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An All-Time Fiscal Fallacy: Tax Cuts Starve the Beast

07 May 2010
Posted by Bruce Bartlett

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.
 

Starve the Beast and groupthink

In 1981, as a Senate staffer, I was present at the scene of the crime when Reagan, Stockman, Gramm and Latta, et. al., pushed through this ideology in the Omnibus Budget Reconciliation Act. Why this discredited idea has persisted among the GOP for so long might be summed up in a statement by Irving Janis, an early expert on groupthink. He wrote:

"The more amiable the esprit de corps among the members of a policy-making in-group, the greater is the danger that independent critical thinking will be replaced by group-think, which is likely to result in irrational ... actions."

Case closed!


Reply

I think STB was a plausible theory when first proposed, worth trying. It just didn't work, that's all. The experience of the last 30 years proves that fact beyond reasonable doubt. The problem is that conservatives today live in a world disconnected from empirical reality. STB is part of their dogma and they will continue to believe it no matter how much evidence is amassed against it.


Starving the Beast

You're right, politicians do not have the wherewith-all to bring the Beast under control by starving to it death. But The Beast is still a Beast, and it needs to be euthanized.


Even Stockman

It's worth noting that Stockman has repeatedly said the same thing, most explicitly and recently here:

http://www.asymptosis.com/david-stockman-on-starving-the-beast-game-over...

He came to the same conclusion in his book, while at the same time rather desperately attempting to absolve Reagan:

http://www.asymptosis.com/stockman-was-it-reagans-fault.html

Not that Norquististas would listen to him, or to you for that matter, or to anyone else...


Starve the public schools

Here in Indiana, the state revenue "crisis" has allowed Governor Mitch Daniels to cut funding to schools that will result in layoffs of about 5000 teachers state wide. Without the "revenue shortfall" those cuts would have been politically unacceptable. The budget crisis allows Mitch Daniels to punish the teachers unions and get school administrators, school boards, parents and teachers all fighting each other while Mitch hides on the sidelines (It isn't his fault, the budget made him do it.).

This takes opponents of public education one step closer to their desire to privatize education. By diminishing the quality of public education and its funding, the wealthy will bolt the system for private schools. This will set up the desired two tiered system where wealthy elites can buy a good education for their legacies and give them a leg up on more meritorious students that are stuck in inferior public schools.

Maybe class sizes over 30 are a bad idea and maybe schools are not the beast that needs to be starved, but Starve the Beast is having an effect at the state level.


States

States operate under a hard budget constraint. When voters oppose tax increases, presumably they know that services will have to be cut as a consequence. If that's their choice, fine. The problem at the federal level, of course, is that there is essentially no budget constraint at all; people can have their cake and eat it, too--low taxes and no cuts in services. In effect, STB presupposed a hard budget constraint when there wasn't one. That's the root of the problem.


Putting a Hard Budget Constraint on Federal Government

If the voters could directly vote on the level of deficit spending they could tolerate, then we could eliminate the "have their cake and eat it, too" problem. With a Debt Limit Referendum (www.thepeoplesdebt.com ), Congress could no longer raise the public debt ceiling at will. It would have to submit requests to increase the limit on government debt held by the public to the voters for approval before it could take effect. The ability of Congress to borrow without constraint with a Federal Reserve able to purchase this debt in a world reserve currency is the root of all this evil.

Assuming that voters really do care about deficit spending, they would balk at any requests by Congress to continue deficit spending unabated without any prospect of eventual reduction.

Without such a constitutional backstop, it would be stupid for Republicans to ever agree to tax increases without any assurance that those incremental revenues would not used to reduce the deficit. The Republicans won't return to the days of Bob Michel being the jovial, obsequious, but morally-anchored loyal opposition. Acting irresponsible like Democrats is more fun and wins more elections.

With a Debt Limit Referendum (DLR) in place, it is possible for Republicans and Democrats to make an ENFORCEABLE compromise. Republicans could support increased income tax rates and a VAT in exchange for Democrats support for slashing entitlement spending and transferring federal programs (housing, agriculture, education, etc.)to the states.

