*Do Tax Cuts Starve the Beast?* by Christina Romer and David

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Transcript *Do Tax Cuts Starve the Beast?* by Christina Romer and David

“Do Tax Cuts Starve the Beast?”
by Christina Romer and David Romer
Remarks by Steven J. Davis
University of Chicago
Brookings Panel on Economic Activity
April 2-3, 2009
Washington, DC
Starving the Beast –
What Is the Mechanism?
• Debt servicing requirements are a claim on
government revenues.
• Assumption: Rising marginal costs of raising
government revenue and non-increasing
marginal benefits of spending (for PM)
• Implication: OTE, a government that inherits
more debt spends less, net of debt servicing.
• Mechanism: Bequeath more debt to future
government, raise servicing costs, and thereby
limit future spending
Strategic Beast Starving
1. Current PM anticipates that future PM has a
stronger taste for public spending
Compared to situation where current PM expects to retain
power, current PM taxes less and runs a bigger deficit.
Why? To constrain future spending.
Persson and Svensson (1989, QJE)
2. Current PM anticipates that future PM wants a
different type of spending
Compared to situation where current PM expects to retain
power, current PM spends more on its preferred type of
spending and runs a bigger deficit.
Why? To constrain future spending on the type of
spending that current PM dislikes.
Alesina and Tabellini (1990, RESTUD)
No Starvation Diets in this Sample
• If deficit-financed tax cuts raise debt-GDP ratio by 5
percentage points and r=2% per year, then debt
servicing costs rise by (.05)(.02)=0.1% of annual
 Desired non-interest spending falls by 0.1% of GDP if MB
of G is flat, less if MB declines with G
• Even less strain on government revenue
requirements if tax cuts stimulate growth.
• More strain if higher debt causes r
• Conclusion: Mechanism is too weak for detection by
RR method in sample of postwar U.S. tax changes.
Another Mechanism
Tax changes are sticky – hard to reverse
Magnifies force of basic mechanism, because tax
changes implemented by current PM carry forward
Large # of tax changes documented by RR suggests
limited stickiness for “routine” tax changes
Stickiness could be a very important factor for outof-sample changes
– Elimination of corporate income tax system
– Adoption of VAT or national sales tax
What’s the Beast?
“Big G” or “Big Welfare State”?
Reagan opposed Big WS, favored defense
Many other advocates of beast starving are more
concerned about Big WS than Big Defense
If Big WS is target, a focus on total G can mislead
– Reagan cut taxes and initiated a persistent rise in
defense spending
– Both created fiscal pressures to restrain WS , but the
rise in defense spending muted decline of total G
Another issue: If defense spending is less
responsive to fiscal pressures, then beast-starving
effects load disproportionately onto WS spending.
– In line with Figure 5.d
Deficit-Fighting Tax Hikes
• Often accompanied by modest spending cuts
• Example: Clinton tax increase of 1993
• RR regard these changes as uninformative
about starve-the-beast hypothesis, because
they reflect a “switch to fiscal responsibility”
• But the need for deficit-fighting tax hikes and
spending cuts, when caused by deliberate tax
and spending decisions of previous PM, is
evidence for strategic beast-starving behavior.
– Persson and Svensson (1989)
Concerns about
Counterfactuals and Exogeneity
1. Suppose PM foresees rising political pressure for
public spending (e.g., because of population aging)
– In response, PM cuts taxes now to limit or slow future
spending growth.
– Spending grows, but less so because of tax cut
– RR interpret this pattern as evidence against starve-the-beast
effects, even if the tax cuts restrain spending growth.
2. Suppose tax cuts are more likely when PM foresees
strong growth and a lessening of fiscal pressures
In response, PM cuts taxes now and expands spending over
RR interpret this pattern as evidence against starve-thebeast effects, even though both tax cuts and spending
growth reflect anticipations of strong growth
• An admirable effort, but not persuasive
Concerns about exogeneity and counterfactuals
Large standard errors
Too little variation to detect effects of mechanism
Issues related to defense spending vs. WS spending
• Figure 5.d says long run nondefense spending falls by
40% of tax cut amount (big standard errors)
• A priori reasoning implies the basic mechanism is
weak for tax change episodes in postwar U.S.
• Frequency of tax changes suggests that stickiness
mechanism also lacks force for routine changes
• Nothing here diminishes Becker-Mulligan-type
concerns about spending consequences of VAT
and other efficient taxes.
Becker and Mulligan, 2003, “Deadweight Costs
and the Size of Government,” J Law&Economics
Alesina and Tabellini, 1990, “A Positive Theory of
Fiscal Deficits and Government Debt,” RESTUD.
Persson and Svensson, 1989, “Why a Stubborn
Conservative Would Run a Deficit,” QJE.
Romer and Romer, 2009, “Do Tax Cuts Starve the
Beast?” BPEA, forthcoming.