Tax Cuts and Federal Spending: Causation or Correlation?

Following up on this post indicating that some folks at the WSJ are maybe just maybe finally seeing the folly of the Laffer Curve, I've been meaning to write about that Cato Institute report about the folly of that other bit of right-wing fiscal dogma, "starving the beast."

This Washington Post analysis (which nicely summarizes a lot of the issues) is pretty indicative of the way the MSM interpreted the Cato report.

Niskanen has crunched the numbers between 1981 and 2005, testing for a relationship between tax cuts and government spending, and controlling for levels of unemployment, since these affect spending and taxes independently. Niskanen's result punctures his own party's dogma. Tax cuts are associated with increases in government spending. The best strategy for forcing cuts in government is actually to raise taxes.

Now, the problem is that the final sentence does not follow from the penultimate sentence.

As a former philosophy major, I get off on pointing out logical fallacies. This particular logical fallacy is the causation/correlation mixup (or, in my native tongue, cum hoc ergo propter hoc).

The Cato study establishes a relationship between tax cuts and huge government spending. But it does not follow that tax cuts cause government spending (how this report was often spun in the media). Maybe they are causally related (directly or indirectly), but maybe (likely, I'd guess) they're just correlated. The two are probably both the effects of another cause (such as fiscal irresponsibility). But the point is, the Cato study is silent on what the nature of the relationship is. It just demonstrates that there is a relationship.

The Cato economist, a stud by the name of William Niskanen, does offer a tentative interpretation/spin, which makes a weak case for causation in terms of voter demand (the most obvious problem with this analysis is that voters are not directly making the choices about taxes and spending).

The most direct interpretation of this relation is that it represents a demand curve—that the demand for federal spending by current voters declines with the amount of this spending that is financed by current taxes. Future voters will bear the burden of any resulting deficit but are not effectively represented by those making the current fiscal choices. One implication of this relation is that a tax increase may be the most effective policy to reduce the relative level of federal spending. On this issue, I would be pleased to be proven wrong.

Anyhow, whether it's attributable to causation, correlation, or a vast right-wing conspiracy, here are the top 5 U.S. federal deficits of all time, very suspiciously clustered around a certain New Haven-born tax cutter:

1. 2004 (George W. Bush) $413 billion
2. 2003 (George W. Bush) $378 billion
3. 2005 (George iW. Bush) $318 billion
4. 2006 (George W. Bush) $296 billion (projected)
5. 1992 (George H. W. Bush) $290 billion