End the tax cut myth

By Sebastian Mallaby Published:

By Sebastian Mallaby

George W. Bush is not the sort of president who reads journals such as the Atlantic Monthly. But at least someone at the White House should check out the piece in the new issue by Jonathan Rauch. For honest believers in tax cuts, its devastating.

Its been a long time since honest believers argued that tax cuts pay for themselves. When you have extremely high rates of taxation say, 70 percent-plus there may be something to this claim: When rates are that high, the rich go to extraordinary lengths to evade taxes and arent motivated to earn more, so its not crazy to argue that tax cuts might boost tax receipts. But you have to go back to the 1970s to find tax rates that high. When the top income tax bracket is in the 30 to 40 percent range, nobody serious believes tax cuts change behavior enough to pay for themselves.

Instead, tax cutters have clung to a separate faith: that tax cuts will force matching cuts in spending by the government. Its a faith Rauch traces to the presidential debates of 1980. John tells us that first weve got to reduce spending before we can reduce taxes, Ronald Reagan declared in reply to the independent candidate, John Anderson. Well, if youve got a kid thats extravagant, you can lecture him all you want to about his extravagance. Or you can cut his allowance and achieve the same end much quicker.

Ever since that debate, the starve the beast argument has been a favorite of Republicans. Its an expedient argument, of course, since it justifies tax cuts that voters are assumed to love. But even the most nakedly cynical politicians need policy fig leaves. Starve the beast has allowed tax cutters to feel decent.

Or at least half decent. Everybody knows the Reagan tax cuts did not cause spending to come down in the 1980s; most people have surely noticed that the Bush I and Clinton tax hikes were followed by spending constraint in the 1990s; and the Bush II tax cuts certainly have not stopped Congress from spending like a drunken sailor recently. But then the plural of anecdote is not data, and until the starve-the-beast theory is conclusively discredited, tax cutters wont stop hiding behind it.

Well, now it has been discredited. Rauch cites William Niskanen, an economist who worked in the Reagan White House and now chairs the Cato Institute. Niskanen has crunched the numbers between 1981 and 2005, testing for a relationship between tax cuts and government spending, and controlling for levels of unemployment, since these affect spending and taxes independently. Niskanens result punctures his own partys dogma. Tax cuts are associated with increases in government spending. The best strategy for forcing cuts in government is actually to raise taxes.

One can speculate about why this is. Maybe cutting taxes before cutting spending makes government feel cheap: People are still getting all the services they want, but they are paying less for them. Maybe this illusory cheapening has a perverse effect: Now that government feels like a bargain, people want more of it. But the really interesting question isnt why the starve-the-beast theory is 180 degrees wrong. Its how Republicans will react to this finding.

Just consider the events of last week. On Monday the government reported that Medicares trust fund would run out of cash in 2018, 12 years earlier than was estimated when Bush came to office. It further reported that Social Securitys trust fund would run out in 2040, one year earlier than last years projection. The systems are going broke, Bush commented, sagely. And now is the time to do something about it.

So what exactly did Bush do? He pressed Congress to extend his tax cuts, thus depriving the government of money it might otherwise have used to plug the holes in Medicare and Social Security. In a world with a viable starve-the-beast theory, this might have been OK: Tax cuts could be presented as a way to force the government to cut spending and maybe even to reform entitlements. But if that fig leaf is gone, how can the administration feel decent?

Right on cue, the Senate followed up its agreement to extend tax cuts with a $109 billion spending bill, complete with money to compensate New England shell fishermen for a red-tide outbreak. In the wake of Rauchs Atlantic article, the way the president responds to this sort of egregious spending bill is going to be interesting. Will he have the guts to veto them? Or will he stand like the proverbial emperor, naked in the public square?

2006, The Washington Post

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