How can you justify cutting taxes when you're already running a huge deficit and you're adding new spending like an extra $400 billion on Medicare? For a quarter-century, tax-cut junkies have had two answers to that. One is supply-side economics: There is no need to cut spending. Tax cuts can be so liberating they will actually pay for themselves, and then some, by inspiring new economic activity.
The second answer is that if you want smaller government, you have to "starve the beast." Larger deficits increase the pressure for spending cuts. President Bush has actually said that deficits are a good thing because they put Congress in a spending "straitjacket." An essay by three conservative economists, including Nobel prizewinner Gary Becker, published in the Wall Street Journal in October, ranked starving the beast ahead of the Laffer Curve as a reason to cut taxes. But there is even less evidence that starving the beast works in real life than there is for supply-side theories. Two rounds of tax cuts and a fast-rising deficit under George W. Bush have not led to serious spending cuts. The federal budget is bigger than ever.
But put reality aside (as the President and Congress seem to have done). Does starving the beast make sense even in theory? Supply-side economics comes with a lot of intellectual paraphernalia, such as that famous Laffer Curve, drawn on a cocktail napkin. It may be nonsense, but at least it's clever nonsense (as Tom Stoppard once put it--though not about supply-side economics). Starve the beast, by contrast, is not a theory or even an assertion. It is barely more than a wish.
There's a reason that starve the beast has no curves, formulas or doctoral dissertations to clothe its nakedness. Cutting taxes with the expectation that spending cuts will follow is a huge and implausible leap not just in terms of human psychology but also in terms of simple mathematics.
How is starving the beast supposed to work? Let's create a simple model, in which every dollar of a tax cut leads to some fraction of a dollar in spending cuts. The trouble is that when you starve the beast by cutting taxes, you also increase the national debt and the bill for interest on that debt. So the first thing that happens is that you increase government spending. From then on, it's a battle between the lingering effects of the tax cut and the ever growing impact of compound interest on the added borrowing.
Let's go to the spreadsheet. Start with a government budget of 100, no debt and an annual deficit of zero. Call interest rates 4%. And say that in year one we get a 10%, across-the-board tax cut. Let's assume further that there is a starve-the-beast effect of 90%. This means that 90ยข of any dollar in tax cuts is covered by spending cuts that emerge spontaneously from the national subconscious. Assume finally that all the other things that affect government revenue and spending don't exist. What happens?