Tuesday, October 30, 2007

They Stab it with their steely knives but they just can't Starve the Beast!

Romer and Romer in a new NBER working paper (ungated link here) ask: Do Tax Cuts Starve the Beast?

Short answer from the paper: NO

Their slightly longer abstract:

The hypothesis that decreases in taxes reduce future government spending is often cited as a reason for cutting taxes. However, because taxes change for many reasons, examinations of the relationship between overall measures of taxation and subsequent spending are plagued by problems of reverse causation and omitted variable bias. To deal with these problems, this paper examines the behavior of government expenditures following legislated tax changes that narrative sources suggest are largely uncorrelated with other factors affecting spending. The results provide no support for the hypothesis that tax cuts restrain government spending; indeed, they suggest that tax cuts may actually increase spending. The results also indicate that the main effect of tax cuts on the government budget is to induce subsequent legislated tax increases. Examination of four episodes of major tax cuts reinforces these conclusions.

I like the bit that goes "the main effect of tax cuts is future tax increases".

1 comment:

John Thacker said...

It seems that they examined the US federal government only. It would be interesting to look at state level and foreign data as well. Granted, many states restrict deficit spending in a way that undoubtedly changes the equation, though.