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How Tax Cuts Can Grow, Not Shrink, Government

January 18th, 2011 . by economistmom

Here is one of my favorite presentations from the Tax Policy Center/Loyola Law School conference I participated in last Friday:  the Tax Policy Center’s Donald Marron and Eric Toder explaining how tax expenditures can reduce revenue but grow government at the same time.  They show how adding “spending-substitute tax expenditures” to the definition of government spending more than doubles the measured size of government (see charts #18 and 19).

If only Tea Partiers could grasp this, then they might realize the logical inconsistency between their desire for more tax cuts, a lower deficit, and smaller government.  And if conservatives who want smaller government begin to realize that raising more revenue by reducing tax expenditures (broadening the tax base) would actually shrink government, and at the same time liberals who want the rich to pay higher taxes begin to realize that reducing tax expenditures would actually raise revenues in a progressive manner, then I think we would have a recipe for bipartisan consensus on one of the smartest ways to reduce the deficit.

9 Responses to “How Tax Cuts Can Grow, Not Shrink, Government”

  1. comment number 1 by: SteveinCH

    So all we have to do is redefine lack of taxes as spending and we’re done. Good luck with that. The presentation defines size of government as foregone tax revenue. I rather doubt you are going to get conservatives to agree to that.

  2. comment number 2 by: SpendingHawk

    The UK has shown how cutting spending can actually reduce government at the same time as raising taxes.

    If only liberals and conservatives would realize this, then I think that we’d have a recipe for bi-partisan consensus. Unfortunately, we have partisan think tank wonks generating papers that continue to focus on raising tax revenue without reducing non-defense spending and pretending that they really care about a bi-partisan deficit reduction strategy.

    So far Kevin Williamson at National Review is the only bogger I’ve seen who has articulated how this consensus will have to be reached. The left keeps pretending that the welfare state will continue on its exponential growth trajectory while the right continues to believe that starving the beast without cutting his appetite will be a successful long-term strategy. There will be bi-partisan pain. A very large pain.

    I’m disappointed to read how Economistmom continue to engage in denial and misdirection.

  3. comment number 3 by: AMTbuff

    Diane has quoted very selectively from Marron and Toder’s presentation: “tax expenditures can reduce revenue but grow government at the same time. They show how adding “spending-substitute tax expenditures” to the definition of government spending more than doubles the measured size of government (see charts #18 and 19).”

    Read the presentation yourself and you will see what I saw. First, the (Narrow Measurement) baseline from which the size of government purportedly doubles entirely omits transfer payments. That’s right, in this fantasy baseline Medicare, Medicaid, welfare, Social Security, and more do not count as government spending, as if they have no effect at all on the economy. Doubling an artificially depressed baseline is a mathematical trick, not a brilliant insight.

    Second, Marron and Toder do an excellent job of presenting just the facts in a non-partisan way. They explain that tax expenditures depend completely on baseline assumptions, and that there are 4 types of tax expenditures, with my examples of each:
    1. Spending substitutes (stimulus rebates)
    2. Targeted incentives to reallocate resources (hybrid tax credits, various business tax credits)
    3. Substitutes for transfer programs (EITC)
    4. Departures from both income and consumption tax base (exclusion of imputed income from owner-occupied housing)
    Some items fall into more than one category. Some items that people like to label tax expenditures do not fall into any category. For example, tax deferral for retirement savings do not depart from a consumption tax base. I’ll bet that Marron and Toder are counting them in category 2 regardless, but that would be inconsistent with their structure.

    Marron and Toder state “Other tax expenditures [not in these 4 categories] are just tax policy choices. I agree completely. Some who use the term “tax expenditure” are overreaching into the realm of tax policy choices, while pretending that removing tax breaks is always and everywhere equivalent to reducing spending. It’s not.

    Marron and Toder see clearly on this issue. I wish that all commentators shared their level of knowledge and objectivity.

    Incidentally, the most shocking fact in Marron and Toder’s presentation was this: “Accrual cost of federal employee and veterans benefits in 2010 was about $500 billion higher than their cash cost.” Congress never runs out of ways to dig the fiscal hole deeper!

  4. comment number 4 by: Arne

    Even without the text of the presentation it seems obvious that the real point is that what you think is the size of the government depends on a number of factors which are open to interpretation. There is no one answer.

    The point about veterans benefits is just an example of the answer depending on the definition. (After all, what is the accrual accounting for taxes that have not been collected yet?)

    If worker’s payroll taxes were half and retiree’s benefits were half, would that really mean government was smaller by that much? Government does not decide how the money is spent.

