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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
13548.
Length: Date of creation: Oct 2007 Date of revision: Handle: RePEc:nbr:nberwo:13548
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Find related papers by JEL classification: E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy H50 - Public Economics - - National Government Expenditures and Related Policies - - - General H60 - Public Economics - - National Budget, Deficit, and Debt - - - General N12 - Economic History - - Macroeconomics and Monetary Economics; Growth and Fluctuations - - - U.S.; Canada: 1913-
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