In theory, raising taxes should be a way to increase revenues that can be used to reduce the federal deficit. In reality, increased tax revenues not only do not reduce the deficit, they lead to increased spending:
In the late 1980s, one of us, Richard Vedder, and Lowell Gallaway of Ohio University co-authored a often-cited research paper for the congressional Joint Economic Committee (known as the $1.58 study) that found that every new dollar of new taxes led to more than one dollar of new spending by Congress. Subsequent revisions of the study over the next decade found similar results.
We’ve updated the research. Using standard statistical analyses that introduce variables to control for business-cycle fluctuations, wars and inflation, we found that over the entire post World War II era through 2009 each dollar of new tax revenue was associated with $1.17 of new spending. Politicians spend the money as fast as it comes in—and a little bit more.
We also looked at different time periods (e.g., 1947-2009 vs. 1959-2009), different financial data (fiscal year federal budget data, as well as calendar year National Income and Product Account data from the Bureau of Economic Analysis), different lag structures (e.g., relating taxes one year to spending change the following year to allow for the time it takes bureaucracies to spend money), different control variables, etc. The alternative models produce different estimates of the tax-spend relationship—between $1.05 and $1.81. But no matter how we configured the data and no matter what variables we examined, higher tax collections never resulted in less spending.
November 22nd, 2010 | 1:24 pm
Never give the US Government any more than required – guaranteed they will just waste our tax dollars.
Our current debt load is $13,757,920,234,926.00, and Obama and the Federal Reserve want to borrow another $600 Billion in mid-2011 to pay Government bills.
Obama’s IRS has not gone after White House, Senate, House and other Federal employees who owe back taxes of over $1 Billion.
We need smaller government, no pork, and less spending in non-essential areas, and equal laws for all – not favoritism by the IRS.
A flat tax should be a serious consideration.
Over many years Congress has twisted the Commerce Clause to do whatever they want. This needs to be fixed.
November 22nd, 2010 | 2:19 pm
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November 22nd, 2010 | 3:14 pm
There is a point at which higher marginal rates depress revenues as those subject to them seek tax shelters. This also depresses the amount of money available for investment (i.e., “job creation”).
Lower marginal rates tend to result in higher revenues due to wealth creation, but that alone will not resolve the budget crisis because Congress is incapable of controlling its urge to spend. The Reagan tax cuts, for instance, caused Federal revenues to increase dramatically. But the budget deficit also increased, because the (largely Democratic) Congress kept increasing spending.
Beyond that, approximately 66% of the Federal budget is now consumed by “mandatory” spending; i.e., programs such as Social Security, Medicare, welfare, and debt payments that automatically increase year over year without any legislative action at all. One could thus eliminate all discretionary spending (i.e., money that must be authorized and appropriated, such as defense, education, energy, agriculture, etc.) and still not close the budget gap. That can onl be done through entitlement reform.
Increasing taxes therefore may (a) actually reduce Federal revenues; (b) depress growth; and (c) allow Congress to defer making hard choices on entitlements. One should adopt a policy of “starving the beast” by reducing the tax burden. This will stimulate growth AND force Congress to address the entitlement cancer that is eating away at our economy.
November 22nd, 2010 | 4:06 pm
I think tax increases would only be acceptable to many Americans if they were pre-earmarked to a deficit/debt reduction fund. But, just like my Social Security contributions which are supposed to be earmarked for my future benefits, this will never happen.
November 22nd, 2010 | 4:26 pm
No doubt higher taxes cause even higher spending. But shrinking Government through tax reduction will not cause Govt. spending to stop.
I have my own theory about this: the real cause of Government’s growth is Capitalism’s phobia toward labor—it will try to expunge every bit of labor it can. Marx called this the “reserve army of the unemployed.” In a democracy this cannot stand. So liberals mobilize Government to create jobs for the ejected. Today Gummit provides half of all incomes. And just wait til Republicans try to shrink Gummint: the price at the polls will be horrific. Smaller Gummint is everyone’s ideal until we get it. The real problem lies in Capitalism itself. And, yes, I’m a strong partisan of the market. But that won’t solve this problem.
November 22nd, 2010 | 9:38 pm
This is silly. Taxes increased under Bill Clinton and so did revenues no matter how you choose to measure them (nominal, real or percentage of GDP). And of course the budget was balanced by 1999.
Moore and Vedder can dismiss this as an aberration in their statistical model but it is quite clear to anyone who has studied this matter that the budget is not going to be balanced again at current levels of taxation.
Moreover, a paper by Romer and Romer shows that tax cuts are associated not with lower spending (let alone the supply-side fantasy of higher revenues) but rather are associated with tax hikes in the future (e.g. Reagan in 1985, Bush I and Clinton).
So this paper doesn’t tell us much about how to balance the budget. It is clear that higher taxation levels will be part of any balanced budget initiative. If Moore and Vedder are arguing that politics in the U.S. is too dysfunctional to restrain spending once taxes are increased (leaving the Clinton years aside), then the clear conclusion is that the U.S. will become Argentina. Their statistical model does not seem to warrant this conclusion, though, and the Clinton years directly argue against it.
November 23rd, 2010 | 9:07 am
[...] Raising taxes and their effect on deficits. [...]
November 23rd, 2010 | 10:03 am
The WSJ editorial page is usually a good place for fantasy, but in this case there is a germ of truth.
