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Do Tax Cuts Starve the Beast? The Effect of Tax Changes on Government Spending

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  • Christina D. Romer
  • David H. Romer

Abstract

The hypothesis that decreases in taxes reduce future government spending is often cited as a reason for cutting taxes. However, because taxes change for many reasons, examinations of the relationship between overall measures of taxation and subsequent spending are plagued by problems of reverse causation and omitted variable bias. To deal with these problems, this paper examines the behavior of government expenditures following legislated tax changes that narrative sources suggest are largely uncorrelated with other factors affecting spending. The results provide no support for the hypothesis that tax cuts restrain government spending; indeed, they suggest that tax cuts may actually increase spending. The results also indicate that the main effect of tax cuts on the government budget is to induce subsequent legislated tax increases. Examination of four episodes of major tax cuts reinforces these conclusions.

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Bibliographic Info

Article provided by Economic Studies Program, The Brookings Institution in its journal Brookings Papers on Economic Activity.

Volume (Year): 40 (2009)
Issue (Month): 1 (Spring) ()
Pages: 139-214

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Handle: RePEc:bin:bpeajo:v:40:y:2009:i:2009-01:p:139-214

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Keywords: macroeconomics; tax cuts; government spending; taxation;

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References

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  1. Christina D. Romer & David H. Romer, 2007. "The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks," NBER Working Papers 13264, National Bureau of Economic Research, Inc.
  2. Valerie A. Ramey, 2009. "Identifying Government Spending Shocks: It's All in the Timing," NBER Working Papers 15464, National Bureau of Economic Research, Inc.
  3. Becker, Gary S & Mulligan, Casey B, 2003. "Deadweight Costs and the Size of Government," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 46(2), pages 293-340, October.
  4. Henning Bohn, . "Budget Balance Through Revenue or Spending Adjustments ? Some Historical Evidence for the United States (Reprint 013)," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 03-91, Wharton School Rodney L. White Center for Financial Research.
  5. Bohn, Henning, 1992. "Endogenous Government Spending and Ricardian Equivalence," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 102(412), pages 588-97, May.
  6. Niskanen, William A., 1978. "Deficits, government spending, and inflation : What is the evidence?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 4(3), pages 591-602, August.
  7. Valerie A. Ramey & Matthew D. Shapiro, 1999. "Costly Capital Reallocation and the Effects of Government Spending," NBER Working Papers 6283, National Bureau of Economic Research, Inc.
  8. Olivier Blanchard & Roberto Perotti, 1999. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," NBER Working Papers 7269, National Bureau of Economic Research, Inc.
  9. Alan J. Auerbach, 2003. "Fiscal Policy, Past and Present," NBER Working Papers 10023, National Bureau of Economic Research, Inc.
  10. Henning Bohn, . "Budget Balance Through Revenue or Spending Adjustments? Some Historical Evidence for the United States," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 28-89, Wharton School Rodney L. White Center for Financial Research.
  11. von Furstenberg, George M & Green, R Jeffrey & Jeong, Jin-Ho, 1986. "Tax and Spend, or Spend and Tax?," The Review of Economics and Statistics, MIT Press, vol. 68(2), pages 179-88, May.
  12. Alan J. Auerbach, 2000. "Formation of fiscal policy: the experience of the past twenty-five years," Economic Policy Review, Federal Reserve Bank of New York, Federal Reserve Bank of New York, issue Apr, pages 9-23.
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Cited by:
  1. Javier Andrés & José Boscá & Francisco Ferri, 2012. "Household leverage and fiscal multipliers," Banco de Espa�a Working Papers, Banco de Espa�a 1215, Banco de Espa�a.
  2. Serbanoiu, Georgian Valentin, 2012. "Transmission of fiscal policy shocks into Romania's economy," MPRA Paper 40947, University Library of Munich, Germany.
  3. Frankel, Jeffrey A., 2011. "A Lesson from the South for Fiscal Policy in the US and Other Advanced Countries," Scholarly Articles, Harvard Kennedy School of Government 8705907, Harvard Kennedy School of Government.
  4. Amihai Glazer, 2008. "Reducing Current Taxes to Raise Future Revenue," Working Papers, University of California-Irvine, Department of Economics 080914, University of California-Irvine, Department of Economics.
  5. Alexander James, 2013. "US State Fiscal Policy and Natural Resources," Economics Series Working Papers, University of Oxford, Department of Economics OxCarre Research Paper 12, University of Oxford, Department of Economics.

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