Economics

New Council of Economic Advisers Chief Romer on Taxes and the Beast

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James Pethokoukis and Tyler Cowen point to newly minted Obama CEA chief Christina Romer as an advocate of tax cuts, and a skeptic that tax cuts will lead to spending cuts, a theory often beloved of market-leaning economists and sometimes known as "starving the beast."

Here's the money quote from the paper Pethokoukis points to on her tax cut bonafides:

Our estimates suggest that a tax increase of 1% of GDP reduces output over the next three years by nearly 3%. The effect is highly statistically significant.

I wrote about the latter study by Romer and her husband in the February 2008 issue of reason. An excerpt:

A new study by University of California at Berkeley economists Christina D. Romer and David H. Romer, published by the National Bureau of Economic Research, indicates that the beast is thriving despite the tax cuts of the last three decades. Government spending seems to march on regardless of revenue or tax rates.

The economists studied the effects of four major legislated changes in U.S. tax rates and policy since World War II, choosing episodes where the "starve the beast" motivation was most conspicuous. After looking at the data every which way, with multiple regressions and time lags, and accounting for wars and military spending, they found that the one thing most clearly connected to tax cuts was not spending cuts but future tax increases.

"Although a tax cut leads to a sharp fall in revenues in the short run, it does not have any clear impact on revenues at horizons beyond about two years," the economists write. "Between one-half and four-fifths of the tax cut is offset by legislated tax increases over the next several years." And spending cuts? "In no episode [of postwar American tax cuts] was there a discernible slowdown in spending following the tax cut," the economists conclude.