The Tax and Spend Hypothesis - a review

Listed below you will find excerpts from the 1987 Congressional Budget Office analysis of two studies on the relationship of taxes to spending by the federal government. Interestingly, the CBO concluded that there is no clear way to determine a definitive relationship between the two because of numerous variables being in a constant state of flux. Based on the premise that these "variables" cannot be accurately quantified through a numerical average they concluded that "there is no persuasive evidence that taxes cause spending at the federal level".

We as citizen taxpayers have had an additional 22 years of data amassed from which to draw our own conclusions, and given the historical record IMHO it would be awfully hard to make the case that taxes have not influenced spending, regardless of government reports to the contrary. I say let's cut taxes across the board and hold Congress accountable to a budgetary standard equivalent to that which most responsible American families have found effective. "Live within your means" is not new terminology, and we all have a better shot at prosperity when our government functions as it was intended.

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THE RELATIONSHIP BETWEEN
FEDERAL TAXES AND SPENDING:
AN EXAMINATION OF RECENT RESEARCH

August 1987

OVERVIEW AND PURPOSE OF THE PAPER

The Congress continues to debate the proper mix of tax increases and spending cuts, the two available tools for reducing the deficit. Recently some commentators have argued that historical evidence indicates that, contrary to the above presumption, federal tax increases cause federal spending increases. An even stronger position holds that these spending increases may be larger than the tax increases that cause them. This position implies that tax increases are ineffective at best, and may even be counterproductive in reducing the federal deficit.

This paper examines the hypothesis that tax increases cannot reduce deficits (hereafter referred to as the "tax-and-spend" hypothesis). First, it presents historical tax and spending data and observes some trends. Next, it shows that the statistical results in one recent study, by Vedder, Gallaway, and Frenze, are extremely sensitive to the sample period, and are also highly dependent on assumptions about the structure of the error term in the basic regression.1 It concludes that the Vedder et al. analysis provides no persuasive evidence in favor of the tax-and-spend hypothesis.

Next, the paper discusses another recent study by von Furstenberg, Green, and Jeong that attempts to test the tax-and-spend hypothesis using a much different econometric technique: by observing the order of precedence between federal tax increases and federal spending increases.2 Again, the evidence does not support the tax-and-spend hypothesis.

Several other studies of the tax-and-spend hypothesis focus on the taxing and spending behavior of state and local governments. These have not been reviewed since the widespread use of constitutional restrictions against deficit spending at the state and local level makes the tax-spending link much tighter than at the federal level.

Excerpt one:
THE TAX-AND-SPEND HYPOTHESIS
Even though annual federal tax receipts have nearly equaled annual spending
during most of the postwar period, the recent divergence of one from
the other has stimulated academic interest and political controversy over
whether there is a direct causal relationship between tax and spending
changes.
Some critics of tax increases argue that tax increases cause spending
increases and that, as a result, tax increases are not very effective in
reducing the deficit. The logical extreme of this argument is that tax
increases cause spending increases of an equal or greater magnitude so
that tax increases cannot reduce deficits.
It is worth noting that even skeptics of the tax-and-spend hypothesis
admit that taxes and spending are related in the sense that taxes always
pay for past or present spending. The controversy is over whether, at the
margin, additional taxes actually reduce the deficit, or whether the political
process inevitably results in the Congress using these additional
taxes for higher spending levels.


[Skip to conclusion]


Excerpt two:
Conclusion:
Given the difficulties of inferring causality from tax and spending data, it
is hard to reach a definite conclusion about whether taxes cause spending,
spending causes taxes, or something else causes both. What does seem
clear, both from CBO's re-estimates of the Vedder specification and from
the Von Furstenberg study, is that there is no persuasive evidence that
taxes cause spending at the federal level.


Read the entire document in PDF format at:
http://www.cbo.gov/ftpdocs/62xx/doc6246/doc14a.pdf