The tax increase sucker play

Back in February our dear comrade leader created the National Commission on Fiscal Responsibility and Reform (more here) to make recommendations on how to reduce the gargantuan economy-killing deficits imposed by the democrat-controlled congress and the comrade himself. While the commission is mostly bipartisan and actually contains some fiscal hawks (like Tom Coburn), one has to question how serious our comrade leader was about deficit reduction given that he appointed former SEIU chief Andy Stern as a member of the commission (more on Stern here and here). Stern can be counted as a sure vote against any recommendation that contains even a hint of fiscal restraint.

The commission is supposed to issue their list of recommendations next month and there have already been some revelations as to what we can expect. According to this story (from the WSJ), revenue (tax) increases will surely be part of the commission’s recommendations. This is certainly to be expected but will tax increases actually do anything to reduce the deficit? According to the article’s authors, they will probably increase the deficit because as history has shown, congress will spend any increased revenue – and then some.

The draft recommendations of the president’s commission on deficit reduction call for closing popular tax deductions, higher gas taxes and other revenue raisers to drive tax collections up to 21% of GDP from the historical norm of about 18.5%. Another plan, proposed last week by commission member and former Congressional Budget Office director Alice Rivlin, would impose a 6.5% national sales tax on consumers.

The claim here, echoed by endless purveyors of conventional wisdom in Washington, is that these added revenues—potentially a half-trillion dollars a year—will be used to reduce the $8 trillion to $10 trillion deficits in the coming decade. If history is any guide, however, that won’t happen. Instead, Congress will simply spend the money.

In the late 1980s, one of us, Richard Vedder, and Lowell Gallaway of Ohio University co-authored a often-cited research paper for the congressional Joint Economic Committee (known as the $1.58 study) that found that every new dollar of new taxes led to more than one dollar of new spending by Congress. Subsequent revisions of the study over the next decade found similar results.

We’ve updated the research. Using standard statistical analyses that introduce variables to control for business-cycle fluctuations, wars and inflation, we found 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.

We also looked at different time periods (e.g., 1947-2009 vs. 1959-2009), different financial data (fiscal year federal budget data, as well as calendar year National Income and Product Account data from the Bureau of Economic Analysis), different lag structures (e.g., relating taxes one year to spending change the following year to allow for the time it takes bureaucracies to spend money), different control variables, etc. The alternative models produce different estimates of the tax-spend relationship—between $1.05 and $1.81. But no matter how we configured the data and no matter what variables we examined, higher tax collections never resulted in less spending.

Surprised? I’m not. For decades the federal leviathan has grown in size, scope and power. The bureaucrats in DC have lost touch with reality because most of their policies only affect the little people as they have largely exempted themselves. Tax cheats abound – including the Treasury Secretary himself and the architects of tax and spend policy. This is not a revenue problem, it’s a spending problem.

We suspect that voters intuitively understand this tax and spend connection, which is why there is such hostility to broad-based tax increases. “Polls consistently find that a majority of Americans believe any new taxes will be spent by the politicians,” pollster Scott Rasmussen told us recently in an interview.

The grand bargain so many in Washington yearn for—tax increases coupled with spending cuts—is a fool’s errand. Our research confirms what the late economist Milton Friedman said of Congress many years ago: “Politicians will always spend every penny of tax raised and whatever else they can get away with.”

Precisely – a sucker play…

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