We Can't Have Low Taxes and Big Government

As the country approaches the "fiscal cliff," President Obama and House Speaker John Boehner are still trying to agree on a deal that would raise taxes only on the highest income earners without doing anything meaningful to control the explosion of spending on entitlement programs. Thankfully, it's not too late to learn from one particular mistake of the Bush years: Lower taxes for most coupled with higher spending make for bad policy outcomes.

However, this is sustainable only if spending goes down along with taxes. In a recent paper called "What Went Wrong with the Bush Tax Cuts," my colleagues at the Mercatus Center, Matt Mitchell and Andrea Castillo, explained that "Cutting taxes allows policymakers to give voters something they want, while appearing to rein in the size of government. But this is a temporary illusion unless the tax cuts are combined with necessary reductions in spending -- a far more difficult but also the more important task." And indeed, the Bush administration didn't cut spending. It didn't restrain spending. It significantly expanded the burden of the federal budget.

The first round of Bush tax cuts in 2001 only minimally reduced marginal rates. The overall reduction was scheduled to take place over several years. When the second round of cuts was adopted in 2003, it accelerated the timing of rate reductions. It also added reductions to the double taxation of capital gains and dividend taxes.

Both laws also included spending provisions disguised as tax cuts, such as the 2001 one-time retroactive "tax rebate." That "rebate" consisted of sending checks to taxpayers who had filed taxes in 2000 (up to $300 for singles and $600 for married couples). Bush hoped these gifts would boost a slowing economy with a bit of Keynesian pump-priming.

And there was much more spending to come. During the eight years Bush was in office, spending grew by 60 percent in real terms, from 18.2 percent of gross domestic product in 2001 to 25.2 percent in 2009. I think it is fair to say the president and his mostly Republican Congress rarely met a spending program they didn't want to jack up. By contrast, spending grew by 12.5 percent during the Clinton years -- barely one-fifth of the increase during the Bush years.

Now compare that with spending growth rates that followed other tax cut episodes. Mitchell and Castillo write, "[The Bush spending binge] was the largest such increase in any eight-year period since World War II. In contrast, eight years after the so-called Kennedy tax cuts, spending as a share of GDP had increased just 1.1 percentage points, and eight years after the Reagan tax cuts, spending as a share of GDP had actually fallen 1.1 percentage points."

It's the spending explosion that took place under Bush that is the main cause of the failure of the tax cuts. And here is our lesson for the fiscal cliff. The types of deals that are being discussed by both the president and Boehner don't cut spending or reform the drivers of our future debt (Social Security, Medicare and Medicaid). Instead, they keep taxes low for 98 percent of taxpayers. But this basically means keeping 98 percent of the failed policies of the Bush years. And the failed part, as I noted above, is the growing burden of federal spending.

This country is at a crossroad. We have to choose between raising taxes on everyone to pay for big government or keeping taxes low and seriously cutting spending. Big government spending and relatively lower taxes are not an option. We learned that during the Bush years.