Cutting taxes will force governments to cut spending, because they cannot spend revenue they do not collect.
The phrase came into use in the 1980s for a strategy endorsed by economists from Milton Friedman to Robert Barro: shrink government by cutting the revenue that feeds it. William Niskanen, a former Reagan adviser, found in 2006 that lower federal revenue went with higher, not lower, spending, and Romer and Romer found no support for the hypothesis in 2009.
In practice
- A state cuts income tax to impose budget discipline and closes the gap by borrowing.
- A household that cuts its income by working fewer hours keeps spending and runs up the credit card.
- Possible explanations
- One explanation, the hypothesis's own, is that tight budgets force hard choices. The explanation offered for the contrary evidence, by Niskanen and by Buchanan and Wagner, is fiscal illusion: tax cuts without spending cuts make government seem cheaper to voters, who then ask for more of it.
- In its favour
- Theoretically plausible, and its defenders note that the studies against it rest on a handful of major tax cuts in a single country's history.
- Against it
- The best-known empirical tests, by Niskanen and by Romer and Romer, found no restraining effect and some evidence of the opposite.
- Standing
- The weight of evidence runs against it, though defenders dispute the tests. Compare Bowen's revenue theory of cost and Buchanan's constitutional economics.
- Subject
- Economics & Incentives
- Essay
- The theories behind every argument about money