Tag Archives: James Buchanan

Do More Revenues Lead to More or Less Spending?

This, I think, is (literally) the trillion dollar question.

As you can see from the animated chart below, ours really is a spending problem in the sense that revenue is set to remain fairly constant while non-interest spending is set to skyrocket.  That, in turn, causes interest payments to skyrocket, adding to the amount we spend and causing the whole thing to go to…you get the drift.

One hopes that at least some of the members of the Super-Committee recognize this. If so, they will draw a hard line in the sand demanding meaningful spending reforms in the entitlement programs that are at the heart of the long-term problem.

But a question remains: should they also draw a hard line in the sand against any and all revenue increases?  I believe this question turns on the one above: do more revenues lead to more spending?

If the answer is yes, then a hard line in the sand against revenue increases may be warranted.  But if the answer is no, then negotiators would be wise to focus all of their energies on reforming entitlement spending and should perhaps be willing to give some ground on revenue if it buys more support for spending cuts.  Interestingly, there are good “free market” economists on both sides of this debate.

Milton Friedman exemplifies the view that more revenue will only encourage more spending (see “The Limitations of Tax Limitation,” 1978; I wasn’t able to find a link).  Those who subscribe to his view may point to Reagan’s 1982 “TEFRA” deal with Democrats.  The president agreed to raise some tax revenue, mostly by closing loopholes, in exchange for spending cuts.  But, say critics, the tax increases materialized while the spending cuts never did.

On the other hand, James Buchanan, another Nobel-laureate with free market bona fides, takes the opposite view.  He argues that the ability to deficit spend biases policy makers to favor more spending.  He believes that if you make policy makers charge current taxpayers for what they spend, the current taxpayers will demand less spending.  Ironically, this leads to the conclusion that revenue increases will lead to less spending.  Advocates of this view might point to the 1990s.  Then, revenues as a share of GDP rose while spending as a share of GDP actually fell for the first time in post-WWII history.

As an empirical matter, I don’t think this is settled.  James Payne (2003) has studied the issue at the state level and has concluded that, at least in a plurality of states, spending does seem to respond to revenue, corroborating the Friedman view.  Thus, he concludes that, “any policy to reduce budget deficits via revenues may not result in deficit reduction.”

On the other hand, Andrew Young has studied the matter at the federal level and concludes:

Perhaps counter-intuitively, the findings suggest that tax increases—even temporary—may serve to decrease expenditures by forcing the public to reckon with the cost of government spending.  The findings suggest that the electorate has to be clearly presented with the bill to recognize the cost of government, rather than being allowed to run up a tab.

It makes some sense that the Friedman view would be corroborated at the state level while the Buchanan view would hold at the federal level.  Most states have an obligation to balance their books (more or less), while the Feds have no obligation whatsoever.  Thus, current state taxpayers tend to be the ones to pay for current state spending while current federal taxpayers can more-easily foist their costs onto the next generation.

If you do subscribe to the Buchanan view, what sort of revenue increases should be on the table?  The answer is almost certainly not rate increases on those who are current taxpayers.  They, presumably, are already resistant to more spending (we also know that these are the most inefficient sorts of tax increases).  Instead, revenue increases ought to be focused on closing loopholes and broadening the tax base (about half of all Americans have no income tax liability).  In a new Mercatus working paper, economists Jody Lipford and Bruce Yandle examine what happens to spending when large numbers of Americans have little or no income tax liability, leaving the rest (and future generations) to pick up the tab.

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Update: Josh Barro rightly noted that large numbers of Americans don’t have an income tax liability; they still pay other taxes including payroll taxes.

Nobel Laureates on Local Governance and the Importance of the Constitution

Last night, the Mercatus Center, among other organizations, hosted a panel discussion on James Buchanan’s contributions to social philosophy and political economy. In addition to Buchanan (the 1986 Nobel laureate in economics), there were two other economic Nobelists on the panel: Elinor Ostrom (2009 Laureate) and Amartya Sen (1998 Laureate).

Professor Ostrom’s closing remarks (at around 32:00 in the video) are particularly germane to this blog. She quoted James Buchanan and Gordon Tullock in their seminal work, The Calculus of Consent:

“Both the decentralization and size factors suggest that, when possible, collective activity should be organized in small rather than large political units. Organization in large units may be justified only by the overwhelming importance of the externality that remains after localized and decentralized collectivization.” (pp. 114-15).

