When a tax cut isn't a tax cut

by Russ Roberts on January 6, 2009

in Stimulus

If the government cuts rates or just gives rebates but at the same time increases the size of government, taxes are not lower. They’re larger. Government is taking a bigger share of the economic pie leaving less for the private sector to spend. The future burden of taxes is higher. As Milton Friedman used to argue, don’t focus on how government is financed, whether it’s out of current taxes or future taxes. Focus on the spending. If government grows as a percentage of the economy, then the burden on the private sector is bigger.

Taxes have risen since George Bush became president. Federal spending as a proportion of GDP has increased since 2001. Bush didn’t cut taxes. He rearranged the burden of taxes. But he didn’t reduce taxes. He increased them because the bill for the higher spending will still have to be paid.

One way to see this (and to see why tax cuts unaccompanied by spending cuts aren’t stimulative) is to think about the government eliminating ALL taxes in 2009. No payroll tax. No income taxes on individuals or businesses. So everyone "has more money to spend." I put that in quotes because it’s not true. If government keeps the level of spending constant while collecting no taxes, then my taxes in the future are going to be double (actually more than double to cover the interest) than they otherwise would be. I’m also assuming the government will be able to sell trillions of dollars of bonds to cover the spending. In that world, would you run out to buy a car or a new plasma TV with your increased income?

Maybe. If you were sufficiently myopic or if you paid no taxes and got a check from the government, you might. But many people are going to worry about the future taxes they’re going to have to pay. They’re going to spend less. Moreover, if the government keeps using goods and services what is going to be available for taxpayers to buy with all the money burning a hole in their pocket? After all, government hasn’t gotten smaller. It’s still using concrete to build those bridges. It’s still using workers to build those bridges. You have to argue that there are all these idle resources wasting away that will spring into life once people have all the extra money. It’s possible as long as resources are sufficiently fluid and if enough people ignore the implications for the future of a $3 trillion deficit. But what is the evidence for this claim?

When unemployment is 6.7%, why will a $750 billion increase in government make the economy bigger? The main effect is to rearrange what we have. We’re going to have more bridges. We already have plenty (HT: MR).

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{ 18 comments }

MnM January 6, 2009 at 1:40 pm

An interesting argument, though it may need some qualification.

Strictly speaking, the government may not necessarily *double* your taxes to cover shortfalls of past spending. They may also *print* the money.

I suspect the net result would be the same, though in this scenario the cost to you would be in terms of the devaluation of the dollars that you have, rather than the strict taking of said dollars.

Bret January 6, 2009 at 1:53 pm

"When unemployment is 6.7%, why will a $750 billion increase in government make the economy bigger?"

This is a valid and objective question. In my opinion, a $750 billion increase in government will not make the economy significantly bigger given the current state of the economy. Though there is some chance that unemployment is at 6.7% and otherwise headed towards something much higher, in which case an increase in government, even if inefficient, might make for a somewhat bigger economy.

The other statements in the last few posts seem much more ideological and assume that government can never do anything right. This one seems a more fair question.

Marcus January 6, 2009 at 2:44 pm

I'm also assuming the government will be able to sell trillions of dollars of bonds to cover the spending.

Russ, some comments (as devil's advocate):

One, right now, the government isn't having any problem what so ever selling bonds. In the current environment, printing up bonds is literally equivalent to printing money.

Second, bank excess reserves are through the roof. I would presume that most of those reserves are in the form of treasuries. Tax cuts are a way of getting those reserves into people's pockets where they can be spent.

Even if people don't spend the money and instead pay down their debts, what's the problem? The government has in essence transferred some amount of private debt into public debt and, presumably, helped flush some of the 'bad' debt out of the system.

Jon January 6, 2009 at 9:29 pm

If government keeps the level of spending constant while collecting no taxes, then my taxes in the future are going to be double [...] I'm also assuming the government will be able to sell trillions of dollars of bonds to cover the spending.

This is interesting. In this scenario, everyone's immediate tax burden is zero. And to sell so much debt, the government will end up not only paying high interest rates, but also making money worth less by inflating. The latter clearly has the same effects as a tax, in that it takes from current owners of money (everyone).

