The Starve The Beast Philosophy Explained

OpinionJournal: The Double Benefit of Tax Cuts: They restrain government growth and promote investment.
The starve the beast philosophy is something I’ve discussed in the past and hearing it come from Gary Becker in this article has given me a new respect for the approach.

I still think the American people will ultimately have to determine how much government they are willing to pay for, but Becker et. al. make a compelling case that Congress will spend whatever revenue it is given and then some. They may act with discipline over the short run, but over the long run it’s a spendfest.

The most compelling argument is for a reduced fiscal burden. That’s what really concerns me in the coming years and, if tax cuts keep it down, I’m all for it. The fiscal burden of the government is a long-term drag on the economy and the smaller it is, the better. In addition, the more mobile, or market-like, the fiscal burden is the better off we will be.

For instance, if MSAs are used in Medicare to cover non-hospital costs it contributes to a functioning market in health care. Likewise, the use of school vouchers would create an active market in education and would lead to a better education industry and a better educational output — poorly performing schools would fail.

If a lack of revenue forces the federal government to embrace reforms of entitlements, I’m all for it. Then we can worry about fixing the deficit and paying off the debt.

Every Democratic candidate for president has called for rolling back all or part of George W. Bush’s tax cuts. All politics aside, and with the economy showing signs of recovery, perhaps now is the right time to revisit the rationale behind tax reductions and what seems to be an excessive fear of budget deficits.

Proposals for tax reductions during periods of a weak economy are inevitably followed by discussion of the stimulus effects that such cuts will have on economic activity over the next year or so. Less often is the focus on the more important issue, which is whether a tax cut helps in the long run. Tax cuts make sense for two reasons. First, government spending responds to tax revenues, so that lower revenues imply lower government spending. Second, economic growth depends on both human capital and physical capital, and investment in human capital, as well as physical capital, is responsive to tax rates. Consider each in turn.

Like any company or household, government spending is constrained by its revenue. The sum of present and future public spending, discounted by the rate of interest on government bonds, must equal the sum of present and discounted future tax revenues. This government budget equation has been recognized by economists since the pioneering work on taxation by economist David Ricardo in the early 19th century. Typically, economists take government spending as given by the needs of society, and assume that taxes, including taxes on money balances generated by inflation, adjust to this spending in order to balance the government budget equation.

Yet economic theory and empirical evidence suggest that spending often adjusts to available tax revenue rather than the other way around. Government spending responds to the ongoing political battles between taxpayers and the interest groups that benefit from government spending.

Developments in the federal budget since the early 1980s illustrate the dependence of spending on tax revenue. The Reagan tax cuts of the ’80s helped promote longer-term growth, but they also increased federal deficits and subsequent interest payments on the debt. The Bush tax cuts will also help future growth, and possibly have already begun to stimulate the economy.

Looking back, federal spending declined relative to gross domestic product in the late ’80s and through most of the ’90s. Many observers link the moderate growth in spending over this period to the large federal budget deficits seen over most of the period and the pressure this put on lawmakers to control spending. But the primary federal budget that excludes interest had a surplus for all but three years between 1987 and 2001, while the budget including interest ran a deficit until 1998. The need to meet payments on the debt helped pressure Congress and the Clinton administration to enact welfare reform, cut defense spending and increase efforts to rein in federal spending on Social Security and health. It is highly unlikely that any of these would have occurred without the need to adjust spending to growing interest payments on the rising debt due to continuing deficits.

This is the first persuasive argument I’ve seen that says the Reagan tax cuts contributed to growth of the economy. Note: it isn’t supply-side economics — the marketing term used to sell tax cuts as generating more revenue — but a restriction on the fiscal burden of the federal government that leads to long-term growth and reform in government programs.

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