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Can Tax Cuts Increase the Size of Government?

Published online by Cambridge University Press:  20 July 2015

Daniel N. Shaviro
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Recent U.S. tax cuts, to the extent that they involved a principled, long-term policy view, seem to have been aimed at shrinking the size of government. The idea apparently was to force eventual spending discipline, even (or perhaps especially) with respect to Social Security and Medicare, by turning reduced tax revenues into a political fact on the ground that would be difficult to reverse. In fact, however, the idea that the tax cuts would make the government smaller seems to have rested on spending illusion, or confusion between the actual size of government, in terms of its allocative and distributional effects, and the observed dollar flows that are denominated ‘taxes’ and ‘spending’.

Given the long-term budget constraint, which holds that government inflows and outlays must ultimately be equal in present value, and the huge preexisting fiscal imbalance, the tax cuts are likely to be paid for, in the main, through some combination of future tax increases and cuts to Social Security and Medicare. (Other government spending cuts, relative to the case where the tax cuts were not enacted, are likely as well, but cannot contribute nearly enough.) To the extent that the 2001 through 2003 tax cuts lead to future tax increases, the combined effect is likely to make the government bigger both allocatively and distributionally. To the extent that Social Security and Medicare spending bear the brunt, the government still gets larger in the sense of increasing redistribution from younger to older generations, although Medicare cuts might decrease the size of government allocatively.

Type
Research Article
Information
Canadian Journal of Law & Jurisprudence , Volume 18 , Issue 1 , January 2005 , pp. 135 - 152
Copyright
Copyright © Canadian Journal of Law and Jurisprudence 2005

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References

Earlier or related versions of this article include “The New Age of Big Government” in Regulation Magazine (Spring 2004) 36 and section III of “Reckless Disregard: The Bush Administration's Policy of Cutting Taxes in the Face of an Enormous Fiscal Gap” Boston C. L. Rev. [forthcoming].

1. See U.S., The Boards of Trustees, Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, 2004 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds (March 23, 2004) at 108, Table II.C22. Online: http://www.cms.hhs.gov/publications/trusteesreport/2004/tr.pdf Google Scholar

2. Quoted in Dreyfuss, Robert, “Grover Norquist: ‘Field Marshal’ of the Bush plan” The Nation 272:19 (14 May 2001) 11 at 12Google Scholar.

3. Saki, , The Unbearable Bassington (Oxford: Oxford University Press, 1982) at 1.Google Scholar

4. The size of government can be either an absolute measure or a relative one, depending on one’s interest in inquiring. Suppose one were asking whether Wyoming or California has a bigger government. If one’s interest lay in how the size of a bureaucratic organization affects its performance, the measure would have to be absolute. California’s government would get no “credit” for presiding over a larger economy. But if one were interested in relative degrees of intervention in the economy, one would have to measure the two governments’ interventions in a relative sense.

5. See, e.g., Murphy, Liam & Nagel, Thomas, The Myth of Ownership: Taxes and Justice (Oxford: Oxford University Press, 2002) at 16–17 CrossRefGoogle Scholar: “The no-government world is Hobbes’s state of nature, which he aptly described as a war of all against all. And in such a state of affairs, there is little doubt that everyone’s level of welfare would be very low and—importantly—roughly equal.”

6. Locke, John, The Second Treatise of “Government(New York: The Bobbs-Merrill Company, Inc., 1952) §6 at 5Google Scholar.

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9. Fried, Barbara H., “The Puzzling Case for Proportionate Taxation” (1999) 2 Chapman L. Rev. 157 at 176Google Scholar. Fried notes, for example, “the enormous gains society bestows on those whose natural talents have little use value on [a] Crusoeian island.” An example is “Wayne Gretzky alone on a desert island, thinking of inventing a game called hockey if he could ever find ice, eleven other players, and an audience to pay to watch,” so that (as in actual late twentieth century America) he could earn $20 million per year. Ibid. at 177.

10. See, e.g., Murphy & Nagel, supra note 5 at 26 (asking whether the state’s role should be limited “to the protection of [basic] entitlements and other rights”); at 76 (discussing the “public-private division”); at 88 (discussing “redistribution,” evidently relative to the pre-intervention distribution of wealth).

11. See Shaviro, Daniel N., Making Sense Of Social Security Reform (Chicago: University of Chicago Press, 2000) at 86, 131–32 Google Scholar; Shaviro, Daniel N., Who Should Pay For Medicare? (Chicago: University of Chicago Press, 2004).Google Scholar

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13. Epstein, Richard A., “Taxation in a Lockean World” in Coleman, Jules & Paul, Ellen Frankel, eds., Philosophy and Law (Oxford: Basil Blackwell for the Social Philosophy and Policy Center, Bowling Green State University, 1987) 49 at 70.Google Scholar

14. See Fried, supra note 9. In any event the distributional effects of the tax system cannot be assessed in isolation, but depend on what else the government does.

15. See Shaviro, Daniel N., “Rethinking Tax Expenditures and Fiscal Language” (2004) 57 Tax L. Rev. 187.Google Scholar

16. Payments of interest on government bonds, but not repayments of bond principal, are treated as spending in official government measures such as that of the annual budget deficit or surplus.

