a case where the result was to increase long-term economic growth by 1.0 percentage points, to 3.0% (which is still lower than the U.S. average over the past 100 years).
At an average real economic growth rate of 3.0% annually, the debt capacity of the U.S. government becomes infinite. This is simply what happens when the GDP growth rate exceeds the interest rate. Note that this is true at a “tax take” of 16% of GDP, but it is also true at a “tax take” of 10%. Any percentage of infinity is infinity.
Is the author suggesting that we could cut the “tax take” to 0.0000000001 percent (or lower) and still have an infinite debt capacity? I assume that this has to do with the fact that a real GDP growth rate of 3.0 percent would be greater than the real assumed interest cost of 2.9 percent. This would mean that, if the government ran a primary deficit (the deficit not counting interest costs) of zero and borrowed all the money required to pay interest on the existing debt, the debt to GDP ratio would decline. That’s because each year’s new debt to GDP ratio would equal (1.029 * the old debt) divided by (1.03 * the old GDP). That would equal (1.029/1.03) of the old ratio. The government could then borrow the difference. However, how could the government possibly run a primary deficit of zero if their take is only 0.0000000001 percent (or lower)?
Earlier in the article, the author stated:
So, why are the markets worried about the Federal debt? One reason that the markets are getting worried is that the debt is rising rapidly and is projected to continue rising rapidly. Another reason is that, in addition to its explicit debt, the U.S. has unfunded liabilities in its Social Security and Medicare programs that have a present value of about $100 trillion-about twelve times our current bonded indebtedness.
However, the biggest reason that the financial markets are concerned about the U.S. fiscal situation is the same reason that they reacted negatively to Portugal’s announcements on April 22. Big deficits create the impetus to do something stupid-namely, raise taxes.
I would suggest that it is the rapidly rising debt and the huge unfunded liabilities in Social Security and Medicare (chiefly the latter) that most worries the markets. As can be seen in the graphs and tables at this link, the most recent budget projects that the primary deficit will grow going forward, reaching a record 24.3 percent of GDP by 2085. As a result, the debt is projected to rise to 830% of GDP by 2085, over 7 times the prior record level that it reached at the end of World War II. If the government is forced to run large and growing primary deficits, all of the authors calculations go out the window. It is these large and growing primary deficits, not the government’s ability to service it’s existing debt, that is the biggest problem and will likely be the biggest concern to the markets.
I truly want to understand his numbers so that I can better judge the validity of his arguments. The author states:
“… At an average real economic growth rate of 3.0% annually, the debt capacity of the U.S. government becomes infinite. This is simply what happens when the GDP growth rate exceeds the interest rate.”
This is absurd. With a real 3% growth rate and a 2.9% real interest rate he’s saying the US govt could borrow 35x GDP (considerably less than an infinite amount) — and pay more than 100% of GDP in interest to service it?
That’s all you need to know about the guy’s math. I’ve seen this phenomenon before in other forums: when engineers begin to lecture about economics they go nuts.
I imagine the guy may be confusing himself this way: If the growth rate is higher than the interest rate then any given debt level diminishes over time as a % of GDP. If one projects that infinitely into the future and then discounts to present value, one can come up with a number for debt/gdp ratio that is considerable lower than the current year number, and will always be so, making the long-term situation look OK.
Unfortunately for such analysis, that doesn’t enable one to survive the current year, as the Greeks are finding out. “Long-term fiscal sustainability” requires sustainability not only in the long run but in all the shorter runs too, starting in year one.
I completely agree with Jim’s point. That’s the flaw in his argument, not his math.
Starve the Beast doesn’t work…
This is a clear and strong claim that spending is not constrained by revenue. Which equally means that spending increases are not “liberated” by revenue increases. (If revenue level does not constrain spending, then increasing the revenue level will not increase spending.)
Does anybody at all really believe this?
Does Bruce Bartlett believe it? Does our host Diane really believe it?
If so, my first words in response are: “Social Security surplus”, the perfect natural experiment.
