Starving the Beast or Free Lunch?

By :: July 22nd, 2010

Senator John Kyl’s (R-AZ) recent insistance that tax cuts should “never” be offset with tax increases got me thinking about the governing philosophy behind this argument. In part, it is based on the idea that tax cuts are always good for the economy while tax increases are always bad. I’ll leave that one for another day, and instead focus on a second premise: The best way to cut government spending is to cut revenues.

This idea, colloquially known since the days of Ronald Reagan as “starve the beast,” seems at first glance to make perfect sense. After all, if you want to stop someone from spending, take away their checkbook. It worked great. Until the invention of credit cards.

Unfortunately, those who bought this theory never counted on a Congress whose insatiable desire to spend was encouraged, not curbed, by tax cuts. It hardly mattered whether Democrats or Republicans were in charge. In fact, for much of the past 30 years it turned out that Republicans were more enthusiastic about spending than Democrats. And delinking spending from taxes made all those new programs appear free, thus encouraging more of them.

Bill Niskanen, president of the libertarian Cato Institute and former economic adviser to President Reagan, figured this out years ago. Bill concluded that if 20 percent of spending is financed by deficits, people will perceive that government programs cost only 80 percent of their real price. And, not surprisingly, they will be more popular at the perceived discount than at their full cost.

In congressional testimony on July 14, Tax Policy Center’s Len Burman took this criticism another step. He argued that Niskanen understated the effect of deficits on spending. Len said, “The message during the last decade seems to have been not that spending and taxes cuts were available at a discount, but that they were free….Citizens could be forgiven for forgetting that there is any connection between spending and taxes.”

As you can see from the chart, there is absolutely no evidence that tax cuts have constrained spending over the past three decades.  In the early 1980s, taxes fell but spending rose. The same thing happened for much of the decade 2001-2010. In fact, the only consistent decline in spending was during the Clinton Administration, a time when tax revenues were rising, not falling.

Of course, this pattern was driven by more than just government policy. Recessions slowed revenues. Robust expansions increased them. But policy mattered. During the Reagan Administration, Congress cut taxes but increased military spending. During the George W. Bush Administration, Congress passed a massive tax cut, but fought two wars and vastly expanded Medicare (75 percent of the Medicare drug benefit is funded by general revenues, not premiums). And during the Obama Administration, Congress again cut taxes while spending tens of billions bailing out banks and auto companies (an initiative begun under Bush) and hundreds of billions trying to stimulate a sagging economy.

Whatever you think of the merits of these spending initiatives, the public was never forced to consider the consequences of paying for them. Would we have fought the Iraq War if it was accompanied by a tax hike? Would we have created the Medicare drug benefit if we had to pay for it?  We’ll never know because Washington never bothered to ask the question. Instead, it spent more even as it cut taxes. No beast was starving. Instead, we were gorging on a free lunch.  

Starve the beast has received a real-world 30-year test. As economic theory, it deserves a place on the ash heap of history. If Senator Kyl wants to cut spending, he’s not going to get there by cutting taxes. He’s just going to have to, well, cut spending. 
  

7Comments

  1. Anonymous  ::  1:50 pm on July 22nd, 2010:

    Yes, the case against Starve the Beast is compelling. Besides that, Len Burman is virtually always right. Too bad he doesn't predict the stock market for us.
    That said, it's still quite possible that Feed the Beast would promote further spending. At the state level, any budget surplus leads to an immediate spending spree.

  2. Anonymous  ::  4:21 pm on July 22nd, 2010:

    For those who want less government, starving the beast is a fools errand. The game is to replace the beast with a new and better beast. Of course, the beast many libertarians offer is worse than the current beast, which is why they have not had much success.
    Trading big government, where citizens have rights and at least theoretically elect who runs it, is preferable to big business where one may or may not be free to get another job or starve where neither leadership is elected nor rights gauranteed (especially in absence of government) is hardly an improvement.
    On the other hand, replacing government with employee-owned companies with effective representation on corporate boards through one's labor or professional organization and the direct election of supervisors is a reasonable alternative – especially if the enterprise provides social and financial services, like education, mental health care and home mortgages, now provided badly by government and the private sector.

