Commentary

A Tale of Two Taxes

As April 15 approaches, taxpayers in the United States are facing both the best of times and the worst of times. At the federal level, President Bush has surprised many by boldly calling for a new round of tax reductions. However, in the states, persistent budgetary shortfalls are causing many governors to propose large tax hikes to bring their budgets into balance.

Why are tax cuts being proposed at the federal level while tax hikes are being enacted in the states? The most obvious reason is that the federal government can run deficits, while 49 states are forced to adhere to constitutional balanced budget amendments. However, it should also be noted that part of the reason why President Bush can propose tax cuts is because, for much of the 1990s, the federal government was more fiscally disciplined than the states.

Indeed, between 1992 and 2000 real expenditures at the federal level have grown by 9 percent whereas in the states, expenditures have grown by more than 25 percent. What accounts for this difference in fiscal outcomes? One factor that cannot be overlooked is the presence of deficits at the federal level for much of the 1990s. Even though the strong economy boosted tax revenues at both the federal and state level, the presence of federal deficits made it easier for Congress to resist the temptation to increase spending.

However, in 1998 all of that changed. The federal government ran its first surplus in 29 years and the subsequent experience is instructive. During the last 5 years, where surpluses were projected, non-defense discretionary spending has soared, increasing by $90 billion in constant dollars (adjusted for inflation). In contrast, during the era of federal deficits that preceded the 1998 surplus, it took 24 years for real non-defense discretionary expenditures to increase by $90 billion.

Supporters of limited government typically oppose federal programs because of the costs they impose on taxpayers, the perverse incentives they create for their recipients, and because the programs crowd out more efficient private endeavors. However, in practice, the presence of deficits appears to be the only effective line of defense that fiscal conservatives have had against spending increases. This actually creates a good argument for President Bush’s tax cuts. By reducing tax revenues, surpluses will be postponed, making it easier for Congress to resist the temptation to spend more.

Balanced budget amendments prevent states from relying on deficits to curtail spending. However, the presence of ballot initiatives in many states makes it possible for activists to enact fiscal discipline measures that can exert control over taxes and spending. In fact, supermajority tax limits have been effective at blocking or minimizing tax increases in Arizona, Oregon, Oklahoma, Nevada, and Louisiana. Similarly, tax and expenditure limitations (TELs) in Washington and Colorado have enjoyed success at limiting spending and providing tax relief.

Now it should be noted that fiscal restraint can sometimes be achieved through political leadership. President Reagan was able to enact some real reductions in expenditures after being elected in 1980. Similarly, in New Mexico, the fiscal restraint shown by former Governor Gary Johnson has made it possible for his successor, Democrat Bill Richardson, to enact sweeping tax reductions. However, such leadership on fiscal issues is in short supply these days. Still, recent history indicates that tax cuts at the federal level and fiscal restrictions in the states can limit spending, create economic growth, and result in prosperity and good times for all.

Michael J. New is an adjunct scholar at the Cato Institute and a post-doctoral fellow at the Harvard-MIT data center.