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A battle is currently raging in Washington. To address our budget deficit should we raise taxes or cut spending. It is assumed that these are two sides of the same coin. Raising one dollar in taxes is the equivalent of cutting one dollar of spending. But is that true?
Although the math may seem clear, history tells us that the two actions produce two different results. The reason is that the government cannot contain itself. Any dollar it takes in burns a hole in its pocket, it just can’t wait to spend it. The problem is, the government can’t stop itself with that dollar. Instead, it takes your tax dollar and then spends $1.58. The result is ever-higher spending levels and unsustainable debt. Higher taxes only work to encourage it.
I didn’t just pull the $1.58 number out of thin air. A 1987 study done by Ohio University economics Richard Vedder, Lowell Gallaway, and Christopher Frenze found that for every one dollar of additional tax revenue the government turns around and spends $1.58.
The reason for the disconnect between revenues and spending is the result of a careful balance made by legislators. On the one hand Congressmen increase federal spending because of its “marginal political benefits” – the concept that voters like what Congress is buying. Any added spending must eventually be financed by taxation and borrowing which impose “marginal political costs” since voters don’t particularly enjoy paying higher taxes. Congress has been willing to cheat the balance, reaping the political reward for spending on preferred projects while delaying (or ignoring) the costs imposed via higher taxes.
In 2007, Richard Vedder and Jonathan Leirer, updated the study. They found many of the same results, namely that the federal government continues to spend more than every new dollar it raises in taxes. The study also contained a very prophetic pronouncement about the current state of politics. They argued that,
“Attempts to reduce the budget deficit will be futile until the “rules of the game” change in a manner that alters the political incentive structure, raising the political costs of deficits, lowering the political benefits of spending, lowering the political costs of taxation, or a combination of the three.”
As the recent election results show, the rules of the game have changed. The political pendulum swung heavily towards conservative candidates who promised to put a stop to the spending habits of Washington and argued for a smaller role for the federal government. In other words, voters’ concern over the deficit (and its impact on the private sector) trumped voters’ desire for the products of government spending.
Today, Richard Vedder is back with yet another update on his groundbreaking research. Using new variable and taking new historical information into account he finds 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.”
Given the current debate over higher taxes versus lower spending as a means of curing our budget deficit, these results are more important than ever. They argue that the Democratic argument that tax increases be “put on the table” before they agree to cuts to entitlement programs is nothing but a “sucker play.” That’s because new tax revenues are almost invariably followed by spending increases, not entitlement cuts.
So as we go forth into the debate over how to conquer our deficit we must go armed with the knowledge that higher taxes more often lead to higher spending and not deficit reduction. As the Nobel winning economist Milton Friedman argued, “The only effective way I think to hold [government spending] down, is to hold down the amount of income the government has. The way to do that is to cut taxes.” As the newest studies show, one way that certainly does not lead to holding down government spending is giving them more money to play with.
by Brandon Greife, Political Director of the College Republican National Committee