  3. Anonymous  ::  4:36 pm on July 22nd, 2010:

    On the whole starving the beast angle, obviously the key transition point is to fund the new beast instead – for example, shifting Social Security taxes to stock purchases in one's employer (with an insurance fund which holds a third of the stock in the employer which can step in and vote it in cases of bad management). A business income tax funding social services could be offset by employee-owners chosing alternative delivery sources – like Catholic schools or now-non-existent Catholic mental hospitals.
    You don't first cut taxes and hope something else happens to come up – you adequately fund government services and begin to certify alternative providers and allow the employees of the business to determine the mix of which providers are selected. If private providers are truly better, the public sector services eventually go away.
    Part of “starve the beast” is a desire for higher personal incomes. Of course, employee-ownership won't provide that – especially at the high end – since salary distribution will be more egalitarian. Additionally, cash income would go down if employers provide services now purchased in the marketplace, like housing finance or even housing itself. If the workplace serves free breakfast and lunch, obviously people would not go out as much and would have lower salaries to reflect that. Of course, one can have a higher standard of living without more available cash.
    I can forsee having very little money and still living in a nice home with abundant food, nice clothes and two vacations a year and efficient and convenient transportation. It's called libertarian socialism and as long as there are multiple providers and some external product for the purchase of resources, it could be quite efficient.

  4. Anonymous  ::  6:57 am on July 23rd, 2010:

    The free lunch aspect of the tax cuts is government will do all the things to promote growth in wages and incomes without the tax revenue, and oh, by the way, the tax cuts will generate the free lunch of higher revenue, so let's shovel pork to the corporations who are struggling to survive competing in the consumer market: weapons makers and anything nuclear.
    Conservatives feel they just have all the bad luck because just after they take office, the economy goes into deep recession, while liberals have all the luck of booming economies.
    Or maybe, the tax cuts conservatives pass don't increase growth in wages and employment, but instead transfer wealth up to people who don't consume, but instead seek out ever higher rates of return on investments production sold to relatively poorer, and thus unable to consume enough, workers. Stock prices soar as money pouring in bids up stock prices forcing firm to increase profits, possible only by slashing payrolls.
    Milton Friedman long ago publish a paper showing business cycles couldn't be smoothed by counter cyclical actions based on business cycle theory, to argue against the economic technocrats fine tuning the economy. To claim that politicians can pass counter cyclical laws before the data is available to show a recession or expansion is beyond belief. So, while there are business cycles and other factors like weather that effect the economy, a big factor in the business cycle is the laws passed.
    And if you chart the tax hikes and the tax cuts against changes in employment, tax cuts are usually followed by job cuts, and tax hikes are followed by job growth.
    Tax cuts do cut certain spending, because tax cutters believe in free lunches. Spending on college education (Pell Grants, GI Bill) and transportation (roads and bridges and rail) is seen as unneeded because the tax cuts will just cause those to be funded by the private sector. On the other hand, with or without war, spending on weapons is good for the war industries, and so on. So, tax cutters shift the spending from investment (building roads) to consumption of hole diggers (big bombs).
    To give the example of wasteful spending as advocated by liberals like FDR, the expression is hiring people to dig holes and fill them in again. But the best example of digging holes and filling them in again is war, and war does boost the economy and create jobs. But FDR didn't want to dig holes, but instead build the nation's infrastructure, and we have many city parks with shelters build by the CCC, plus the national parks and many other investments, not only in the nation's public lands, but in the people. And FDR, like Hoover, who was also a builder, hiked taxes to pay for these public works.
    Contrary to the claims of conservatives, job growth was fantastic in the 30s with more than 5E more jobs for the millions of people leaving the farms. (Like is taking place in China as millions move from the farm to the city and factories.
    Tax cutters want the free lunch of having everything without working for it and without sacrifice.
    Investment is inherently working more than you consume, because you must make all you consume, plus make the capital that is the investment.
    I see tax cutters as those who are retiring to live off savings, in anticipation of death.

  5. Anonymous  ::  3:30 pm on July 23rd, 2010:

    Tax hikes on the wealthy spur growth because they move money out of speculation and into consumption and investment (by freeing funds in the credit markets which would have gone to government debt). They also force businesses to expand to get the same overall return for the owners. Income represents the total amount of goods and services demanded by an individual – so it has a negative sloping curve rather than a positive one – except on the extremes – in other words, once your income needs are met, you stop working or expanding your business. Of course, with time, your preferences change if you have a business that can expand.
    When fighter production lines were being shut down at the end of WWII, people got more productive and made more planes, even in the face of lower prices, in order to keep up revenue. That's econ in the real world and it is why Obama needs to let tax cuts on the wealthy expire.

  6. Anonymous  ::  8:55 pm on July 27th, 2010:

    On last thought on Kyl's comment. One tax increase that should be offset with a cut is the institution of a VAT and increases in payroll taxes for healthcare. Both of these should be offset by eliminating income tax filing for the poor and lower middle class.

  7. Anonymous  ::  11:18 am on August 27th, 2010:

    The society is facing problems with such laws. This has to go legal
    and it’s needed to be sorted at the earlier.
    ADREN
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