The Stroke the Beast Hypothesis Posted by: Jon Henke
on Thursday, May 11, 2006
Writing in Atlantic Monthly — also available here for free — Jonathan Rauch discusses a 2003 report (pdf) by Cato Institute Chairman William Niskanen on theoretical problems with the Starve the Beast hypothesis. Writes Rauch, Niskanen "thought it more likely that tax cuts, when unmatched with spending cuts, would reduce the apparent cost of government, thus stimulating rather than stunting Washington’s growth." Specifically...
Suppose the federal budget is balanced at $1 trillion. Now suppose Congress reduces taxes by $200 billion without reducing spending. One result is a $200 billion deficit. Another result is that voters pay for only 80 percent of what government actually costs. Think of this as a 20 percent discount on government. As everyone knows, when you put something on sale, people buy more of it. Logically, then, tax cuts might increase the demand for government instead of reducing the supply of it. Or they might do some of each. [...] Niskanen recently analyzed data from 1981 to 2005 and found his hunch strongly confirmed. When he performed a statistical regression that controlled for unemployment (which independently influences spending and taxes), he found, he says, “no sign that deficits have ever acted as a constraint on spending.” To the contrary: judging by the last twenty-five years (plenty of time for a fair test), a tax cut of 1 percent of the GDP increases the rate of spending growth by about 0.15 percent of the GDP a year. A comparable tax hike reduces spending growth by the same amount.
Niskanen's research led him to believe that "taxation above [19%] shrinks government, and taxation below [19%] makes government grow." And with recent revenue levels well below 19% thanks to the Bush tax "cuts" (i.e., "tax temporal relocation"), spending has risen.
This hypothesis has a certain Econ 101 symmetry that makes it initially appealing, but further thought leads me to more skepticism. The hypothesis is too simple. For one thing, as Daniel Drezner notes — via Ryan Sager — "the starve the beast idea does not say that government spending will immediately go down as deficits rise; it argues that eventually the increase in deficits creates market and political pressure to cut government spending." In this sense, the Starve the Beast hypothesis might be correct, but I don't see this as a terribly useful insight or strategy. It's a bit like saying "we know this car will eventually go so far that it will run out of gas, which will be unfortunate. So let's poke holes in the tank and get to the disaster faster!"
However, as a supply/demand calculation, I'm not sure that Niskanen's hypothesis really stands up, either. My initial objections...
If a relatively small, widely dispersed shift in tax rates will substantially affect voters appetite for government spending, why haven't Europeans been clamoring for much less government?
When we talk "tax cuts" we're usually talking about income taxes and various corporate taxes. With a progressive tax system, that usually means the bulk of the immediately apparent benefit goes to the higher earners and corporations. But are millionaires and big business really responsible for the bulk of increased government spending? I have trouble believing the top quintile was responsible for the Medicare Drug bill, NCLB, etc.
The bottom quintile gets a lot of the social welfare spending, but they don't pay much in the way of taxes in the first place. What difference would a tax cut make to their appetite for government spending?
Finally, are voters really making electoral decisions on the tax bill margin? Personal income/wealth is dependent on so many factors besides minor tax shifts that I have trouble believing tax burdens are a significant factor in their policy preferences. With tax withholding, voters just don't see/think about minor changes in their tax situation, relative to their appetite for public spending. What's more, it seems to me that year-to-year shifts in income and lifestyle factor more prominently than the tax system in most people's marginal spending decisions.
This Stroke the Beast hypothesis would have more merit if people were more directly attuned to the costs of government — ending withholding, for example — or if we had a Flat Tax indexed to total spending in such a way that people would be immediately cognizant of the tax effects of additional spending.
But we don't, so I think this is more a case of correlation than of causation.
UPDATE: Niskanen defends his hypothesis at Cato @ Liberty — unpersuasively, in my view — but also writes something with which I can generally agree:
My estimate is that an increase of federal revenues to about 19 percent of GDP would be necessary to stabilize the federal spending percent of GDP. Control of at least one house of Congress by the Democrats, however, is likely to be necessary to achieve this outcome. Republicans should not consider this inconsistent with Reaganomics.
A divided Congress will almost certainly result in more federal restraint than our current Republican-dominated government.
But we don’t, so I think this is more a case of correlation than of causation.
Interesting piece. I think you’re exactly right, Jon. Also, I firmly believe that tax increases or decreases do not have any effect on how the general public views government spending. Therefore, it is useless to encourage limited government through tax hikes or cuts.
Certainly transparency in the actual cost of government would make testing either ‘hypothesis’ a less daunting proposition, but I’ve always taken the so-called "starve the beast" catch phrase as more about politics than economics. That is to say, it seems to me it is more about the party currently in power making it that much more difficult when it loses control for its opposition to engage in profligate spending. (Obviously, profligate spending by the party in power, itself, doesn’t seem to raise equivalent scruples.) Call me cynical, but I can only conclude that most elected officials are either indifferent or ignorant of economics, at least in contrast to their abiding interest of gaining and retaining power.
Costs, however, are costs, whether they are current costs or deferred. I continue, therefore, to worry less at least for the time being about deficit rates per se and government financing in general than about the magnitude and nature of government spending.
So the question occurs, for example, whether people are so naïve that they believe consuming government services financed in part by running deficits is indeed benefiting from a discount. Consumer credit spending habits lend credence to that possibility, but it pains me too much to concede the point. Of course, turning to one of Mr. Henke’s points, people’s marginal spending decisions including deficit (i.e. credit) spending are at least partially influenced by their future earnings or wealth expectations. (One reason I don’t worry too much about deficit spending, per se, is that I expect my grandchildren will be much richer than I am. If you can’t borrow from rich relatives, who can you borrow from?)
Because the middle class, broadly construed as, say, the middle three quintiles, is both the source of the bulk of tax revenues and the demographic determinant of electoral politics in terms of sheer wealth and numbers, the question then becomes: What difference would a tax cut or a tax increase make to their appetite for government spending?
Given the political status quo ante, I think the answer in both cases is very little. As long as the politics of government budgets is determined by identity politics and interest groups, incumbents without term limits care more about reelection than the general welfare, and omnibus appropriations and authorizations (with no executive line item veto) encourage tit-for-tat pork barrel budgets, the beast will be neither starved nor stroked.
The reason none of the starve the beast strategy has had much effect is that for quite some time now we have been operating at some point above equilibrium on the laffer curve. Therefore, tax cuts have had a stimulative effect causing government revenues to increase. Of course spending has gone up even higher. Government spending growth must slow soon, or the interest payments will begin to balloon as a percent of the federal budget like it was in the early 1980’s.
Therefore, tax cuts have had a stimulative effect causing government revenues to increase. Government spending growth must slow soon, or the interest payments will begin to balloon as a percent of the federal budget like it was in the early 1980’s.
I assume by "must" you mean "had damn well better", because I can’t see any sign that anyone likely to end up holding the reins will show any kind of restraint any time soon.
I would also argue that you give Washington too much credit — they’re not spending the money because it’s there (it’s not). They’re spending it because they can.
I agree, he’s making a classic error of mistaking what happens (correlation) with it being the result of his preferred events (causation). Governments spend more money because they choose to, not due to some economic force that compels them to when taxes get lower than a certain level. At present we have a bunch of idiots in congress who think fiscal responsibility is insulting and getting reelected by people spoonfed goodies at home is the highest possible priority. Combine that with a lack of leadership and a president who doesn’t care to veto things and you’ve got out of control spending. This wouldn’t be a problem with truly conservative congressmen, they’d be more interested in the constitution than bribing constituents to vote for them.