Archive for Budget
Starving the Beast or Free Lunch?
Posted by: | CommentsSenator 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.
We Can’t Always Get What We Want: Why Governing Americans is So Hard
Posted by: | CommentsThe conventional wisdom is that Americans are fed up with their government. But our demands on policymakers are so inconsistent and irrational that we make governing nearly impossible. We hate big deficits, but oppose the actual tax increases or spending cuts that we need to dam the flood of the red ink. We are furious that government passed an $800 billion stimulus last year, but feel lawmakers are not doing enough to get the economy going. We want government to “do something” about the gulf oil spill but reject government interference in private business.
And that’s just the beginning. Conservatives cry “states rights” when it comes to the new federal law requiring individuals to have health insurance, but are silent about the parallel federal requirement that insurance companies must sell to all comers. Liberals want to make Social Security benefits more generous, but only as long as they are paid for with higher taxes on the wealthy. Seniors oppose the “government take-over” of health care for those under 65, but will fight to the death to preserve their (government-run) Medicare.
We oppose new spending, but happily support targeted tax subsidies that are economically no different. And governors of both parties demand more federal money to pay their teachers and fund their Medicaid programs, but would rather complain about the accompanying red tape rather than repair their budgets by rationalizing their own hopelessly outdated tax systems.
We are, collectively, four. We want what we want, and we want it now. And we want somebody else to pay for it.
A new Washington Post-ABC News poll provides new evidence of our schizophrenia. Fifty-seven percent of respondents oppose the federal government spending more money to boost the economy. But 62 percent want Congress to extend jobless benefits for the long-term unemployed. Go figure.
Americans are not stupid, and in fact their collective wisdom on public policy is usually pretty sound. But the nation faces immensely complex policy issues at a time of severe economic turmoil. Americans are nervous and uncertain. They want change, a mood that both presidential candidate Barack Obama and the tea party have successfully tapped. But change also makes people very uncomfortable, especially when they already feel insecure. So we want to move in a new direction and are simultaneously terrified about what it would mean.
Politicians sometimes talk about having an “adult conversation” with the public about difficult issues. But they rarely do. Eighteen years ago, Ross Perot tried to have one on fiscal policy. He came in third in that year’s presidential election. Twenty-six years ago, Walter Mondale said he’d raise taxes if elected president. He won one state. Ronald Reagan, who painted a gauzy picture of morning in America, won 49.
Obama has not forgotten those lessons. That’s why he said so little about the need to control medical costs during the health reform debate, why he vows to raise taxes only for the rich, and why he describes climate change legislation as a jobs bill rather than what it ought to be, an effort to reduce consumption of oil, gas, and coal. Like Reagan, he hopes to build his reelection campaign around flowers and bunnies.
Maybe Obama should try some honest talk about fiscal issues. Jack Lew, his choice for Budget Director can help. No doubt our constant and inconsistent demands for a free lunch won’t make it easy. On the other hand, the way things are going for the president and his party, a candid chat or two couldn’t make matters much worse.
Why Taxes Are Going Up
Posted by: | CommentsIt’s hard to imagine that spending restraint alone can solve America’s long-run fiscal woes. Facing an aging population and rising health care costs, the federal government will continue to expand even if policymakers take serious steps to trim spending. That’s why policy wonks are working so hard to evaluate ways to raise more revenue. Cutting back on loopholes and other tax expenditures, taxing carbon emissions, introducing a value-added tax – all of these deserve attention in case America decides that it wants to finance a substantially larger federal government.
However, that focus sometimes overshadows a key fact about our tax system: Revenues are already on track to rise substantially in coming years. And not just because of an economic rebound and expiring tax cuts. There are structural reasons why tax revenues will grow faster than the economy.
The Congressional Budget Office estimates that tax revenues will rise from 14.9% of GDP in 2010 to 20.7% in 2020 and 23.3% in 2035 if current law remains in place (the “extended baseline” scenario in pink):
To put those figures in context, note that federal revenues have averaged about 18.2% of GDP over the past forty years. Tax revenues today are thus remarkably low. Indeed, they are the lowest they’ve been since 1950. But that will quickly reverse under existing law. By 2020, revenues would near their all-time record (20.9% of GDP in 1944) and by 2035, revenues would be more than 25% higher than historical levels.
That rapid growth reflects six factors. First, the economy will recover, lifting revenues from currently depressed levels. Second, the 2001 and 2003 tax cuts will expire, as will tax cuts enacted in the 2009 stimulus. Third, the Alternative Minimum Tax, which is not indexed for inflation, will boost taxes for millions more taxpayers. Fourth, the new taxes that helped pay for the recent health legislation will go into effect. Fifth, retiring baby boomers will make more taxable withdrawals from tax-deferred retirement accounts. Finally, in a phenomenon known as bracket creep, growing incomes will push taxpayers into higher brackets and reduce their eligibility for various credits.
Together, those six factors will increase tax revenues by 8.4 percentage points of GDP over the next 25 years, according to CBO. About a third of that increase (2.7 percentage points) comes from expiring individual income tax provisions and the expansion of the AMT. Another third (2.6 percentage points) is due to real bracket creep and reduced credits. And about one-seventh (1.2 percentage points) results from the tax increases in the health legislation. The other factors account for the remainder.
We clearly have sizeable tax increases built into our revenue system. The trillion-dollar question, however, is whether policymakers will allow them to happen. That’s why CBO considers a second scenario in which Congress gives in to the temptation to cut taxes. Under that “alternative fiscal” scenario (blue), Congress would permanently extend most of the 2001 and 2003 tax cuts and would limit the growth of the AMT. That would slow the growth of tax revenues but they would still reach 19.3% of GDP by the end of the decade, well above the forty-year average. CBO assumes that policymakers would then enact a series of unspecified future tax cuts to hold revenues at that level rather than letting structural factors lift them higher.
CBO’s bottom line is thus simple: tax revenues will rise faster than the economy even if Congress does nothing new. Indeed, revenues may rise faster than the economy even if Congress enacts substantial tax cuts. Our long-run fiscal dilemma exists because the scheduled growth in future spending is even larger than the scheduled growth in future revenues.