Tuesday, May 02, 2006

Voodoo Economics 

The modern conservative is engaged in one of man's oldest exercises in moral philosophy; that is, the search for a superior moral justification for selfishness.
-- John Kenneth Galbraith (1908-2006)

A hundred bucks (or, in San Francisco terms, less than two tanks of gas) for you; billions for business and big investors. Robin Hood, thou shouldst be living at this hour:
President Bush and congressional Republicans agreed yesterday on a $70 billion package of tax-cut extensions that they hope will help halt the deterioration of their political fortunes.

The package would extend the 2003 cuts to the tax rates on dividends and capital gains, continue tax breaks for small-business investment and the overseas operations of financial service companies, and slow the expansion of the alternative minimum tax, a parallel income tax system that was enacted to target the rich but is increasingly snaring the middle class . . . .

In 2003, Congress passed a measure to lower the tax rate on most dividends to 15 percent from as high as 38.6 percent and to lower rates on most capital gains from 20 percent to 15 percent. That measure is set to expire in 2008 but would be extended through 2010 under yesterday's agreement, at a cost to the Treasury of $21 billion over five years and an additional $30 billion between 2011 and 2015, according to aides familiar with the deal. The alternative-minimum-tax provision would restrict the reach of the tax for one year, at a cost of $34 billion.

The agreement would also allow small businesses to write off investments worth up to $100,000 for an additional two years, 2008 and 2009, while letting banking, securities and insurance companies defer income tax payments on overseas trading profits for one additional year . . . .

The House had given the president what he wanted last year -- an extension of the tax cuts for dividends and capital gains. But Sen. Olympia J. Snowe (R-Maine) single-handedly blocked that extension in December, protesting that Congress should not be extending tax cuts that benefit the wealthy while lawmakers are advancing a broad budget-cutting bill that mainly targets programs for the poor, such as Medicaid and welfare. Instead, the Senate tax bill centered on alternative-minimum-tax relief and tax incentives for the Gulf Coast.
But surely (we can imagine you saying; we are vivid imaginers) Republican fiscal policy is not exclusively about the upward redistribution of wealth; surely there is some larger social benefit to be derived from further starving the poor, and further fattening the rich. For when Big Government, along with the poor, is starved, its pernicious influence upon our daily lives must dwindle; and, as a famous Tom, either Jefferson or Paine, once said, that government is best which governs least (or perhaps it was least effectively). No?

In the June Atlantic (accessible online, but only to print subcribers), Jonathan Rauch writes about William A. Niskanen, a veteran of the Nixon OMB and the Reagan Council of Economic Advisers, who now serves as chairman of the libertarian Cato Institute. An old-school conservative, Mr. Niskanen has always been skeptical of the conventional GOP wisdom that by cutting taxes, and thus decreasing federal revenues, you "starve the beast" -- i.e., force spending cuts and thereby shrink government to the point where, in Mr. Norquist's famous formulation, "it can be drowned in the bathtub." (You see the appeal of the notion: as Rauch puts it, "Suddenly Republicans could offer both lower taxes and smaller government without any need for fiscal [restraint].") In a show of rare bad form Mr. Niskanen undertook to chart changes in the tax code against a quarter-century's worth of real-world government spending -- and so discovered that starve-the-beast theology is at least as bogus as that other Reagan-era nostrum, the Laffer curve:
Even during the Reagan years, Niskanen was suspicious of Starve the Beast. He thought it more likely that tax cuts, when unmatched with spending cuts, would reduce the apparent cost of government, thus stimulating rather than stunting Washington’s growth. “You make government look cheaper than it would otherwise be,” he said recently.

Suppose the federal budget is balanced at $1 trillion. Now suppose Congress reduces taxes by $200 billion without reducing spending. One result is a $200 billion deficit. Another result is that voters pay for only 80 percent of what government actually costs. Think of this as a 20 percent discount on government. As everyone knows, when you put something on sale, people buy more of it. Logically, then, tax cuts might increase the demand for government instead of reducing the supply of it. Or they might do some of each.

Which is it? To the naked eye, Starve the Beast looks suspiciously counterproductive. After all, spending (as a share of the gross domestic product, the standard way to measure it) went up, not down, after Reagan cut taxes in the early 1980s; it went down, not up, after the first President Bush and President Clinton raised taxes in the early 1990s; and it went up, not down, following the Bush tax cuts early in this decade.

Niskanen recently analyzed data from 1981 to 2005 and found his hunch strongly confirmed. When he performed a statistical regression that controlled for unemployment (which independently influences spending and taxes), he found, he says, “no sign that deficits have ever acted as a constraint on spending.” To the contrary: judging by the last twenty-five years (plenty of time for a fair test), a tax cut of 1 percent of the GDP increases the rate of spending growth by about 0.15 percent of the GDP a year. A comparable tax hike reduces spending growth by the same amount.

Again looking at 1981 to 2005, Niskanen then asked at what level taxes neither increase nor decrease spending. The answer: about 19 percent of the GDP. In other words, taxation above that level shrinks government, and taxation below it makes government grow. Thanks to the Bush tax cuts, revenues have been well below 19 percent since 2002 (17.8 percent last year). Perhaps not surprisingly, government spending has risen under Bush . . . .

The conservative movement is in no position to accept or even acknowledge those implications, now that tax cutting has become the long pole in the Republican tent. Therein lies the element of tragedy. By turning a limited-government movement into an anti-tax movement, conservatism has effectively gone into business with the Big Government that it claims to oppose. It is not starving the beast. It is fueling the beast’s appetite. And the beast has a credit card.

| | Technorati Links | to Del.icio.us