Taxpayers and tax spenders: does a zero tax price matter?

• Author: Lipford, Jody W.

In January 2011, the U.S. Congressional Budget Office (CBO) issued its latest analysis of the U.S. budget and outlook. The report described a ballooning federal deficit that was the largest since World War II as a share of gross domestic product (GDP) in 2009 and 2010. The CBO summarized the situation as follows:

For the federal government, the sharply lower revenues and elevated spending deriving from the financial turmoil and severe drop in economic activity--combined with the costs of various policies implemented in response to those conditions and an imbalance between revenues and spending that predated the recession--have caused budget deficits to surge in the past two years. The deficits of $1.4 trillion in 2009 and $1.3 trillion in 2010 are, when measured as a share of gross domestic product (GDP), the largest since 1945--representing 10.0 percent and 8.9 percent of the nation's output, respectively. (2011, 1) As figure 1 shows, the looming deficit has a long pedigree that, notwithstanding the anomalous years 1998-2001, emerged systematically around 1970. The deficit problem clearly did not start with the Great Recession of 2007-2009.

[FIGURE 1 OMITTED]

Shiploads of ink have been spilled on the U.S. deficit problem and its possible solutions, and we will not attempt to summarize this literature or enter the important debate about remedies (see Yandle 2010). Our purpose here is, instead, to examine a relationship between the share of citizens who pay taxes (taxpayers) and those who receive federally funded benefits (tax spenders), which we believe may explain part of the U.S. deficit explosion that has occurred in recent years. The relationship examined empirically is a simple one: When the tax price of federal benefits is zero, do people demand more of them, even if they are funded by deficits?

Of course, operating a deficit-financed public economy is not unique to the United States. As indicated in Carmen Reinhart and Kenneth Rogoff's (2009) excellent survey of experiences with government debt, deficits, and default over several centuries, high levels of debt and default have been common. These authors count twenty-six countries in Europe and Latin America that experienced default in the twentieth century up to 2008, with some countries defaulting multiple times (96). They also provide data on financial and banking crises for more than sixty-six countries for the years 1800-2008 (348-92). We focus here on the U.S. deficit experience, making no claim with regard to how our findings may apply to other countries.

In the first section, we discuss political and economic thought with regard to fiscal constraints and the relationship between those who pay taxes and those who receive the benefits of taxation. Our discussion begins with John C. Calhoun and James Madison and extends through Milton Friedman's recommendation for a negative income tax. The relative strength of fiscal constraints is central to this discussion. Viewing the issue from a different perspective in the second section, we consider how to ration activity on the fiscal commons, the theme of an important strand of economic literature. This discussion focuses on literature that has examined the fiscal commons and the deficit commons that results. In both cases, an incentive exists either to get as much as one can or to avoid as much cost as possible. We then document what has happened on the fiscal commons as the share of citizens who pay no taxes has increased, deriving a series of refutable hypotheses. And in the third section, we look at trends and use regression analysis to test our hypotheses.

Taxpayers and Tax Spenders on the Commons

Among U.S. policy analysts, focused concern about the uneasy political relationship between those who pay taxes and those who receive benefits funded with tax revenues goes back at least to the early nineteenth century, when politicians and political theorists engaged in major debates about how to constrain the new government's spending. Writing in 1810 in A Disquisition on Government, American politician and political theorist John C. Calhoun warned of a problem that can develop when a community becomes divided into those who pay taxes and those who spend taxes. When one citizen group or region gains at the expense of another group, he reasoned,

it must necessarily follow, that some one portion of the community must pay in taxes more than it receives back in disbursements; while another receives in disbursements more than it pays in taxes.... The necessary result, then, of the unequal fiscal action of the government is, to divide the community into two great classes; one consisting of those who, in reality, pay the taxes, and, of course, bear exclusively the burthen of supporting the government; and the other, of those who are the recipients of their proceeds, through disbursements, and who are, in fact, supported by the government; or, in fewer words, to divide it into tax-payers and tax-consumers. ([1810] 1992) Calhoun's deeper concern was how to construct a constitution that would constrain political behavior and preclude the oppression of the minority who pay taxes by a majority consisting of those who receive benefits. In this context, he wrote:

There is no difficulty in forming government. It is not even a matter of choice, whether there shall be one or not. Like breathing, it is not permitted to depend on our volition. Necessity will force it on all communities in some one form or another. Very different is the case as to [a] constitution. Instead of a matter of necessity, it is one of the most difficult tasks imposed on man to form a constitution worthy of the name; while, to form a perfect one--one that would completely counteract the tendency of government to oppression and abuse, and hold it strictly to the great ends for which it is ordained--has thus far exceeded human wisdom, and possibly ever will. ([1810] 1992) Calhoun famously developed a theory of concurrent majorities, a constitutional order in which, for federal action to be accepted, a majority of the federated units must ratify the central government's action--a feature of the earlier Articles of Confederation.

Calhoun's older contemporary and Founding Father James Madison had similar worries as he struggled over the rights of suffrage. On the one hand, restricting the right to vote to those who own property risks oppression of the "rights of persons" and "violates the vital principle of free Govt. that those who are to be bound by laws, ought to have a voice in making them." On the other hand, granting the vote to those who do not own property risks oppression of a propertied minority by an unpropertied majority. Madison writes: "And whenever the Majority shall be without landed or other equivalent property and without the means or hope of acquiring it, what is to secure the rights of property agst. the danger from an equality & universality of suffrage, vesting compleat power over property in hands without a share in it: not to speak of a danger in the mean time from a dependence of an increasing number on the wealth of a few?" ([1821] 1987]). Madison thought through and proposed various voting strategies to try to balance these conflicting ideals, such as dividing the rights of suffrage between branches of government and differentiating the size of electoral districts and the length of legislators' terms.

When Calhoun and Madison were writing, the U.S. Constitution still contained Article 1, section 9, clause 4, the so-called Apportionment Clause, which required that "No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken." Though altered later, the...