Would raising taxes help pay down the deficit?

November 23, 2010

We have long contended that the federal government has a spending problem, not a revenue problem. As we’ve pointed out, federal spending is currently at about 24 percent of GDP — well above its historic average of less than 20 percent. Revenue is currently low because of the recession, but it is on track – without tax increases – to return to its historic average by the end of the decade. Giving more evidence to the fact that our problem is over spending is an op-ed in yesterday’s Wall Street Journal. WSJ editorial board member Stephen Moore and Ohio University professor Richard Vedder explain why raising taxes to close the deficit would be a self-defeating exercise.

In the late 1980s […] Richard Vedder, and Lowell Gallaway of Ohio University co-authored a often-cited research paper for the congressional Joint Economic Committee (known as the $1.58 study) that found that every new dollar of new taxes led to more than one dollar of new spending by Congress. Subsequent revisions of the study over the next decade found similar results.

We’ve updated the research. Using standard statistical analyses that introduce variables to control for business-cycle fluctuations, wars and inflation, we found that over the entire post World War II era through 2009 each dollar of new tax revenue was associated with $1.17 of new spending. Politicians spend the money as fast as it comes in—and a little bit more.

We also looked at different time periods (e.g., 1947-2009 vs. 1959-2009), different financial data (fiscal year federal budget data, as well as calendar year National Income and Product Account data from the Bureau of Economic Analysis), different lag structures (e.g., relating taxes one year to spending change the following year to allow for the time it takes bureaucracies to spend money), different control variables, etc. The alternative models produce different estimates of the tax-spend relationship—between $1.05 and $1.81. But no matter how we configured the data and no matter what variables we examined, higher tax collections never resulted in less spending.

Here is the authors’ conclusion:

We suspect that voters intuitively understand this tax and spend connection, which is why there is such hostility to broad-based tax increases. “Polls consistently find that a majority of Americans believe any new taxes will be spent by the politicians,” pollster Scott Rasmussen told us recently in an interview.

The grand bargain so many in Washington yearn for—tax increases coupled with spending cuts—is a fool’s errand. Our research confirms what the late economist Milton Friedman said of Congress many years ago: “Politicians will always spend every penny of tax raised and whatever else they can get away with.”

 

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