I could cite the SSA.gov history section quoting Bob Myers, former SS chief actuary and executive director of the Greenspan Commisssion, and Pat Moynihan, Commission member and Senate Finance chair, on how the SS surplus was created by accident and how Congress, as soon as it realized this, rushed to spend all that money without end. (Moynihan once got into entertaining exchange over whether this was “theft” or “embezzlement”.)
But with only two links per comment I’ll just quote a study by Kent Smetters (of NBER and Wharton):
Oops, the increase in revenue not only was all spent but increased debt. (There are other studies that find the same thing.) How’s that for spending?
Of course, this is entirely logical: The size of a credit line is determined by the amount of income. More income = bigger credit line == more debt.
Does anyone really disagree?
Why didn’t “starve the beast” work? … Well, maybe because when you reduce a kid’s allowance, he doesn’t normally just turn around and max out his credit card
Um, the point is that when you increase the kid’s allowance he turns around and maxes out his credit line too — at a larger amount.
And let’s not grossly misrepresent Milton Friedman on this, just because he can no longer speak for himself. (BTW, he saw the same things Bruce Bartlett did and still endorsed STB as working until his dying day.)
Friedman said politicians will spend all the money they can get through taxes and then also the maximum sustainable amount extra in debt, which averages to 3% of GDP (the average growth rate). Look at the deficit data for ALL the OECD countries since 1970 (I have) and tell me it’s not true. It is true for all of them, they all average impressively close to 3% (except Norway, with it’s all of 4 million people sitting on big oil field used as a national endowment).
Look at the US. Reagan deficits shoot up to 6%. Then tough paygo rules for a decade limit spending and reduce the deficit. Then a boom creates a surplus — and paygo rules disappear because of that. Bush II promptly pushes his average deficits to up near 3%. Then a steep recession pushes deficits way up higher — an a “bipartisan commission” is created to get deficits down again to a target of … 3%! (Coincidence?) … Now look at the records of the UK and the rest in Europe.
Exactly where was Friedman wrong?
The idea that STB “doesn’t work” because it hasn’t cut spending programs like some people would like is totally sophomoric at best — and, well, disenenuous by those who know better.
STB works on a points of GDP scale and works to constrain spending growth. If revenue constrains spending, it works.
Here’s Rudy Penner, CBO head when the late-1990s surplus came in, to Brad DeLong:
Gee.
Now here’s Krugman wailing about how the revenue level set by Bush is constraining Democratic spending today…
Revenue doesn’t constrain spending? Well there’s a couple of people who think it does. [Google up the links.]
Denying that “revenue constrains spending” is the foundation for arguing “Raise taxes now! VAT now! Because the revenue increase will not be spent away by politicians, and so will happily reduce the debt.”
That sounds nice, but let’s look at the data points for “VAT & fiscal responsibility”: Greece, Spain, Portugal and Italy all have VATs and are at the cliff’s edge (or over it) today. The big EU nations, Germany, France and the UK are all projected to go over the cliff at the same time as the US or sooner. How have their VATs helped?
In fact, they all are in an unambiguously worse position than the US, because they don’t have a potential VAT in reserve to enact at crisis time, to keep from going over the cliff. (What efficient new extra tax can Greece enact today?)
So the data looks like it 100% says: “VAT –> future fiscal crisis”. How the heck can anyone look at all that data and say: “VAT equals future fiscal crisis averted”? Except as one of the secular world’s religious-type beliefs, deeply held in spite of all real-world evidence to the contrary. Really, I’m asking.
In fact here’s an open challenge to Bruce Bartlett, Diane, anyone else who is arguing “VAT now!” Explain clearly and specifically how revenue received from a VAT enacted 10 to 20 years (we hope) before the US “fiscal crunch” hits won’t be consumed by politicians in the meantime, as per all the EU examples — leaving us in even worse shape then.