17. Gokhale, Jagadeesh & Smetters, Kent, Fiscal and Generational Imbalances: New Budget Measures for New Budget Priorities (Washington, D.C.: The AEI Press, 2003) at 2.Google Scholar

18. U.S., The Board of Trustees, Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, 2004 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds (March 23, 2004) at 59, Table IV.B7, online: http://www.ssa.gov/OACT/TR/TR04/tr04.pdf.Google Scholar

19. Supra note 1 at 60, Table II.B11. [“Unfunded HI Obligations from Program Inception through the Infinite Horizon”]

20. Ibid., at 99, Table II.C16. [“Unfunded Part B Obligations from Program Inception through the Infinite Horizon”]

21. Ibid, at 108, Table II.C22.

22. See Gokhale & Smetters, supra note 17 at Table 2. Using the President’s 2003 budget as the baseline for future policy, Gokhale and Smetters estimated in 2002 that the total fiscal gap as of 2004 would be “only” $46.9 trillion This lower estimate reflected, among other things, assuming that prescription drug enactment would cost “only” $7 to $12 trillion. See Antos, Joseph and Gokhale, Jagadeesh, “The Cost of Adding a Prescription-Drug Benefit to Medicare” American Enterprise Institute for Public Policy Research (July 17, 2003), online: http://www.aei.org/news/filter.,newsID.18039/news_detail.asp.Google Scholar

23. See Gokhale & Smetters, ibid at 36.

24. Given the preexisting FI, one or both of these changes would have been necessary even without the recent tax cuts, but the tax cuts increase their necessary magnitude.

25. Shaviro, Who Should Pay for Medicare?, supra note 11 at 148.

26. Rosen, Harvey S., Public Finance, 5th ed. (Homewood, IL: Irwin Press, 1999) at 294.Google Scholar

27. Generational accounting also ignores Ricardian offsets, or increased saving by altruistically minded members of current generations to offset the debt burden they are leaving their heirs. However, empirical evidence suggests (with strong theoretical backing) that Ricardian offsets to the government’s fiscal transfers from future to current generations are extremely limited. See Shaviro, Daniel N., Do Deficits Matter? (Chicago: Chicago University Press, 1997) at 71–78.CrossRefGoogle Scholar

28. Kotlikoff, Laurence J. “The Coming Generational Storm” (June 2001) [unpublished, archived at http://econ.bu.edu/kotlikoff/GenerationalStorm.pdf] at 22.Google Scholar

29. Ibid. at 60, Table 1.

30. Lifetime net tax payments would be even more uneven, since lifetime income is assumed to continue rising.

31. See Shaviro, “Who Should Pay For Medicare?” supra note 11 at 76-91 for a fuller comparison of Social Security and Medicare financing to a Ponzi scheme. That used by these two entitlements has a less “exploding” character than a classic Ponzi scheme, but is subject to demographic and technological shocks.

32. Examples of cuts to Social Security and Medicare that might be relatively feasible politically at some point include raising eligibility ages, not fully indexing Social Security benefits to inflation, and squeezing healthcare providers on their Medicare reimbursements even if this causes many of them to drop out of the program.

33. See McCaffery, Edward J. & Baron, Jonathan, “Thinking About Tax” (July 16, 2004). USC Law School, Olin Research Paper No. 04-13 Google Scholar; and USC CLEO Research Paper No. C04-10 at http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID567767_code49181.pdf?abstractid=567767 &mirid=1, for evidence that changes in form can affect public perceptions of the government’s redistribution policy, and thus, presumably, actual political outcomes.

34. Kotlikoff, Laurence J. & Sachs, Jeffrey, “It’s High Time to Privatize” (1997) 15 The Brookings Rev. 16 at 17.Google Scholar

35. In addition, since one does not earn additional Medicare benefits at the margin by working more (once one has become eligible, as nearly everyone who reaches retirement age does), the taxes that pay for the benefits would deter work at the margin even if people correctly understood the entire program.

36. See Shaviro, Who Should Pay for Medicare?, supra note 11.

37. See ibid. at 29-32.

38. Medicare does not, however, result in significant, if any, progressive redistribution. See ibid. at 34-36.

39. See U.S., The Congress of the United States—Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2005-2014 (January 2004) at 129–30, tables F-1, F-2. Online: www.cbo.gov/ftpdoc.cfm?index=4985&type=1.Google Scholar

40. See ibid. at 135, table F-7.

41. An example is provided by Stephen Moore, the President of the Club for Growth, an influential private campaign organization that, according to its website, seeks to elect candidates who “support the Reagan vision of limited government and lower taxes.” http://www.clubforgrowth.org/about.php. A recent New York Times Magazine profile of Moore notes: “As Moore readily admits, spending has multiplied like a virus in Washington under Bush and the Republican Congress, but while the club gleefully goes after … moderates on taxes, it has yet to take aim at a single conservative for going soft on spending.” Bai, Matt, “Fight Club” New York Times Magazine (10 August 2003) §6 at 24.Google Scholar

42. See discussions in Kotlikoff, Laurence J. & Burns, Scott, The Coming Generational Storm: What We Need to Know about America’s Economic Future (Cambridge, MA: MIT Press, 2004)Google Scholar and Shaviro, Daniel N., “Reckless Disregard: The Bush Administration’s Policy of Cutting Taxes in the Face of an Enormous Fiscal Gap” Boston C. L. Rev. [forthcoming].Google Scholar

43. See Gale, William G. & Orszag, Peter R., “Sunsets in the Tax Code” (2003) 99 Tax Notes 1553, online: http://www.urban.org/UploadedPDF/1000499_TaxBreak_060903.pdf Google Scholar

44. See McCaffery, Edward J. & Cohen, Linda R., “Shakedown at Gucci Gulch: A Tale of Death, Money, and Taxes” (2004). USC Law and Economics Research Paper No. 04-20 Google Scholar; and USC CLEO Research Paper No. C04-14 at http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID582481_ code49181.pdf?abstractid=581084&mirid=1.