Stop Distorting U.S. Spending Priorities into Tax Cuts

Feb. 8.09 | About: SPDR S&P (SPY)

It is unfortunate that much of the congressional debate regarding the stimulus package is phrased in terms of a summary statistic: what fraction of the stimulus is to be increased spending and what fraction is to be tax cuts. It currently looks to be about 70-30, but the Republicans say they want more in tax cuts and the Democratic holdouts say they want more in spending.

To judge the merits, one has to go into greater detail. One can have smart spending and stupid spending. (The U.S. has had plenty of both in recent history.) Similarly, one can have smart tax cuts and stupid tax cuts (ditto). At the present juncture, some of the tax cuts I strongly support include (i) fixing the Alternative Minimum Tax (to help the middle class) and (ii) letting more low-income workers have the child deduction (to help reduce what are currently some of the highest effective marginal tax rates facing any class of American workers). And there are plenty of other examples, where “letting Americans keep their money” is indeed a more efficient way of achieving social goals than having the government spend it.

But summing things up in an overall tax-cut-vs.-spending statistic can be pernicious. How so? Many things that government does are more efficiently accomplished by spending. Defense and transportation infrastructure are two obvious examples, but I personally would add much of health care and primary education. The result of the bias in favor of tax cuts is that all sorts of initiatives go through a tortuous re-casting as tax credits or deductions. In many cases this leads to increased paperwork and an ever-more complicated tax system.

Both parties have been responsible for this “junking up” of the tax code. Consider this 2001 rendition of what happened in the 1990s, from those who know:

Martin Feldstein asked Gene Sperling whether Republicans were to blame for the Clinton administration’s apparent use of tax expenditures [e.g., tax credits for education] rather than direct expenditures. That is, Republicans accused Democrats of being the party of taxing and spending, so the Clinton administration responded by finding a way to achieve implicit spending objectives while ostensibly reducing taxes. Sperling responded that he largely agreed…
American Economic Policy in the 1990s, edited by Jeff Frankel and Peter Orszag (MIT Press, 2002), pages 188-189.

I realize that the preference for tax cuts over spending was originally motivated by a preference for smaller government over bigger government. But it doesn’t work anyway. Leave aside those on the Left who think that – because of the Bush failure, Obama victory, financial crisis, and recession – the case for big government has now returned. Even those on the Right who retain their belief in small government, at least at a rhetorical level, should admit that the Bush policies of big tax cuts did nothing to shrink the rate of growth of spending, which was in fact far higher after 2001 than in the preceding decade.