Liberals have found a new way to scratch their itch to raise taxes. Writing in the Washington Post, Sebastian Mallaby states that the “best strategy for forcing cuts in government is actually to raise taxes.” In the Atlantic Monthly, Jonathan Rauch argues that conservatives who want to stop the current federal spending orgy “should be talking about raising taxes.”
Actually, their argument makes more sense than you might think. It is based on price theory: when the price of something declines, people demand more of it. If taxes are the “price” of government, then cutting taxes may lead people to the erroneous conclusion that they are getting a discount and, hence, they will demand more government leading to a deficit. If taxes go up, people feel the pinch and demand that Congress keep a lid on spending.
Empirical support for this theory (and the source of Rauch and Mallaby’s excitement) is found in a new paper by Cato Chairman William Niskanen. Entitled “‘Starve the Beast’ Does Not Work,” the paper examines the relationship between federal tax revenues and spending. Using a regression model, Niskanen found that when tax revenue declined between 1981 and 2005, spending increased. Conversely, when taxes rose, spending declined. Niskanen uses these findings to challenge the “Starve the Beast” theory, popular at one time among conservatives, that the way to reduce what Washington spends is to limit what it takes in taxes. Niskanen also uses the regression model to determine that the optimum amount of tax revenue that the government should take is 19 percent of Gross Domestic Product. That is the level of tax revenue “necessary to prevent a continued increase in… federal spending.” Since the federal revenue amounts to about 17.8 percent of GDP, Niskanen’s paper gives the likes of Rauch and Mallaby the intellectual cover to advocate a tax increase. Even Niskanen seems resigned. Balancing the budget without a tax increase “would be desirable but most unlikely in the near term,” he writes.
Yet there are some holes in the price theory of government, which Niskanen is willing to concede. For example, in his paper he writes, “If our political system is biased in favor of larger government spending that a majority of voters prefer, as is surely the case, we need to identify and correct these biases.” How can government spending be larger than a majority of voters prefer if most voters feel they are getting a discount after tax cuts? It turns out that the price theory may not apply to all voters. The greatest pinch from raising taxes is felt by upper-income folk since they “face the largest tax increases in a progressive system,” Niskanen said later in an interview with me. The reason increasing taxes on upper-income voters restrains spending, he stated, is that “this group is very vocal politically.”
Another hole in the theory is that Niskanen’s model doesn’t capture political factors. The spending restraint of the 1990s may have had as much to do with Ross Perot as with increased taxes. Perot’s big issue was the deficit, and he garnered 19 percent of the vote with it in 1992. Both Clinton and the GOP may have been willing to hold down spending to reduce the deficit in a scramble to attract such voters. Niskanen discounts that by noting “Clinton had many new spending ideas when he came to office.” True enough, but he largely tempered that after his party’s 1994 rebuke at the polls.
Finally, if we are genuinely concerned that voters have the illusion that they are getting government at a discount, there are ways to fix that other than raising taxes. One is eliminating withholding. The amount that the government deducts from each paycheck does far more to hide the cost of government than any tax cut. If voters were required to pay a lump sum to the IRS each year, they would be far more likely to demand that politicians hold the line on spending than they do now.
When people realized exactly how much the government actually took of their income, they would probably demand big spending cuts. And that is probably why you won’t see Rauch and Mallaby come out in favor of ending withholding.