The Idiocy of Starve-the-Beast Theory

A prime reason why we have a budget deficit problem in this country is because Republicans almost universally believe in a nonsensical idea called starve the beast (STB). By this theory, the one and only thing they need to do to be fiscally responsible is to cut taxes. They need not lift a finger to cut spending because it will magically come down, just as a child will reduce her spending if her allowance is cut — the precise analogy used by Ronald Reagan to defend this doctrine in a Feb. 5, 1981, address to the nation.

It ought to be obvious from the experience of the George W. Bush administration that cutting taxes has no effect whatsoever even on restraining spending, let alone actually bringing it down. Just to remind people, Bush inherited a budget surplus of 1.3 percent of the gross domestic product from Bill Clinton in fiscal year 2001. The previous year, revenues had been 20.6 percent of GDP, spending had been 18.2 percent, and there had been a budget surplus of 2.4 percent.

When Bush took office in January 2001, we were already well into fiscal year 2001, which began on Oct. 1, 2000. He immediately pushed for a huge tax cut, which Congress enacted. In 2002 and 2003, Bush demanded still more tax cuts, even as the economy showed no signs of having been stimulated by his previous tax cuts. The tax cuts and the slow economy caused revenues to evaporate. By 2004, they were down to 16.1 percent of GDP. The postwar average is about 18.5 percent of GDP.

Spending did not fall in response to the STB decimation of federal revenues; in fact, spending rose from 18.2 percent of GDP in 2001 to 19.6 percent in 2004, and would continue to rise to 20.7 percent of GDP in 2008. Insofar as the Bush administration was a test of STB, the evidence clearly shows not only that the theory doesn’t work at all, but is in fact perverse.

Of course, spending rose partly because of terrorist attacks and wars in Iraq and Afghanistan. While it’s true enough that these events caused an increase, they do not come close to justifying a rise in spending equal to 2.5 percent of GDP. Even if one believes that things like the Transportation Security Administration were worth the money, it doesn’t necessarily follow that they justify putting all the expense on the national credit card. Bush could have proposed spending cuts or tax increases to pay for these things and prevent a run-up in the debt. But he didn’t. Throughout his administration he didn’t veto a single spending bill until well into his second term.

Nor was Bush’s budgetary profligacy limited to programs that could be justified, however loosely, on national security grounds. As I detailed last week, he and a Republican Congress created a massive new entitlement program, Medicare Part D, to buy the votes of seniors and buy themselves reelection in 2004. Among those voting for this monstrosity were many Republicans still in Congress today who are unjustly considered to be staunch fiscal conservatives, including incoming Speaker of the House John Boehner, House Majority Leader Eric Cantor, and House Budget Committee chairman Paul Ryan.

Because of its obvious ridiculousness, one seldom hears conservatives say openly that tax cuts automatically reduce spending. But it still underpins the entire Republican budget strategy — tax cuts never have to be paid for, no meaningful spending cuts are ever put forward, earmarks and foreign aid are said to be the primary sources of budget deficits, and similar absurdities.

But there is a flip side to STB at work as well. If tax cuts starve the beast, then it logically follows that tax increases must feed the beast. This variation of STB was on full display in a Nov. 21 Wall Street Journal op-ed article by Wall Street Journal editorial writer and Republican operative Steve Moore, who founded the Club for Growth, which gives vast sums to Republican candidates, and Ohio University economist Richard Vedder.

The Moore-Vedder article argues strenuously that tax increases must never be considered no matter how big the deficit is. The reason, based on research Vedder has been updating since the 1980s, is that tax increases always feed the beast, leading to spending increases larger than the tax increase. Originally, he said that spending would rise $1.58 for every dollar of tax increase, leading to an increase in the deficit rather than a reduction. Vedder now says that spending only rises $1.17 for every dollar of tax increase.

By this logic, the tax increase enacted in 1993, which raised the top federal income tax rate to 39.6 percent from 31 percent, should have caused a massive increase in the federal budget deficit. In fact, it did not. Spending was 22.1 percent of GDP in 1992 and it fell every year of the Clinton administration, to 21.4 percent of GDP in 1993, 21 percent in 1994, 20.6 percent in 1995, 20.2 percent in 1996, 19.5 percent in 1997, 19.1 percent in 1998, 18.5 percent in 1999, and 18.2 percent in 2000.

And contrary to another commonly-held Republican idea — that all tax increases reduce revenue via the Laffer Curve — revenues rose from 17.5 percent of GDP in 1992 to 20.6 percent in 2000.

According to Republican mythology, repeated by Moore and Vedder, the budget was balanced only because Republicans got control of Congress in the 1994 elections. But the deficit had already shrunk from 4.7 percent of GDP in 1992 to 2.9 percent in 1994. Budget experts who don’t shill for the Republican Party generally agree that the budget reforms and tax increases of 1990 and 1993 — which were both enacted against strenuous opposition from almost every Republican in Congress — deserve the bulk of the credit for bringing down spending and the deficit with tough budget enforcement rules and higher taxes.

Moore and Vedder simply deny that the 1990 and 1993 tax increases had anything to do with the budget surpluses that emerged in 1998, even though higher federal revenues contributed 44 percent to the improvement in the deficit. Between 1992 and 1998, spending fell by 3 percent of GDP and revenues rose 2.4 percent.

To the extent that there was an increase in revenues, Moore and Vedder imply that it was due to a Laffer Curve effect from the cut in the maximum capital gains tax rate that Republicans achieved in 1997 — an argument first made by Republican speechwriter Clark Judge in a Wall Street Journal op-ed on Jan. 10.

To be sure, there is good research showing that a cut in the capital gains tax may raise short-term revenues due to an unlocking effect as people realize gains on assets they may have owned for many years. But this is a one-time effect. To raise revenues for more than a couple of years, a lower capital gains rate would have to raise investment and economic growth, which it undoubtedly does to some extent. However, it’s implausible to attribute all of the rapid growth in the late 1990s to lower capital gains taxes. The keys were development of the Internet, which long predated the 1997 capital gains rate cut, and an easy money policy by the Federal Reserve.

In any case, Treasury Department data show that higher capital gains tax revenues contributed at most 0.33 percent to the 1.4 percent-of-GDP rise in revenues between 1997 and 2000. Of course, they contributed nothing to the decline in spending from 19.5 percent of GDP to 18.2 percent. Thus even taking the Republican argument at face value, higher capital gains revenues contributed at most 6 percent to the deficit improvement between 1997 and 2000.

Starve the beast is a crackpot theory, and its flip side that higher taxes invariably feed the beast is no better. They are just self-serving rationalizations for Republican budgetary irresponsibility.

Note: A few years ago, I went into great detail explaining the origin and development of STB in an academic journal. My article is available online for those with an interest in the gory details. In July, I posted a bibliography of more recent academic research in The Fiscal Times, all of which shows no evidence whatsoever that tax cuts reduce spending. More recently, the International Monetary Fund has confirmed this conclusion in a September working paper.