Starving Leviathan With Unlimited Credit

Is the Milton Friedman-blessed Grover Norquist concept of "Starving Leviathan" -- letting the federal government run huge budget deficits so that it eventually runs out of money for basic programs -- really an effective way to impose spending discipline on Congress and the public? Cato's Will Wilkinson votes no.

[E]conomist William Niskanen, chairman of the Cato Institute (also my employer), has presented econometric evidence that federal spending tends to increase when tax revenues decline, flatly contradicting the starve-the-beast theory. Furthermore, according to William Gale and Brennan Kelly of the Brookings Institution, members of Congress who signed the President's "No New Taxes" pledge were more, not less, likely to vote for spending increases, which is hard to square with the starve-the-beast theory. […]

By promulgating the idea that given a tax cut, spending will take care of itself, advocates of the "starve the beast" theory have helped produce a political climate in which principled vigilance about spending seems unnecessary.

Comments

[Joshua W. Burton]

Seems commonsensical to me. Thought experiment: imagine a hypothetical US government that passes a constitutional amendment against taxation of any sort, reasoning that if $400B deficits are good Keynesian medicine then $1.3T deficits are pure white heroin. We'll make it up on raw economic growth, of course, and our creditors will happily go along because the potential tax base of the United States will be increasing faster than the national debt, so that the (never realized) possibility of future repeal more than suffices to compensate them. Investors are so happy with our growth rate that we start to phase out conventional T-bills, replacing them with zero coupon bonds of no fixed maturity. Owning US debt becomes a bit like investing in a growth common stock that pays no dividends.

Question: given all you know and believe about panem et circenses, would you expect a democratically elected Congress to be more, or less thrifty than it is today, given this blank check?

[Jason Ligon]

This is a strange problem. We are acknowledging that the lower tax rates aid our growth. Are we really to the point where we are saying that slow growth of the economy as a whole is justified from a libertarian perspective because the government runs higher defecits in a low tax environment? That is a horrific conclusion.

[drf]

seems counterintuitive to me.

"starving the beast" argument is about as partisan as it is stupid. sure - we're gonna have to reign in spending at some point, preferably when the "other side" is in charge.

another problem with this idea, accepted by the neokeynesians (including NG mankiw, Bush's first-term economic advisor) and even chicagoites, is the crowding out effect. the expansionary fiscal policies are not paid for and are therefore funded by borrowing. the reduction in public savings (and since we're not saving any more), the end result is a higher interest rate.

compare the reaganesque rhetoric surrounding government spending in the 80s and now. one was a positive message, emphasizing getting individuals working. today it is a power struggle of one big government force against the other.

[Ruthless]

Jason Ligon,
You need to distinguish between a low tax revenue environment and a low tax rate environment.

Paging Arthur Laffer.

[gaius marius]

the truly horrific conclusion is that government should manipulate the economy by managing the fiat currency and the government debt -- thus creating the moral hazard we're trapped in.

once the keynesian idea of beneficial deficit spending is accepted, no politician in a democracy is going to be allowed to cut spending to run a surplus for any length of time. clinton only managed it through the passing benifecence of a massive investment boom (which is subsequently busting); we haven't had a prolonged period of surplus since the 1950s.

furthermore, to ease the burden of debt, the fed has adopted inflationary policies which can only be accelerated because of the political anathema of responsibly inducing recession.

these manipulations conspire to put an assumed floor under the market -- as was seen in the averted LTCM disaster in 1998 -- which causes investors to assume more debt and risk than is prudent.

of course, what is never said is that policies of debt and monetary expansion have limits -- and meeting those limits is an experience that can ruin nations.

[Warren]

"Starve the beast" another pithy Washington phrase that means the opposite of what it says. It should be called "stuff the beast" and it's about as effective as giving a junky all the smack they want, hoping that they'll OD sooner that way.

Hey, like Keynes said "In the long run, we are all dead". I guess some anti-Keynesians would rather see us dead in the short run.

[drf]

"I guess some anti-Keynesians would rather see us dead in the short run."

pro-keynes sentiment?

ruthless: when "conservatives" start defending keynes, our supply-side references are dead. sigh.

[joe]

Uh, drf, wasn't it the Supply Siders who called their program "Keyenesianism on Steroids?" It's a little odd to present Supply Side Economics - which posit a large debt as a good way to stimulate the economy - as the polar opposite of J.M. Keynes.

gaius, "once the keynesian idea of beneficial deficit spending is accepted, no politician in a democracy is going to be allowed to cut spending to run a surplus for any length of time." Keynesians posit debt as beneficial only during downturns. The supluses of the 1950s were supported by the Keynesians.

Also, Clinton and the Republican Congress were "allowed" to cut spending (in real terms, if not in absolute dollars) on programs during the 1990s by conforming to the deficit reduction spending limits, and imposing pay-as-you-go rules.

[drf]

joe:

no - political pundits tried the comparison.

the classical model and the supply permutations of it are very different in how they consider debt and gov't spending.

the magnitude of fiscal stimuli or monetary changes are different, depending on which POV you take.

plus, the demand side doesn't enter the classical equation, while demand is the alpha and omega of keynes and the ISLM etc. so, presenting them as opposites is theoretically accurate. how politicans distort the terms is beyond what i was trying to say.

one thing that you have to realize when you're talking about supply-side vs demand-side policies is that our current president is a pure keynesian dude. he tried the tax credit (banking on the liquidity constraint) and is doing this deficit thing. humorously enough, we can see from the sunset on the tax breaks whether ricardo was correct.

again, there were downturns in the 50s, and giving keynesian-based policies the credit may be indeed appropriate. since the composition of the us economy was radically different, much more planned than today (unionized, protectionized), trying to get into that pissing match is about as relevant as looking at depression era or pre income tax era policies in today's context.