The key to getting these compromises is that the voters impose an external constraint that forces members of Congress to offer closely-balanced budget proposals. With a DLR in place, then the center of power in both parties would move to the center. Proposals to cut tax rates that fail to reduce spending would become impossible political options under a DLR.


What is the alternative to STB?

It could well be that the STB hypothesis 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 was true in 1978 and is still true. Merely fatally incomplete.

I agree that STB has proven false in actually reducing the beast's appetite and size -- for whatever reason. Maybe it's because pols will never STB that feeds them. Maybe it's groupthink. Whatever the reason, doesn't matter. Because what seems clear in the proven STB "falsity" is that there is no idea - no internal peaceful "reform" - that can change the beast's behavior.

However, that does not change the first part of the statement by Friedman. -- the only effective way. If STB doesn't work; then it is still perhaps true that nothing will work.

Perhaps once the beast is too large to be fed via the normal democratic manipulation of one group against another; then it simply turns on everyone and reveals itself to be the enemy of all. The enemy of those who unilaterally "revenue revolt" (via tax evasion, nonreporting, expatriation, refusal to buy bonds, refusal of the young to accept the future taxation/unemployment of excess bond issuance, etc) and of those who "spending revolt" (strikes by civil servants, pensioners, military, etc).

Perhaps Greece is more of an example than we want to believe. Perhaps STB is merely a means of trying to avoid that end-game.

Excellent article btw.


Actually the neighboring

Actually the neighboring school district just voted in referendum to increase property taxes to pay for their schools. They were afraid the school cuts would do more harm to their property values than they could possibly save in Mitch Daniels property tax cuts. Big cuts for the millionaire slumlords, pennies for everyone else. Plus sending kids to private schools is far more expensive than paying for good public schools.

I might agree about voting for tax decreases, except Indiana does not do referendum. Instead we got bait and switch. Mitch Daniels lowered property taxes and promised to make up the loss in school revenue from other taxes, mostly sales tax. Once the economy tanked, tax revenues tanked and the state either A) did not have a large enough rainy day fund or B) grossly underestimated the amount of revenue that they could raise with the tax shift. The result was that millions of people paid far less taxes (HUGE TAX CUT) and Mitch Daniels reneged on his promise rather than bring tax revenues back into line so he could make good on his promise. This is simply bait and switch. The promise was that the State would provide the tax revenue to support the schools. Obviously politicians lie. However, Starve the Beast is working at the State level. We are rapidly becoming the Mississippi of the north. We will see if it generates a backlash.


Jfree:

>there is no idea - no internal peaceful "reform" - that can change the beast's behavior.

You are correct. A simplistic "idea" is not going to change things. That is the utopian fallacy under which the right has labored for decades.

What is the only thing that can change things? Everyday, in-the-trenches, blocking-and-tackling policy work, undertaken in good faith and over (very) long periods.

It's harder to explain to the voters than the childish, finger-twirling-in-the-cheek "I'll cut your taxes and everything will be better!" claptrap, but it's reality.


It's tough to believe that

It's tough to believe that STB was ever viewed by serious people as anything other than a perpetual motion machine cynically sold to Southern whites upset over Federal civil rights intervention.

"Drill here, drill now" is the contemporary analogue. When oil exporters demand hard currency rather than US dollars, the blame will be laid on those who wanted to move away from the cheap petroleum mid-20th century model of the economy, when in fact it's the STB mentality epitomized by B43's keeping his wars "off the books" that is at fault.

I wonder if Mr. Bartlett would enjoy addressing Greenspan's advocacy of B43's tax cuts. Greenspan did so, as Fed chairman this time, in the aftermath of an election in which the victor did not garner the majority of votes yet all signals were pointing toward the remarkably lock-step partisan executive-legislative cooperation that would continue until the nomination of Harriet Miers in 2005.

