Tax Cuts Alone Cannot Shrink Government

The U.S. Treasury recently announced that the government is running a deficit of $66.5 billion for the first seven months of the fiscal year. Increased government spending coupled with a downturn in revenues has pushed the federal government back into deficit spending. Despite this dramatic swing in fiscal balances, the federal budget continues to flounder in Congress, with the Senate unwilling or unable to even establish parameters to limit federal spending. Indeed, the congressional urge to spend is threatening to eliminate the economic benefits of lower taxes.

With time running short, Senate Majority Leader Tom Daschle (D-S.D.) has yet to bring a budget resolution to the floor. The resolution is an important step in the budgetary process, because it provides overall guidelines for spending. Without the resolution, there are fewer constraints on the appropriations process and more room for mischief when bills come to the floor. Some have suggested the House and Senate adopt “deeming resolutions” or extend the expiring budget caps to constrain appropriators, but with the Senate unwilling to adopt a budget resolution, it is not evident that the alternatives would fare any better.

While Republicans attribute the deficit’s return to the war on terrorism and Democrats blame it on President Bush’s tax cut, the simple fact remains that Congress lacks the fiscal discipline to live within its means. The growth of government is well chronicled. The recent $190 billion farm bill dropped all pretense of attempting a more market-based approach to agriculture. In addition, Congress is moving forward with a supplemental spending bill of almost $30 billion, along with a budget that includes $768 billion in discretionary spending.

Government spending not only means a greater burden for American taxpayers, it also has an impact on the economy’s performance. A study by Professors Richard K. Vedder and Lowell E. Galloway demonstrates that throughout the 20th century, as the size of government grew, the economy suffered. Conversely, the greatest economic growth occurred as the role of government in the economy receded. The study also suggests that it is not surprising that surpluses have turned to deficits. Since World War II, increased federal spending has quickly dissipated any surpluses.

True to form, Congress continues to spend at a pace that diverts resources from productive uses in the private sector to redistributive uses by the government. Discretionary spending has increased significantly, much of it not related to defense. At the same time, Congress has repeatedly failed to address ailing entitlement programs that are a significant strain on the fiscal budget. This budget year, Social Security, Medicare, and Medicaid have been the largest drain on federal revenues and should warrant serious federal oversight. Each of these programs is staving off failure; outdated policies, changing demographics, and simple waste, fraud, and abuse are chronic problems. Without much-needed reform, these entitlement programs will continue to increase pressure on the federal budget.

President Bush ran on a platform of lower taxes, and Congress passed the legislation enacting those tax cuts. Voting for the tax cut meant more than a tax rebate for constituents; it was an important vote about the size and scope of government. The American people opted for a smaller government. Unfortunately, Congress has yet to deliver. It is important to remember that tax cuts alone cannot boost the economy—government spending must follow suit. If the government does not alter its behavior, resources will continue to flow from the private sector to government coffers.

When Congress continues spending in the wake of a tax cut, the bill eventually comes due, and the federal government will need to have the wherewithal to pay. The government has three options, none of which is conducive to economic growth. The first option is to print money. However, as the 1970s demonstrated, inflation can have a debilitating effect on economic growth. The second option is to borrow. The federal government can seek to raise money in the financial markets, which, again, has adverse effects on economic growth. While deficits may not directly translate into higher interest rates, many government programs have marginal, or even negative, rates of return, so excessive government spending will result in lower economic growth than if resources were left in the more productive private sector. Finally, a Congress determined to spend can simply abandon tax cuts, which many in Congress appear willing to do; opting instead to generate more revenues to satisfy profligate policies.

Sadly, Congress has done little to heed the call for a more limited government. The Senate used procedural rules to block a permanent reduction in taxes, leaving all of the Bush tax cuts to expire after ten years. The Death Tax, which is costly to administer and a poor source of revenue, is up for repeal, but the Senate leadership is playing games to minimize the chances of actually eliminating the tax. And Congress continues to spend in the face of burgeoning deficits. For many in Congress, it seems to be business as usual, which suggests that further reforms may be necessary to secure the benefits of tax cuts. Institutional reforms that make it more difficult to raise taxes or increase spending levels may be an important element of efforts to limit the size and scope of government. In the past, Congress has successfully avoided balanced budget amendments, supermajorities for tax increases and other restraints on congressional behavior. But in the face of renewed government expansion and rising deficits, it may be time to revisit ways to impose fiscal discipline on Congress.