[joe]

drf, why are you using "classical economics" as a synonymn for "supply side economics?" I usually only see that comparison drawn by lefties, who divide policy up by "pro-rich" or "pro-poor."

Supply siders supported big deficits, theorizing that the extra stimulus would boost the economy - just like Keynesians. Classical economists would have none of this.

[drf]

joe:

i'm not equating them in the sense that one is the other, rather, that the supply side of the classical model is the donkey that pulls the apple cart, while in the keynesian universe, it's demand. and while we're at it, you're probably right: we should abandon each model, as neither are really used today.

and you're taking the "supply siders" as a monolith, just as we see people assuming the mantle of reagan - it's all talk.

in the reagan years, there was a conflict between the supply siders (sticking with a reduced gov't, lower tax burdon) and keynesians (second sec'y of treasury) and with those who like hog-wild gov't spending.

here's a good article on the perversion of the concept "supply side". remember that just as the religious right ruins terms such as "liberty", this term got co-opted, too.

http://www.mises.org/freemarket_detail.asp?control=161&sortorder=articledate

and "why are you using "classical economics" as a synonymn for "supply side economics?" I usually only see that comparison drawn by lefties, who divide policy up by "pro-rich" or "pro-poor.""

i've never seen that at all, so, whatever.

[drf]

either way (even taking what you're saying as true, joe, that the reagan years manifestation of "supply side economics" is the only definition), i don't like massive gov't spending, deficits, or buying votes through popular political programs (steel tarifs, wars, etc). and i don't think that the characterization of "supply side economics" has a component of "trickle down". whenever that thought is there, i'd argue that we don't have a supply side system, rather a system that tries to use taxes to engineer social progress (even if it's for reduced taxes, i'd want taxes to be a step on the way, not the cause)

so, while i do think the supply side of the model is important, in the context of reigned-in gov't spending, ie., pay for the tax cuts. i don't like corporate welfare and i want the troops home and the trade barriers down.

however, i simply don't think that the demand stimulus works as the driver. we didn't see such a boom with bush II's keynesian demand side plans. and there is no incentive to work in his tax "cuts", there's corporate welfare galore, and his crony capitalism shouldn't for a minute be mistaken for the "free market".

i don't think reagan was the end-all of limited gov't - he and thatcher talked a better game than they played. i think that many of the supply siders had the right idea, but the attraction of gov't spending was too great. we're talking about the wielding of gov't power above - that corrupting power is getting in the way.

[thoreau]

Jason-

They said that spending goes up when revenues drop, not when rates drop.

[Jason Ligon]

"They said that spending goes up when revenues drop, not when rates drop."

So is Will W. arguing to increase marginal rates or not?

[joe]

drf, you're using a definition of "Supply Side Economics" that is distinctly different from that which is most commonly used.

Reagan's willingness to create huge deficits should be enough to tell you that the Supply Siders were a deviation from the classical ecnonomics of the 1920s Republicans.

[thoreau]

Jason-

I think the point is simply to debunk the notion that tax cuts can serve as an indirect route to spending cuts by "starving the beast", by pointing out that when politicians break out the credit cards they become less responsible.

The only way to address spending cuts is to do so directly. It might not be easy, but it's the indirect approaches clearly don't work.

[drf]

hey joe:

fair enough. the popular definition of "supply side" is as useful to me as the popular definition (diagnosis?) of "depression".

i shoulda made myself more clear from the get go.

[Ken Shultz]

"By promulgating the idea that given a tax cut, spending will take care of itself, advocates of the "starve the beast" theory have helped produce a political climate in which principled vigilance about spending seems unnecessary."

I don't remember the argument that, "...given a tax cut, spending will take care of itself..." Surely, other things being equal, there is a direct relationship between the size of the budget deficit and our lawmakers' reluctance to spend.

The people advocating the "starve the beast" theory were typically the same people arguing for deep cuts in marginal tax rates. Has everyone already forgotten the Laffer Curve?

Given the opportunity, most ol' time, Reaganomic conservatives would cut both marginal tax rates and the budget. Politically, however, I don't remember there being such an opportunity; it was always an either/or proposition. Reagan was able to get the tax cuts but not the budget cuts, and Gingrich was able to get the budget cuts but not deep cuts in marginal tax rates. They both tried to do both.

Conventional wisdom has it that cutting taxes can stimulate the economy to grow out of deficit. Cutting the budget may lower interest rates, keep down inflation, etc., but it doesn't cut taxes, does it? Given an either/or proposition (and in the Bush Administration, it's been a neither/nor proposition), I'd rather have a tax cut.

[Mark Bahner]

"Reagan was able to get the tax cuts but not the budget cuts, and Gingrich was able to get the budget cuts but not deep cuts in marginal tax rates. They both tried to do both."

As I recall, Brad DeLong posted some of Ronald Reagan's PROPOSED budgets. They didn't have significant spending cuts, as I recall.