Ostrom then declared:

Boy, if I could get that up on the wall of every university I visit and get it into the textbooks on public policy and urban governance, I would be thrilled. 

Then, she addressed the importance of a constitution:

But somehow, we have forgotten this core idea…A lot of people and students come in and, when asked “what is democracy,” they say, “It is voting; democracy is defined by voting for officials, not by people being engaged in constitutional decision making.” And people have lost the idea of a constitution. Some of my students come in and think “well that’s just a piece of paper written by dead, old white men at a national level.” The idea that citizens would craft their own rules and really struggle with how to get things organized at a local community as well as all the way up, has been lost.

I think that Professor Ostrom’s diagnosis is spot-on. Many—students, journalists, and especially policymakers—almost worship the notion of voting (see professor Holcomb’s From Liberty to Democracy for a nice treatment of the evolution of this idea). To them, if 50 percent + 1 favor X, then X is by definition correct.

And note that this cuts across the political spectrum. On the left, you have a lot of people who are willing to say that if a majority thinks that smoking ought to be banned—even on private property—then it ought to be banned. The right is no stranger to this notion either. A lot of conservatives are willing to say that if the majority favors banning certain bedroom activities, then those activities should be banned. And if a court steps in to overturn the ban, then it is automatically a case of judicial activism (irrespective of what the law does or does not actually say). 

In contrast, Buchanan emphasized the “external costs imposed by collective action.” These are all the burdens that can be imposed on an individual as a result of collective action. Mundane examples are regulation or taxation. But, sadly, horrific examples abound: slavery, subjugation, and racial or sexual discrimination have all been imposed by majority vote at one time or another. In other words, Buchanan took seriously the possibility that democracy might impose costs on individuals.

The founding fathers took this notion seriously too. As Madison put it, “I believe there are more instances of the abridgement of freedom of the people by gradual and silent encroachments by those in power than by violent and sudden usurpations.” And as Franklin is purported to have said (though I understand that he may not have actually said this): “Democracy is two wolves and a lamb voting on what to have for lunch.” 

If democracy can lead to bad outcomes, the solution is not monarchy or despotism. According to Buchanan and Madison, the solution is a Constitution: a document that carefully circumscribes the powers granted to the majority. Yes, the majority rules, but under a constitution, they only possess those enumerated powers that are granted to them (ideally, according to Buchanan, these powers would be granted by unanimous consent). Moreover, powers are distributed across different political units (branches) and levels (federal and state). By organizing collective action in small, dispersed political units, Buchanan argued, we can diminish the expected costs that individuals might bear.

Our particular constitution may, indeed, have been written by a bunch of old, dead white guys. But that hardly diminishes the value of a written constitution. Nor does it mean that it should become a “living, breathing, document,” as some would have it. After all, if its meaning changes with whatever gloss the majority chooses to put on it in any particular time, then what is the purpose of a written constitution anyway?

The Flat Tax Debate in New Jersey

The Wall Street Journal writes that the Republican primary race in New Jersey is the center of contentious debate over the flat tax. Frontrunner Chris Christie rejects rival Steve Lonegan’s proposal to flatten New Jersey’s highly progressive income tax rates (which run from 1.47% to 8.97%) to 2.98%. Christie claims it will raise the taxes on “70 percent of working families.” Lonegan argues it will only raise taxes on 40 percent of working families, by about $300. But more importantly, as the Journal notes,  if  implemented the flat tax represents a $1000 reduction in taxes for the average New Jersey income taxpayer.

Should the state decide to go this route, they will not be alone. Alvin Rabushka who proposed a national flat tax with Robert Hall back in 1981, traces the advance of the flat tax in the last 25 years around the world  (including Russia and Estonia) and in the states. Colorado, Illinois, Indiana, Massachusetts, Michigan, Pennsylvania all have flat taxes. Rhode Island and Utah, have an optional flat tax (taxpayers must pay the higher of the AMT or the regular income tax).

If any state could use tax (and institutional) reform  it is New Jersey.

As my colleague Frederic Sautet notes at The Austrian Economists, the ideas of James Buchanan and of the Austrian economists – fiscal prudence- are immensely relevant to New Jersey’s (and many other states’) fiscal crisis.  For more on how these ideas are driving emerging policy prescriptions in New Jersey, watch the debates here. As Frederic rightly concludes, the liklihood of true reform will ultimatley depend, not on the merit of the ideas, but politics.