An All-Time Fiscal Fallacy: Tax Cuts Starve the Beast
My Forbes column this week calls starving the beast the most pernicious fiscal doctrine in history. I trace its origin among Republicans to testimony by Alan Greenspan in 1978. BB
I believe that to a large extent our current budgetary problems stem from the widespread adoption of an idea by Republicans in the 1970s called “starve the beast” (STB). It says that the best, perhaps only, way of reducing government spending is by reducing taxes. While a plausible strategy at the time it was formulated, STB became a substitute for serious budget control efforts, reduced the political cost of deficits, encouraged fiscally irresponsible tax cutting and ultimately made both spending and deficits larger.
Once upon a time, Republicans thought that budget deficits were bad; that it was immoral to live for the present and pass the debt onto our children. Until the 1970s, they were consistent in opposing both expansions of spending and tax cuts that were not financed with tax increases or spending cuts. Republicans also thought that deficits had a cost over and above the spending that they financed and that it was possible for this cost to be so high that tax increases were justified if spending could not be cut.
Dwight Eisenhower kept in place the high Korean War tax rates throughout his presidency, which was a key reason why the national debt fell from 74.3% of the gross domestic product to 56% on his watch. Most Republicans in the House of Representatives voted against the Kennedy tax cut in 1963. Richard Nixon supported extension of the Vietnam War surtax instituted by Lyndon Johnson, even though he campaigned against it. And Gerald Ford opposed a permanent tax cut in 1974 because he feared its long-term impact on the deficit.
By 1977, however, Jack Kemp, Dave Stockman and a few other House Republicans concluded that the economy was desperately in need of a permanent tax rate reduction. Kemp believed that such a tax cut would so expand the economy that the revenue loss would be minimal. He also thought that much spending was driven by slow economic growth—welfare, unemployment benefits and so on—that would fall automatically if growth increased.
But the Republican Party’s economic gurus—Alan Greenspan and Herb Stein, in particular—were not comfortable supporting a tax cut without stronger assurances that the deficit would not increase too much. At a time when inflation was our biggest national problem their concerns were not unreasonable.
After enactment of Proposition 13—a big property tax cut with no offsetting spending cuts or tax increases—by California voters on June 6, 1978, there was an immediate change in attitude among Republican economists previously skeptical of a permanent cut in federal income tax rates. They could see that a tax revolt was in the making and that Republicans could very possibly ride it all the way back into the White House in 1980.
On July 14, 1978, a few weeks after the Prop. 13 vote, the Senate Finance Committee held a hearing on the Kemp-Roth tax bill, which would have cut all federal income tax rates by about a third. A key witness was Greenspan, who had recently served as chairman of the Council of Economic Advisers and was undoubtedly the most respected business economist in the United States. He was the first Republican to articulate what came to be called starve the beast theory.
Said Greenspan to the committee, “Let us remember that the basic purpose of any tax cut program in today’s environment is to reduce the momentum of expenditure growth by restraining the amount of revenue available and trust that there is a political limit to deficit spending.”
Citing Greenspan’s testimony, conservative columnist George Will endorsed Kemp-Roth and STB in a column on July 27, 1978. “The focus of the fight to restrain government has shifted from limiting government spending to limiting government receipts,” he reported.
On August 7, 1978, economist Milton Friedman added his powerful voice to the discussion. Writing in Newsweek magazine, he said “the only effective way to restrain government spending is by limiting government’s explicit tax revenue—just as a limited income is the only effective restraint on any individual’s or family’s spending.”
By 1981, STB was well-established Republican doctrine. In his first major address on the economy as president on February 5, Ronald Reagan articulated the idea perfectly. As he told a nationwide audience that night, “Over the past decades we’ve talked of curtailing spending so that we can then lower the tax burden…. But there were always those who told us that taxes couldn’t be cut until spending was reduced. Well, you know, we can lecture our children about extravagance until we run out of voice and breath. Or we can cure their extravagance by simply reducing their allowance.”
Unfortunately, there is no evidence that the big 1981 tax cut enacted by Reagan did anything whatsoever to restrain spending. Federal outlays rose from 21.7% of GDP in 1980 to 23.5% in 1983, before falling back to 21.3% of GDP by the time he left office.
Rather than view this as refutation of starve the beast theory, however, Republicans concluded that Reagan’s true mistake was acquiescing to tax increases almost every year from 1982 to 1988. By the end of his presidency, Reagan signed into law tax increases that took back half the 1981 tax cut. His hand-picked successor, George H.W. Bush, compounded the error, Republicans believe, by supporting a tax increase in 1990.
When Bill Clinton became president in 1993, one of his first acts in office was to push through Congress—with no Republican support—a big tax increase. Starve the beast theory predicted a big increase in spending as a consequence. But in fact, federal outlays fell from 22.1% of GDP in 1992 to 18.2% of GDP by the time Clinton left office.
Although all of evidence of the previous 20 years clearly refuted starve the beat theory, George W. Bush was an enthusiastic supporter, using it to justify liquidation of the budget surpluses he inherited from Clinton on massive tax cuts year after year. Bush called them “a fiscal straightjacket for Congress” that would prevent an increase in spending. Of course, nothing of the kind occurred. Spending rose throughout his administration to 20.7% of GDP in 2008.
Nevertheless, STB remains a critical part of Republican dogma. On April 8, Rep. Michele Bachmann, R-Minn., told right-wing talk show host Sean Hannity that the Republican response to health care reform would be to “starve the beast” by refusing to fund it. On April 14, Sarah Palin begged her followers in Boston to “please starve the beast” by resisting any tax increase no matter how large the budget deficit.
Despite its continuing popularity among Republican politicians, at least a few conservative intellectuals are starting to have misgivings about STB. In 2005, free market economist Arnold Kling admitted that he had been wrong. “Cutting taxes did not help to reduce the size of government,” he conceded.
For some years, Bill Niskanen of the libertarian Cato Institute has argued that STB actually increased spending and made deficits worse. His argument is that the cost of spending is ultimately the taxes that will have to be raised to pay for it. Thus fear of future tax increases was the principal brake on spending until STB came along. By eliminating tax increases as a necessary consequence of deficits, it also reduced the implicit cost of spending. Thus, ironically, STB led to higher spending rather than lower spending as the theory posits.
In the latest study of STB, political scientist Michael New of the University of Alabama confirms Niskanen’s analysis. “Revenue reductions, by themselves, are not an effective mechanism for limiting expenditure growth,” New concluded. “The evidence suggests that lower levels of federal revenue may actually lead to greater increases in spending.”
In effect, STB became a substitute for spending restraint among Republicans. They talked themselves into believing that cutting taxes was the only thing necessary to control the size of government. Thus, rather than being a means to an end—the end being lower spending—tax cuts became an end in themselves, completely disconnected from any meaningful effort to reduce spending or deficits.
Starve the beast was a theory that seemed plausible when it was first formulated. But more than 30 years later, it must be pronounced a total failure. There is not one iota of empirical evidence that it works the way it was supposed to and growing evidence that its impact has been perverse—raising spending and making deficits worse. In short, STB is a completely bankrupt notion that belongs in the museum of discredited ideas along with things like alchemy.