Raising Taxes Won’t Fix the Deficit
More revenue in the federal coffers will only lead to more government spending
By Veronique de Rugy and Jack Salmon
Since the pandemic-induced economic crisis began in 2020, the Biden administration has been pushing for significant tax hikes on high earners and corporations to pay for profligate spending proposals. The latest proposal in the president’s 2023 budget includes two notable tax increases: a minimum 20% tax on unrealized gains (increases in the value of investments that have not been sold) for families worth $100 million or more, and an increase of the corporate tax rate from 21% to 28%. The White House predicts that these proposed tax increases on the rich will reduce budget deficits by $1 trillion over the coming decade. Meanwhile, advocates of trillions of dollars in additional social spending have argued that such spending would be “fully paid for” by the proposed tax increases.
Politicians like to justify new spending proposals by claiming that they will cut deficits, or at best be deficit neutral. But these claims overlook the effects of increased revenues on the actual spending behavior of public officials. To get some idea of how policymakers might adjust their spending habits in response to newly found revenues—that is, tax hikes—it is necessary to consider how government spending patterns have historically responded to tax increases.
The relationship between tax increases and changes in public spending has been studied by economists for decades. One study found that tax-driven deficit reduction “will result in the long run not only in more taxes, and more expenditures but also in more deficit.”
Other studies on the tax-spend relationship find that the effect on spending of raising taxes largely depends on the political motivation behind the tax hike. If policymakers raise taxes to offset politically unpopular deficit financing, higher resultant spending is unlikely, and the budget deficit will decrease. If, however, the increase in revenue is motivated by an increase in demand for public expenditure, then government spending will increase to meet that demand, and the deficit will grow larger and more persistent.
Amid the tax-spend debate of the 1980s and 1990s, a study by economist Richard Vedder and his co-authors found that every $1.00 raised by new taxes generated $1.58 of new spending. The study was revised at least three times (in 1991, 2007 and 2010) and continued to be influential during the years of heightened deficit spending following the 2008 financial crisis.
Observing the period 1947-2009, using different financial data and different control variables, the study’s revised and updated models estimated that each $1.00 of new tax revenue resulted in between $1.05 and $1.81 of new spending.
In a 1987 Senate congressional record, Vedder argued:
Public officials are under intense pressure to boost funding for constituent spending programs. Raising taxes reduces their political popularity, and endangers job security. If taxes are to be raised, lawmakers tend to anticipate this and compensate by increasing government spending, an action that increases popularity, enhances job security, and perhaps even raises prospective post-Congressional income.
To understand this point, consider an analogy between the behavior of private companies and that of government. Businesses compete for the patronage of customers. Similarly, politicians compete for the support of the electorate—often by promising expansive social programs and popular policies to secure their reelection. As James Buchanan and Richard Wagner note in their 1977 book, “Democracy in Deficit,” within a democratic system of political competition, growth in public expenditure benefits citizens, while taxation lowers their disposable income, reducing their support for politicians.
Within this framework of political competition, politicians must consider the gains and losses of constituent support by evaluating the alternative taxing and spending programs that shape budgetary outcomes. Because they want to get reelected, they have strong incentives to spend more and tax less, creating perpetual budget deficits. Regardless of how the data are configured, the empirical literature reveals that higher tax collections have historically been associated with significantly larger increases in government spending.
Recent tax proposals, driven by a desire to massively expand government social programs, do not change this rule. Far from reducing budget deficits, imposing new taxes will more likely increase growth in spending even further and make our bad fiscal condition worse.