NFX readers will notice a new name appearing in their RSS feeds. I’m delighted to welcome my coauthor Andrea Castillo to the blog. When she isn’t coauthoring with me, she’s coauthoring with more eminent scholars such as Florida State’s Randall Holcombe (don’t miss their excellent forthcoming paper on the ways cronyism manifests itself in various economic and political structures). And when she isn’t coauthoring with anyone, she is keeping the Mercatus trains running on time as a program associate. You will soon discover, as did I, that she is a superb writer and a gifted researcher. As exhibit A, see her first post on the mortgage interest deduction.
This episode should have advocates of limited government asking themselves an important question: are tax cuts without spending cuts good for the cause of limited government? Decades ago, Milton Friedman answered this question with a resounding yes. Cut taxes, he counseled, and starve the beast. With less revenue, spending will fall too. Tax cutters from Ronald Reagan to George W. Bush have been convinced of “starve the beast” ever since.
But there is another Nobel laureate with free market bona fides who begs to differ. James Buchanan, a founding father of public choice economics—which uses the tools of economics to shed light on the incentives of policy makers—has long questioned “starve the beast.” When politicians are legally and politically permitted to run deficits, he warned, they will simply fund government by borrowing. In this case, tax cuts give voters the illusion that government spending is cheap. And with government seeming less-costly, voters will be happy to have more of it.
That’s me, writing on the Bush Tax Cuts in the latest issue of Reason. It was part of broader piece, edited by Peter Suderman on the fiscal cliff and it includes great essays by Charles Blahous, James Pethokoukis, Veronique de Rugy, Tad DeHaven, Susan Dudley, Maya MacGuineas, and Marc Goldwein. The whole piece can be found here.
Finally, Lars Christensen has some insightful comments on our paper here.
On behalf of all of us at Mercatus and Neighborhood Effects, Happy Holidays to all.
Back in April, President Obama had this to say about the Bush tax cuts:
We tried this for eight years before I took office. We tried it. It is not like we did not try it. At the beginning of the last decade, the wealthiest Americans got two huge tax cuts, in 2001 and 2003. Meanwhile, insurance companies, financial institutions, there [sic] were all allowed to write their own rules, find their way around the rules. We were told the same thing we’re being told now—this is going to lead to faster job growth, it’s going to lead to greater prosperity for everybody. Guess what? It didn’t.
At first blush, the data would seem to be on the President’s side: even if we ignore the Great Recession, economic growth in the 26 quarters that followed passage of the Bush tax cuts averaged just 2.5 percent while it averaged 3.7 percent in the 26 quarters that preceded the cuts.
So is this experience reason to throw out every microeconomics 101 textbook? Or at least to rip out the sections that cover the deadweight loss of taxation? No. The fact is that the Bush tax cuts were deeply flawed, even from a free-market perspective. In a new paper with Mercatus program associate, Andrea Castillo, we contend:
[T]he Bush tax cuts had a number of problems from a market-oriented perspective: they were phased in slowly, they were set to expire within a decade, they entailed a Keynesian emphasis on stimulating aggregate demand, and—above all—they were undertaken without any effort to reduce spending. In light of these problems, there is no reason to overturn decades of theoretical and empirical research supporting the link between low taxation and growth. The episode offers a cautionary lesson in how not to cut taxes.