BPEA | Spring 2009

Do Tax Cuts Starve the Beast? The Effect of Tax Changes on Government Spending

Authors: Christina D. Romer and
Christina Romer
Christina D. Romer Nonresident Senior Fellow - Economic Studies
David H. Romer
David H. Romer
David H. Romer Nonresident Senior Fellow - Economic Studies
Discussants: Steven J. Davis and
Steven Davis Headshot
Steven J. Davis William H. Abbott Professor of International Business and Economics - The University of Chicago Booth School of Business
Jeffrey A. Miron

Spring 2009

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 derive more reliable estimates,
this paper examines the behavior of government expenditure 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, the point estimates
suggest that tax cuts 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