  5. comment number 5 by: Brooks


    I don’t know why, with this issue, you always insist on focusing on a few relatively inconsequential trees rather than on the important forest.

    Yes, some people sometimes may be including in their definition of tax expenditures some relatively small portion of items that are arguably not similar to explicit expenditures. ok, got it. So what?

    Is that point worth side-tracking discussion of an important issue and distracting people who are having enough trouble understanding the basic conceptual point that you finally acknowledged was valid (after laborious back and forth and much teeth-pulling by me — final leg of it at ), which is that it is nonsensical for conservatives to defend a subsidy that is provided via tax deduction or credit on the basis that it supposedly represents smaller government, lower spending and lower taxes, if they would attack the same subsidy if it were provided in explicit spending form on the basis that the latter represents bigger government, higher spending and higher taxes?

    As soon as this issue comes up you always insist on a detour to a sideshow.

    It’s like whenever someone points out that we should be eating more vegetables you say “Hey everybody, listen up: A lot of people are including tomatoes in their definition of ‘vegetables’, but a tomato is actually a fruit. Until we agree on every single thing that should be called a vegetable we cannot get into the question of what’s good or bad about eating vegetables in general or any vegetables in particular.”

    ok, you have a point about tomatoes. Why don’t you focus your mind and energy more on the general nature of vegetables — or some subset of them, like green leafy vegetables — what’s good/bad about them, and whether we should lean toward eating more/less/the same amount of them?

    And re: the home mortgage deduction, I also suggest you try not to get distracted by whatever that technical point is you always bring up.

    Put terminology and extraneous technical points aside and ask “What is going on via this policy?” Joe buys Product X and because he did, Joe ends up with more money because of this subsidy than he’d have without this subsidy, and the immediate effect is a larger deficit, which means sooner or later, others will have to sacrifice more in some way. That applies whether this subsidy occurs through the tax code or through explicit spending (assuming hypothetically no difference in dollar amounts or timing either way, just to make the conceptual point clear). It is what it is, regardless of what label someone wants to put on it, and regardless of what one considers the appropriate baseline level of taxation or spending. Don’t obsess with labels; focus on what is happening — what the policy incentivizes, and what effects it has on all involved on what basis.

    As a note, I haven’t yet read Donald Marron’s presentation, but I look forward to it when I have a chance, because his analysis and commentary is consistently outstanding.

  6. comment number 6 by: Vivian Darkbloom

    I’m glad that AMTbuff and Arne have highlighted the seemingly parenthetical statement by Marron and Toder about the accrual method of accounting. The issue is a significant one. We need to insist on better and more accurate accounting with respect to federal revenues and obligations (particularly the latter). There is no excuse for using the cash method of accounting with respect to huge entitlement programs such as social security when calculating the (off) budget deficit. Actuaries can do this; it isn’t that difficult. Corporations are not allowed to use the cash method of accounting for pension obligations and this is for good and obvious reasons. The failure to insist on accrual accounting with respect to social security is the main reason most people, even educated ones, are in a state of denial and think that program is “in surplus”. As regards pure pensions, most governments use accrual method, but abuse it by making unrealistic assumptions regarding future returns. A modest suggestion would be to have a national accounting board annually determine an appropriate interest rate for accruing pension obligations and have everyone, public and private, stick to it. Insisting on better and more accurate accounting is one of the simplest and best means of improving the long-term fiscal situation of government, federal and state.

  7. comment number 7 by: Gipper


    The 2 main aggregate figures are 1: how much cash does the government receive through tax revenue and borrowing; 2: how much cash does it disburse.

    Whether it uses tax expenditures, taxes, expenditures or anything else certainly has an impact upon economic incentives. But when it comes to discussions about the accounting of deficits, these are incidental topics to the question of how large is the requirement for deficit financing now and in the future (i.e. accrual accounting) .

    While you are correct about behavioral or moral equivalence, AMTbuff is correct about the accounting issues. So, when it comes to deficits, I would say that you are the one introducing a sideshow issue, not AMTbuff.

    And Arne, let’s not make this too difficult. For purposes of our discussions, the size of government is the amount of federal outlays, disbursements of cash, as a percentage of GDP. That’s the figure that impacts deficit spending.

  8. comment number 8 by: Arne

    There are two problems I see with the floor/ceiling numbers that were being discussed on the 36000 feet post.

    1) The narrow definition of what to include does not allow for the way things change over time.

    2) It is not desirable for tax receipts and government spending (however defined) to track the drops in GDP during a recession.

  9. comment number 9 by: SteveinCH


    1 can be revisited over time if necessary.

    I agree on 2 which is why you need to balance in good times.