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Commentary

What Tax Cut?


     
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I favor a much smaller government but I do not favor the Bush tax cut. Or, to be more precise, I would support a tax cut if one had been proposed. But so far President Bush has neither proposed nor implemented a tax cut—only a tax shift.

To grasp the difference between a tax cut and a tax shift, we must first understand that what ultimately drives taxes is spending. If spending increases, as it has under the current administration, then sooner or later taxes must increase (or inflation, a type of tax, will go up). Milton Friedman, the libertarian-leaning Nobel prize-winning economist, has long reminded us to be suspicious of any tax cut not matched by a spending cut. If spending isn’t cut, then less taxes today means more taxes tomorrow. Thus, the Bush tax cut plan is really a plan for future tax increases.

Whether taxes go up today or tomorrow would be a small matter but for the fact that future taxes are already scheduled to rise because of demographic changes. The aging of the baby-boomers means that Social Security and Medicare spending will rise tremendously in the next several decades. To finance these jumps in spending, it’s been estimated that taxes will have to rise 50 percent on a lifetime basis (assuming we don’t cut benefits severely). Thus Bush is shifting taxes to precisely a time when future taxes will be increasing for other reasons. Sound tax policy aims to smooth taxes over time, not to concentrate them so that we take our hits in one staggering blow.

Against these considerable negatives are some small positives. First, a tax cut has a small short-term stimulative effect, but the key word is small. Conservatives have long argued, correctly, that “fine-tuning” the economy is a chimera, but that argument seems to have disappeared from the conservative handbook. (Perhaps it is hiding alongside the arguments against “nation building” and “federalizing education.”)

Second, although Bush’s tax proposal does shift taxes away from capital (which, other things equal, would promote long-run economic growth), the mismatch between the tax cuts and spending increases means a rise in government borrowing to make up the difference. Some of this borrowing will come out of capital markets, thereby draining the source of private investment. Thus, on net, I don’t expect significant gains in long-run economic growth from these tax cuts.

Some conservatives recognize that the proposed tax cuts would create deficits long into the future, but they have a secret Machiavellian argument held in reserve. The Bush deficits, they believe, will force future administrations—presumably of a more liberal bent—to cut spending. Conservatives used to argue that the public didn’t want big government but was fooled by deficit financing and other hidden taxes into thinking that it costs less than it actually does. Today, conservatives seem to believe that the public does want big government and that the only way to curb government growth it is to fool the public with lower taxes today so that the costs of government will be so high tomorrow that no one will accept the offer. How cynical.

Will deficits in fact force future administrations to cut spending? It’s possible but I am fearful. The combination of changing demographics and current tax cuts is seeding our economy for a fiscal “perfect storm.” When the storm hits there will be a crisis, and as economist and historian Robert Higgs has ably demonstrated in Crisis and Leviathan, small government rarely does well in a crisis.

Today it is evident that we have two political parties: the Tax and Spenders and the No-Tax and Spenders. Neither party is fiscally conservative. Is there no room at the inn for an honest conservative? A conservative who makes the case for smaller government on its merits and not just as the fallback option when fiscal bankruptcy threatens?


Alexander Tabarrok is Senior Fellow at The Independent Institute, Assistant Editor of The Independent Review, and Associate Professor of Economics at George Mason University. He received his Ph.D. in economics from George Mason University, and he has taught at the University of Virginia and Ball State University. Dr. Tabarrok is the editor of The Independent Institute books, Entrepreneurial Economics (Oxford University Press), The Voluntary City (with David Beito and Peter Gordon, University of Michigan Press), and Changing the Guard: Private Prisons and the Control of Crime.


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