This requires openly declaring either…
(1) “Revenue does not constrain spending. Thus the revenue increase from a VAT will not be consumed by politicians but increase national savings in like amount — notwithstanding the example of the Social Security surplus, Penner on the suplus and paygo, the examples of all EU nations consuming their VAT revenue…”
or
(2) “Indeed politicians usually do rapidly consume revenue increases, as per the US Social Security surplus, the late 1990s fiscal surplus, all EU VAT revenue, etc. Indeed, they may even increase deficits with additional revenue, as the national credit line increases with revenue and politicians use it (as per Smetters and the SS surplus, and all those EU nations with VATs and big debt loads). However, this will not happen with the VAT that I propose because of the specific mechanism I include as part of the tax which will prevent it, which is…. [xxxxxxx]”
Anyone up for that challenge? Until someone is I can only conclude nobody is truly serious about revenue not constraining spending, and must equally conclude that engaging in “Bloat the Beast” with premature tax increases that will only be consumed — at a time when we already have $100 trillion (!) of unfunded entitlement liabilties — will only take us in the fiscal direction of Greece.
Which means the only way to use a VAT to create fiscal responsibility is to follow the 1983 model of Social Security reform: Wait until the crisis hits, then enact a VAT when its revenue can’t be spent on anything but debt reduction — and then only as part of a deal that gets the spending side people to cut waste … including such “radical reforms” as increasing the benefits age for Medicare to 67 and means testing the richest out of benefits, which have already been adopted for Social Security!
The 1983 Social Security reform was almost exactly 50% benefit cuts and 50% tax increase — so don’t anyone say “politically, benefits just can’t be cut”. They can. And until they are, I say “not a penny” from a VAT or any other tax increase … because the increase will only be wasted and leave us that much worse off in the long run.
Now, admittedly, “wait until the crisis” brinksmanship is an unhappy way to deal with the problem — but it can work, and it did in 1983.
If anyone has a better way to deal with it make me happy and show me, such as by answering to #2 in the challenge above.
As I’ve said. Don’t Feed the Bear. Even if starving the beast didn’t stop the spending (which as AMT points out is not entirely obvious), it doesn’t mean that giving the beast more food will not increase its appetite. To the contrary, the evidence suggest that it will
Jim, here’s what I posted at tax.com. The first paragraph is what I was responding to:
>As David Leonhardt pointed out in the New York Times, “We just can’t afford the unrealistic promises that the government has made. We need to make choices.” Choice one could be taking a good hard look at our mostly lunatic tax expenditure budget.
I was thinking that choice one could be repealing the recent massive expansion of government promises for subsidized health care. Given that prior promises for Social Security, Medicare, and Medicaid need to be broken, why did we add another one to the list? Repeal it now before it takes effect and we will solve at least that portion of the problem.
Choice two could be means testing and benefit cuts that bite deeper over time, breaking government promises in a gradual and predictable way. Otherwise a bond market crash will force the promises to be broken suddenly and massively.
Choice three could be a VAT, once choices one and two are in place. These three actions would avoid the bond market crash. However we all know that these steps cannot happen prior to a crash. The public will never accept the pain until the need is apparent. By then the crash will have happened.
End of quoted post.
Speaking of sudden and massive breaks in the safety net, California is once again leading the way: http://www.latimes.com/news/local/politics/la-me-state-budget-20100515,0,6650342,full.story
My favorite Arnold quote: “California no longer has low-hanging fruits”. Just nuts and flakes.
SteveinCH wrote:
I completely agree with Jim’s point. That’s the flaw in his argument, not his math.
In your prior post, you gave a qualified defense of his math saying “his math is correct, if you are simply looking at debt service ratios over very long periods of time and using simplistic models where debt service is the only concern”. You repeat that here, saying that there is no flaw in his math. I never say that someone’s math is correct unless I’ve actually checked it myself. Have you done so? If so, please answer my questions in post #19 and tell me the formulas by which you obtain the 93% of GDP and two 0.11 percent figures.
In any event, I agree that there are also flaws in his arguments. One is that he makes no explicit mention of the concept of a primary deficit though most of what he says seems to depend on the country having a primary deficit of zero. I ran across an article that seems to explain this entire relationship much better at this link.