Starving the Beast, or Feeding the Beast?

In an excellent post on Barack Obama's fiscal policy, one that builds on arguments recently made by Matt Yglesias and Clive Crook, The Atlantic's Ross Douthat suggests that Barack Obama is offering his own version of "starve-the-beast."

What you see in [Obama's] budgeting proposals, I think, is the liberal equivalent of the conservative attempt to "starve the beast." In both the Reagan and Bush eras, Republicans passed tax cuts and ran up large deficits while hoping that by starving the federal government of revenue they would curb its long-run growth. Obama's spending proposals would effectively reverse that dynamic -- they would create new spending commitments and run up large deficits, in the hopes that the dollars poured into health care and education will create a new baseline for government's obligations, which in turn will create the political space for tax increases on the middle class.

As Ross notes, this "didn't work out as well as small-governmenteers." If anything, that is an understatement. As William Niskanen of the libertarian Cato Institute has argued,

The "Starve the Beast" assertion is inconsistent with the facts, at least since 1980. My study finds that there was a strong negative relation between the federal spending percent of GDP and the federal revenue percent of GDP from 1981 through 2005, even controlling for the unemployment rate.

As a result, small-government Republicans have found themselves in a fiscal policy trap.

An increased belief in the "Starve the Beast" assertion has substantially reduced the traditional Republican concern for fiscal responsibility - leading to a pattern of tax cuts, increased spending, and increased deficits. This pattern has been strongest during the current Bush administration, primarily because the Republicans control both the administration and a majority of both houses of Congress.

A number of Republicans have defended President Bush's departures from small-government conservatism by arguing that these moves were overwhelmingly popular with the public, e.g., the creation of an essentially unfunded Medicare prescription drug benefit. Had President Bush failed to put in place a prescription drug benefit, he may well have lost his bid for reelection, or so the argument goes. In contrast, Bush's conservative critics argue that he should have focused on cutting taxes and spending.

But Niskanen's analysis suggests that you can't have it both ways. By insulating voters from the costs of government, the "starve-the-beast" strategy increased demand for government. And anecdotally, it is worth noting that Democrats sharply increased their support among high earners during the Bush years -- the same voters who benefited most from the Bush tax cuts.

This could, in theory, be a source of Republican optimism: as the tax burden on hgih earners declines, perhaps they will embrace the GOP's trademark tax-cutting once again. Yet that doesn't change the basic dynamic that Niskanen identified. Advocates of small government would be better served, in Niskanen's view, by accepting the need for higher taxes, as that would raise the effective price of public services and thus reduce the appetite for them.

Obama's approach, in contrast, appears to be more politically sustainable, as Ross argues in his post.

Like the starve-the-beast approach, the Obama strategy puts off the hard part till tomorrow: Give them tax cuts today, conservatives said, and they'll swallow spending cuts tomorrow; give them universal health care, universal pre-K, subsidies for green industry and all the rest of it today, liberals seem to be thinking, and they'll be willing to pay for it tomorrow. ...
if you can change the baseline of social spending that Americans expect from their government before that day of hard choices arrive -- and once created, government programs are awfully hard to get rid of, whether they're actually effective or not -- then you've tilted the landscape of negotiation in liberalism's favor, and ensured that a post-Obama entitlement compromise will look a lot more like social democracy than a pre-Obama compromise would have.

Given that Obama's programs are designed to benefit the median voter and his tax policy is designed to further lighten the burden on the median voter, loss aversion will kick in and entrench the new, higher baseline. To finance this increased level of spending, the public will presumably press for more taxes on the rich. Yet that approach will have diminishing marginal returns. A tax hike on the middle class will remain unthinkable. So would we find ourselves in another trap?

The missing ingredient here, as Yglesias, Lane Kenworthy, Bruce Bartlett and others have suggested, is a value-added tax or VAT, a consumption tax used by virtually all advanced economies. A VAT is far friendlier to economic growth, yet it is capable of raising a great deal of revenue and it is far harder than other consumption taxes -- like a straightforward retail sales tax -- to evade. Larry Summers has floated the idea of an American VAT, and I strongly suspect you'll be hearing more about the idea in the years to come.

There is another possibility, of course: a sharp increase in inflation. You'll be hearing more about that too!