The fact is that the deficit is mainly endogenous. Since the only way the private sector can net save is for the government sector to run a deficit (this is accounting identity, since every financial asset must have a corresponding debt and all must sum to zero), when the private sector changes it savings desires (as it has in the last few years, as it has furiously been trying to deleverage) the government will naturally go into deficit via the “automatic stabilizers” – tax collections go down as less money is spent, and transfer payments go up as fewer people are working.
Attempting to “cut the deficit” either by increasing taxes or cutting spending, will not work since the savings desires will still be there. All it will do is furthur reduce private sector activity until the accounting balances again at a lower level.
You can, however, by proactively increasing the deficit through tax cuts and spending increases, fulfill the savings demands of the private sector at higher levels of economic activity and reduce unemployment. There is no danger in this, since the federal government is a currency sovereign and faces no financial limits on it’s spending. But since no one in power seems to know that, we continue to hear about the nonexistant dangers of the deficit while 20% of the population is unemployed…
November 23rd, 2010 | 10:29 am
Jim, doesn’t your analysis presuppose a closed economy, with no competition between dollars and foreign currencies?
Also, could we perhaps see some numbers? What percentage of the current deficit is directly due to decreased tax revenues and increased transfer payments? How much deficit *would* we have, in the absence of these “endogenous” affects, i.e. if our economy had not gone into recession?
I’m a bit skeptical of our ability to quantify such things, and thus of analyses such as yours to be rigorously testable.
November 23rd, 2010 | 10:43 am
Stuart, correct me if I’m wrong (as though you need to be told that!), but isn’t “starving the beast” what we’ve been trying to do for the last eight or ten years, under Bush’s tax cuts? It seems to me that it doesn’t appear to have been working too well.
Not, of course, that “feeding the beast” is likely to work either, as the original article indicates. Contra Mark I do I think this is an effect of the dysfunction of the American government, whether one inherent to our governmental structure or a result of a flaw in national character I will not presently judge.
I’m not at all confident that we won’t end up “like Argentina.” After all, Argentina sure did, and it certainly wasn’t expecting to. I can’t say I see much evidence in our current politicians and public environment that we could return to even Clintonian levels of political wisdom — a very low bar, for sure.
And keep in mind that a great deal of the Clintonian prosperity, and hence ability to balance the budget, was an illusory effect of the dotcom bubble.
November 23rd, 2010 | 11:13 am
Higher taxation is not part of any future balancing of the budget from here.
Higher taxation simply will mean that government will spend more. Government jobs will be created, but for every one of them created, the rest of the economy loses more than one job.
Higher taxation will make us all poorer, from top to bottom. A poorer populace will never be able to be taxed to take care of runaway entitlements from the center.
The growth of spending must be stopped, and it can be. It’s been done before. But not by the present crowd in Washington. Two things need to happen–use the ballot box, and stop expecting the feds to solve all our problems. Once we change those expectations, we can delete the Departments of Agriculture, Education, Energy, Commerce. Abolish the TSA and let the airline industry do the screening. Totally defund subsidies for the “arts” and public broadcasting. Incrementally trim back the overstated inflation adjustment for Social Security payments (I’m a recipient, BTW.)
Freeze hiring and pay raises for at least two years until the feds have had a 10% reduction in headcount, more or less across the board, among the surviving departments. I’ve seen organizations reach a point of, not just diminishing returns, but negative returns for adding people. If you have too many people for the job, they actually start getting in each others’ way and reduce the amount of productive work done. By and large, all federal departments are at this point.
November 23rd, 2010 | 2:40 pm
The fact is that the economy grew faster and, thus, revenues increased faster, under the much higher tax rates of the late 1940s through 1981 than it has since and it grew faster during the latter half of the 1990s than at anytime between 1981 and today. The best period of growth under Reagan was after he slashed the top rate to 50% and before he slashed it to 28%. The Laffer curve is a bell. At either end the government collects zero revenue. Somewhere in between is the revenue maximizing range. I would suggest that that range is somewhere between the rates under Clinton (39.6%) and Reagan’s first round (50%).
The simple fact is that it is politically impossible to cut spending enough to balance the budget or come even close to doing so without some tax increase. I believe the recent plans which have been floated which call for approximately $1 of tax increases for every $3 of spending cuts is the best chance we have of getting our fiscal house in order because it is the only one that is realistic in its realization that the American people will only accept so much in spending cuts.
Eisenhower was spot on when he observed more than half a century ago:
“Every dollar spent by the government must be paid for either by taxes or by more borrowing with greater debt. The only way to make more tax cuts now is to have bigger and bigger deficits and to borrow more and more money. Either we or our children will have to bear the burden of this debt. This is one kind of chicken that always comes home to roost. An unwise tax cutter, my fellow citizens, is no real friend of the taxpayer.”
George W. Bush was an unwise tax cutter and no friend of the taxpayer, particularly those future taxpayers who many of us are still rearing today. Unfortunately, Bush, Jr. cut taxes like Reagan, but spent money like LBJ. The best thing we could do now is let his unwise tax cuts expire, beginning with upper income earners today and spreading to everyone else as the economy improves and begin the necessary paring of spending as a simultaneous action to get our fiscal house in order.
November 23rd, 2010 | 9:07 pm
Joe DeVet, pretty much everything you listed above except for SS makes up a tiny portion of the budget. If you want to balance the budget over the long-run, you need to make truly massive cuts to future Medicare spending. That means “death panels.”
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