This was a crucial moment. Greenspan would have been aware that Asians traumatized by their crisis were focused on building reserves. The prospect of US budget surpluses was raising questions about how the world might adopt to decreasing supplies of US sovereign debt. (I suspect one consequence was that the Fed decided to put the US home mortgage market into play as a means of meeting demand for AAA credits. They didn't foresee the explosion of Chinese demand, and were happy to believe that the most outlandish examples of financial engineering were proof that the true competitive advantage of the United States of America was to provide innovative financial products. If the result was a society resembling that of Mexico rather than Denmark, fine.)

An old school Republican, in these circumstances, might have said that we should continue to pay down debt. She or he might have said, let's generate AAA credits by creating a national investment budget that stands apart from what Krugman has called a heavily armed insurance operation.


Greenspan

According to Stephen Axilrod, Inside the Fed (MIT Press, 2009), p. 127, Greenspan viewed tax reduction "partly as a means of starving the budget over the long run and keeping government spending in check." 


While people like Greenspan

While people like Greenspan may believe what they spout, they are apparently dogmatic and unable to accept conflicting facts and data. Their economic beliefs are shaped by their politics, morals, and philosophy. They serve merely as predictable expert witnesses for the actions of like-minded politicians.

But what of the politicians? A few may have a limited notions of economics and fiscal theory, but again they tend pick only those theories which are notionally found on their part of the political spectrum.

The reality is that polticians seek three things: re-election, power, and money. The example of the Republican party riding tax cuts to the White House clearly demonstrates that. The politicians cared not a whit about the economic theory, only the popularism of tax cuts.

When fiscal responsability and cutting deficits become causes that motivate voters, we will see Republicans (and Democrats) returning to their old values. Until then, these whores on the Potomac will trot out any economic policy or theory that they believe will keep them in power.

Let's face it. If Washington really cared about people, they would be nurses, doctors, and social workers, not Senators, Cogressmen, and lobbyists.

Wouldn't it be amusing to bar re-election for any political office? I think it would make things infinitely better.


STB and The Two Santa Claus Theory

STB may be a myth but its a convenient myth for the Republican party and is related to the "Two Santa Claus Theory".

The Two Santa Claus Theory is a political theory and strategy developed by Jude Wanniski in 1976, which he promoted within the U.S. Republican Party.

The theory states that, in democratic elections, if one party appeals to voters by proposing more spending, then a competing party cannot gain broader appeal by proposing less spending. The "Santa Claus" of the theory title refers to the political party that promises spending. Instead, "Two Santa Claus Theory" recommends that the competing party must assume the role of a second Santa Claus by offering other appealing options.

The "Two Santa Claus Theory" does not argue against STB, but holds that such arguments cannot be espoused alone in an effort to win democratic elections. In Wanniski's view, the Laffer curve and supply-side economics (SSE) provide an attractive alternative rationale for revenue reduction: that the economy will grow, not merely that the government will be starved of revenue. Wanniski argued that Republicans must become the tax-cutting Santa Claus to the Democrats' spending Santa Claus.

The only problem is that SSE is also a myth. As a result the Republicans have turned out to be the Grinch (or Gingrich) that stole Christmas.


Supply-side is just a form of Keynesianism

Supply-side economics is simply a form of Keynesianism. "Tax cuts will spur growth which will allow us to pay off debt" vs "Government spending will spur growth which will allow us to pay off debt". Just different ways of expressing the same macroeconomic bookkeeping/arithmetic.

IMO, until we really really understand that; there is ZERO possibility of understanding the fix we are in. BOTH political parties have -- at core -- accepted Keynesian notions that break the links between revenues/spending (per Keynes' breaking of the link between savings and investment in his general theory). The entirety of the political establishment accepts that core Keynesian premise. Our current economic problems and debt mess stem from that. From EVERYONE accepting that Keynesian attitude about debt/growth. It is why the Tea Parties are so important imo -- and perceived as so dangerous. Because they (as individuals) don't accept that even if they don't see the alternative.

