Working Paper: NBER ID: w13548
Authors: 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.
Keywords: Tax Cuts; Government Spending; Fiscal Policy; Starve the Beast Hypothesis
JEL Codes: E62; H50; H60; N12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tax cuts (H29) | Government spending (H59) |
| Tax cuts (H29) | Subsequent legislated tax increases (H29) |
| Long-run tax changes (H31) | Government spending (H59) |
| Tax cuts (H29) | No support for 'starve the beast' hypothesis (E65) |