Isn't taking through inflation a flatter tax than a progressive income tax? Wouldn't this affect incentives somehow?

A different question: taxpayers are mobile–wouldn't that modify their incentives even in light of the possibility of future tax hikes (i.e., they know they can simply leave if the hike does come)?

Mr. Econotarian January 6, 2009 at 11:35 pm

Where is the evidence that fiscal stimulus has EVER been highly effective at improving the economy?

vidyohs January 7, 2009 at 10:23 am

Jack Lohman,

"There is but one way to bring spending into line with taxes and that is to pass public funding of campaigns. The $5 per taxpayer cost would be paid back 100 times over. It makes absolute sense, but it limits election dollars and politicians don't like that. See:
Posted by: Jack Lohman | Jan 7, 2009 9:49:46 AM"

In regards to a person's willingness to sell his power, are you, sir, absolutely certain sure that how he gets into office is as important as how he will behave once in?

I think this reflects the naivity about politicians that, Prof Roberts has mentioned before as well, "fish gotta swim, birds, gotta fly, and water gotta run downhill".

Your problem, sir, is that once a politician is elected you have no way to control him or exert any real influence on his behavior until re-election comes up. Once your politician is elected he answers to the party not the people. See Art. 1, Sec. 5, Para. 2. "Each house may determine the Rules of its Proceedings,".

that flaw in the Constitution allowed the creation of the Committee system wherein the party having the most members in a house has the power to appoint Committee chairmen and the majority memebers of the Committee. No bill gets out of a committee without the approval of the chairman and he has to power to even block his own members if he deems it to be in his personal best interest.

That little flaw guarantees all of the lobbying and the corruption we see, your method of campaign funding is meaningless until that flaw is fixed.

Jack Lohman January 7, 2009 at 10:37 am

I don't care how the "house rules" are written. If politicians are getting their campaign money from special interests, they will initiate bills and vote on legislation that benefits those special interests. What is it about money do you not understand?

If special interest money did not benefit the givers it wouldn't be given. If it didn't benefit the takers they'd vote for public funding of campaigns so they didn't have to prostitute themselves and spend nights away from their families.

Until they get the corruption out of the political system, expect more of the same.

vidyohs January 7, 2009 at 12:51 pm

Jack,

I recognize right now I am talking to a koolaid drinker so from here on out my comments are not as debate but just to offer information you'd do well to consider.

What happens to put your man through the door is irrelevant once he goes through the door. Those "rules" you don't care about guarantee it.

As I said, and you refuse to consider, you can put your sainted publicly financed man in the house; but the flaw guarantees that his corruption is certain. Those "rules" you don't care about guarantee that in order to advance any proposal (bill) he WILL have to SELL something to the committee chair, even more so if he is in the minority party.

Did you get that Jack, he WILL have to SELL something to the committee chair. That is corruption, both the buyer and the seller are guilty. The political process, in spite of your naive belief and desire, does not work or run on the fuel of altruism and nobility.

Because of human nature, those "rules" you don't care about guarantee corruption, and it is self evident if you just look.

Your fixation is on sending the new congress critter through the door clean, but when the door leads to the cesspool the results are the same, and once you shove him through the door you no longer have any control over what influences him. This too is self evident.

If your publicly financed man does resist temptation and corruption he will be useless to you as a representative because he will get no committee assignments, get no bills introduced to the floor for a vote, and he will be shoved off in the same corner as Ron Paul. Those "rules" you don't care about guarantee that, again this is self evident because it is exactly what is happening now and your method of selecting new representatives will not change it. The door leads to the cesspool.

Sam Grove January 7, 2009 at 12:54 pm

Until they get the corruption out of the political system, expect more of the same.

Good luck with that.
Politics is systemically corrupt.

Do you suppose special interests would no longer have interest in legislation if they were isolated from electoral campaigns?

Then there's the problem of incumbents rigging the rules to favor incumbents. What do you propose to do about that?

