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Budget Calculations Slay the ’Starve the Beast’ Mythology: View

July 19, 2011

July 20 (Bloomberg) -- For more than 30 years, since the election of Ronald Reagan in 1980, some Republicans have pursued a theory called “Starve the Beast.”

STB holds that you don’t cut government spending in order to lower taxes; you lower taxes in order to cut government spending. The deprivation of revenue will force the government to get smaller. How this is supposed to happen has always been a bit of a mystery. Sages across the political spectrum have noted that both parties have consistently shown a willingness to spend money the Treasury doesn’t have.

At first, this strategy was considered a scandalous secret. Democrats -- most notably the late Senator Daniel Patrick Moynihan of New York -- asserted that this was what the Republicans were up to. Republicans denied it, insisting publicly that they were merely following the prescriptions of supply-side economics: Painful spending cuts are unnecessary because tax cuts will pay for themselves in new revenue. STB considers, by contrast, that tax cuts will pay for themselves by forcing spending cuts. Gradually, this theory became something Republicans would openly brag about.

Now, it appears that shrinking the government has become the focus of House Republicans. They claim to be concerned about reducing the national debt, but they’re actually using that issue as a way to force cuts in government spending. The deficit and the accumulated debt are almost considered good things, in a way, because they will force the government to get smaller.

Cut, Cap, Balance

The STB ethos inspired the “Cut, Cap and Balance” proposal that was passed by the Republican-controlled House yesterday. It conditions a $2.4 trillion debt-ceiling increase on cutting spending next year by more than $100 billion, capping future spending as a percentage of the economy and passing a balanced- budget amendment to the Constitution.

The measure is symbolic, unlikely to pass the Senate, and subject to a White House veto, in any case. But it helps show why negotiations have been so difficult. If your shared goal is a smaller deficit, there’s an obvious split-the-difference compromise: a dash of tax increases and a sprinkling of spending cuts. If one side’s purpose is only or overwhelmingly to reduce the size of government, then, from its point of view, any tax increase is a step backward, making compromise much more difficult.

The argument about supply-side economics, we suppose, will never end, because the devotion of believers is more-or-less evidence-proof. Before the dogma of Starve the Beast also hardens into an article of faith, let’s consider its sheer mathematical improbability.

Compound Interest

The problem in a nutshell is that when you cut taxes, and do nothing else, the first thing that happens is that government spending goes up -- it now includes interest on the added debt. Any STB effect must first overcome this additional expense before it starts paying off. (This, of course, assumes that smaller government and less government spending are the same thing -- and that both are desirable. But STB theory itself makes the same assumptions.)

Attached is a simple spreadsheet illustrating the point, and explaining the underlying formulas and assumptions. Government spending in Year Zero is set at 100 and other inputs are set roughly proportionate to reality. (For example, gross domestic product is 400 because current government spending is one-fourth of GDP.) But you can change the starting levels of almost any input (the yellow cells) and get a similar result: STB doesn’t decrease government spending, it increases it.

Try at Home

The attached chart offers three examples. The STB effect is the fraction of every dollar of a tax cut that leads (somehow) to a spending cut. Example 1 assumes a $10 tax cut in Year Zero that takes effect in Year 1. Revenue drops from an assumed $85 to $75. The STB effect drives government noninterest spending down by half that amount, $5 (from an assumed $85 to $80), and the additional interest because of added debt is only 75 cents. Government spending as a share of GDP drops a little more than 1 percent.

So far so good. But as compound interest does its devilish work, the situation changes. By Year 10 the government is spending $107, up from $100, which is 27 percent of GDP, up from 25 percent. Example 2 tries a very low STB factor of 0.5 percent, and Example 3 tries 95 percent, meaning that every dollar of revenue cut automatically forces almost a full dollar of spending cut. This is the absolute limit of plausibility. Even so, government spending drops sharply for two years. But by Year 10 it’s back to $100.

Read more Bloomberg View editorials.

--Editors: Michael Kinsley, Max Berley

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To contact the Bloomberg View editorial board: view@bloomberg.net.


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