Thursday, June 08, 2006

"Starve the Beast" is a Bankrupt Idea

Jonathan Rauch of the Brookings Institute has an interesting comment on the use of tax cuts to “starve the beast,” in the June 2006 issue of The Atlantic Monthly. He visits William Niskanen, chairman of the Cato Institute, a libertarian think-tank, for some numbers. Niskanen does a statistical regression of spending on taxes from 1981 to 2005, controlling for unemployment, and shows that tax cuts actually “stoke the beast.”

“A tax cut of 1% of GDP increases the rate of spending growth by about 0.15 percent of GDP a year. A comparable tax hike reduces spending growth by the same amount.”

Niskanen found that the level of taxes that neither reduce nor grow spending is about 19% of GDP.

Niskanen has an interesting little story explaining this. If the government spends 25% more than it receives in taxes, this feels like a 20% discount to voters on the price of government. And as the law of demand says, when the price of something goes down, people purchase more of it.

That story leaves a bad taste in my mouth.

Okay, maybe that story went over well with you, the lay reader. But that little story has so many things wrong with it that no economist worth their salt can walk by without doing a double take. Since Niskanen went to the same school as I did, I’m going to give him the benefit of the doubt and assume that he didn’t want to overwhelm Rauch with a more accurate model. But really, he should be more careful, because a more accurate model better describes reality, and most of us here prefer to live in reality.

Here’s what’s wrong with the story: voters don’t choose government spending. Politicians choose government spending. Politicians choose tax cuts. Ordinary citizens can comment on that every two, four and six years. But they don’t choose government spending.

To make the story work, you must replace voters in the story with politicians. That’s right; the politicians who order the tax cuts are the ones who spend like it’s the last day of the 20%-off sale at Macy’s. And to make the story work, you must further assume that politicians are either so stupid that they don’t realize we are going to have to pay the money back, or so selfish that they don’t care. While I don’t dismiss the possibility of the former, I would lay my money on the latter. The objective of most politicians is to get re-elected, to keep playing this game, and that means cutting taxes as well as spending money on constituents back home even when it is contrary to their stated ideological goal of reducing the size of the government.

“Starve the Beast” is a bankrupt idea because it expects the same pandering politicians who cut taxes to also cut spending. It turns out you don’t even need to model the politicians’ objective functions, because it all comes down to common sense. Responsible governments pay for what they buy. Irresponsible governments put it on the grandkids’ credit card and toss a little extra in the cart for their friends.


C.L. Hanson said...

"Honey, look what a good bargain on government today!! Let's buy some more of that!!" LOL, is that supposed to be serious?

Good analysis. I'm no economist, but I am absolutely disgusted with the way the current administration is wantonly maxing out the U.S.'s every last ounce of credit and credibility without a thought for the future.

Julia said...

Your thoughts on economics always make me think about things I haven't really thought much about...and that's one of the things I love about you! Helping the lay person think about things that matter in a new and useful manner.