There's only one congressional office that is not frequented by lobbyists.
Why do you suppose that is the case?

Eric Sipple January 7, 2009 at 12:59 pm

"We already have plenty."

That are, y'know, falling down.

maximus January 7, 2009 at 4:49 pm

"That are, y'know, falling down."

Yeah, well design them right in the first place and they won't, ya know, fall down…

Anonymous January 7, 2009 at 6:45 pm

Sam, there is nothing wrong with lobbying, but lobbying with cash in hand will be stopped under a clean election system. And vidyohs, I'll keep drinking my koolaid. A corrupt political system dooms our country, it's up to us to stop it.

vidyohs January 7, 2009 at 7:04 pm

Mystery man,

"A corrupt political system dooms our country, it's up to us to stop it.
Posted by: | Jan 7, 2009 6:45:57 PM"

Absolutely, but you're still missing the point.

You don't protect the livestock from the blizzard by counting snowflakes, you have to do something relevant, something that will be an actual fix, cure, or deterrent.

Public financing of elections is no more relevant to deterring corruption than counting snowflakes is a deterrent to frozen livestock.

Plus as someone else pointed out, it opens the door to more corruption or an official nature…..like who gets public financing, what hoops does the reigning party in power require, can a new candidate compete with an incumbent. I can see so many ways public financing would just make a bad situation worse.

Fix the damn constitution, man. Gather the herd back into our corral where we can control them. There is ytour answer.

vidyohs January 7, 2009 at 7:05 pm

There is ytour answer. Should have been:
There is your answer.

Jack Lohman January 7, 2009 at 8:10 pm

Wow…

It seems you understand that money buys legislation (and spending that leads to taxation), but you don't see how eliminating that money reduces taxation. But you know a lot about livestock and snowflakes. This is a real intelligent conversation.

Okay, you fix the system your way.

vidyohs January 7, 2009 at 10:22 pm

Everything I said was about money, useless squandering of money, excessive taxation to pay for that spending, and the selling of influence of positions in order to gain. I am sorry I could not grab you by the hair and drag you to the blackboard and push your nose in it and spell out the explanantion word for word for you.

When I talked of corruption what else could I have been talking about but lobbys, pork projects, squandering of peoples money? It all begins and ends with the ability of congress to seize your money and squander it, how could you mistake that I understand that and was addressing it?

I want to drain the cesspool and pave over it, and you want to bring people to it clean before you let them jump in. Which of us has the more intelligent and permanant solution? Which of us sees the problem as it really is, Jack?

The flaw could be fixed with a simple amendment but until people actually read the constitution and understand what they have read they can't possibly see how it is distorted in practice.

How damn smart do you have to be, Jack, to understand that you don't give your servants, your employees, your hired hands, free rein to decide the rules of their employment and expect to retain control over their activities?

The conversation could have been intelligent but when you can't see what my 12 year old neighbor can see, then as I said back with the statement of dealing with a koolaid drinker, I no longer felt I had a debate or a conversation.

Did you have trouble understanding my blizzard/snowflake analogy and its point, Jack? That says so much more about you than about me or the analogy.

But, let's not end this on a bitter note. Think about it for awhile, think about everything I have said to you, let it percolate in your head and you'll maybe come to see what I have given you.

Don't come back to me with questions or arguments, you either get it or you don't.

Sam Grove January 8, 2009 at 1:54 am

but you don't see how eliminating that money reduces taxation.

But you don't see how campaign finance, of any sort, does nothing to eliminate the money.

Political government is all about the money; control of resources and distribution of same via control of the money supply and taxation.
Washington D.C. is "the money" central.

Marcus January 8, 2009 at 1:02 pm

It seems you understand that money buys legislation (and spending that leads to taxation), but you don't see how eliminating that money reduces taxation.

You're not going to eliminate money from politics. Even if you require candidates to be funded with public money (and all the political gaming that creates) how are you going to stop private citizens from campaigning on a candidates behalf?

Unless you just throw the first amendment right out the windows. At which point you're throwing the baby out with the bath water.

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