I tend to agree that it becomes the only political/electoral option when the other side is promising free lunches for everyone. Distasteful yes. But still. Wanniski is right.

Debt/deficits is not - has never - and will never be an electoral issue for more than a single election. The whole point of "public debt" is to pass the bill for today's spending on to the next generation -- and there is no such thing as infant suffrage. They are simply the sheep who don't even get to vote on what's for dinner. Only the wolves get to vote.

Even if debt/deficits becomes an issue for a single election; there are plenty of ways (fraudulent accounting -- eg Medicare liability, etc) to confuse the issue so that voters can't really decide anything. The mass media and beltway bs artists will always work hand-in-glove with the pols to ensure that voters are confused on that.

Hard to remember now -- but in the late-1970's, Congress had been under one-party control for two generations - 40+ years. Anyone who yearns for "old-fashioned deficit hawks" is simply yearning for something that never existed - was rarely elected when it did exist - and never had the slightest influence even when it was elected by chance.


SSE has little credibility in the field of economics

The difference between SSE and Keynesianism is that there is far more theoretical and empirical evidence for the effectiveness of a discretionary fiscal stimulus than for the long run growth effects of a cut in the marginal tax rates.

Theoretically there may have been some credibility when the top marginal income tax rate was 90% or 70% but not when it is less than 40%. And the empirical literature in support of SSE is scarce. Its chief enthusiasts usually lack any kind of academic background in the subject and/or lack credibility in the field. Robert Mundell perhaps is the lone major exception.

In contrast there is literally tons of theoretical and empirical research showing under what conditions a discretionary fiscal stimulus can be effective. Those conditions are precisely the ones we face now with a Federal Reserve unwilling to pursue effective unconventional monetary stimulus despite having hit the zero lower bound in the fed funds rate. The major private and institutional macroeconomic models (Goldman Sachs, J.P. Morgan Chase, Macroeconomic Advisers, IHS/Global Insight, FRB, CBO, IMF, OECD etc.) all assign it great potency under these conditions.

SSE may have made some sense in the early 1980s but today it is little more than a tired political gimmick. In contrast the concept of a discretionary fiscal stimulus is usually taken quite seriously within the field of economics.


Keynesians are not any better

Starve the beast does not work because politicaisn substitute borrowing for taxes. It increases the amount of spending but giving the public government at a discount.

However, deficit spending during bad times never works because politicians refuse to make cuts during the good times, politicians expand program during the good times, and the ratchet effect on spending causes taxes to go up and spending to not go down.

Anyone who believes that raising taxes alone will fix budget deficits is a fool. Raising taxes just give the government more money to create more long term entitlement spending.

As said above, cutting the budget requires hard work on Policy and the goal of every policy should be to cut spending and make the government more efficient.


Few conservatives actually wanted "starve the beast" as policy

Bush called them "a fiscal straightjacket for Congress" that would prevent an increase in spending.

If you follow the link you can see that a few sentences later, Bush noted that the budget he submitted to Congress called for a 6% increase in spending. We hadn't seen a budget increase of that magnitude since the Reagan Administration, and we wouldn't have seen an increase of that size if Gore had become president. I didn't hear any complaints from people in the conservative movement about the increase.

As far as I can tell, by the time Bush came along, "starve the beast" wasn't a policy prescription; it was simply a marker in conservative identity politics. By using "starve the beast" type rehtoric, Bush was in effect saying to the conservative movement, "I'm one of you." The actual policy supported by Bush and most people in the conservative movement was to increase the percentage of economic output consumed by the government.


Bakho The fact that Mitch

Bakho

The fact that Mitch Daniels has some republican cred is testimony to the weak field in the party. Inidiana had a garage sale and when the money ran out from the sale, guess what? The budgetary issues still remain. Chicago is finding out the same thing.

Two issues remain oif concern to me and they are low interest rates and low tax rates. We have lost the ability to utilize tax cuts and lowered interest rates as a tool to goose the economy by institutionalizing low tax rates and low interest rates. The next recession ought to be a doozy.




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