September 2000 Fraser Forum: Is Big Government a Bargain?
There are those who contend that the last 40 years have been a successful experiment in big government (Klein, 2000). They point, for example, to advances in life expectancy and literacy as proof positive that big government works. They also scoff at the possibility that the explosive growth in government since the 1960s may have had some negative side effects.
A growing body of work by a number of distinguished scholars casts serious doubt on both of these contentions.1 The latest study of this type, completed by Dr. Gerald Scully of the University of Texas (Dallas) and the National Center for Policy Analysis, catapults the debate for smaller government forward by arguing that many western countries, including Canada, could significantly reduce the size of their governments without incurring any adverse social effects.
The hockey goalie: an analogy
An easy way to conceptualize Prof. Scully’s work is with an analogy. Imagine a hockey goalie playing the game with no equipment. Even a semi-competent player could score a goal against this unprotected goalie. But as the goalie dons a helmet, then pads, then a hockey stick, his ability to stop goals increases. In other words, as equipment is added to the goalie, his goal-stopping productivity increases. However, there is an optimum level of equipment for the goalie. At some point, overloading him will impede his movement, and decrease his ability to stop goals. That is, adding equipment beyond some optimum level actually results in decreased productivity.
This same relationship holds with government and economic growth. Government can encourage higher economic growth rates, and thus higher income levels for its citizens, by providing certain goods and services. Professor Scully specifically notes the advantages of government providing infrastructure, elementary and secondary education, and a functioning justice system. However, beyond some optimum level, as with the effect on the goalie, additional government not only fails to yield positive returns, but actually hinders economic progress.
Public spending and social progress
The findings of Scully’s latest study, Public Spending and Social Progress (www.ncpa.org), strike at the heart of the big government argument. Scully examined 1995 data for 16 indicators2 of social progress, including literacy, infant mortality, and life expectancy, across 112 countries. He concluded that there is little or no difference in social outcomes among countries in which governments spend less than 40 percent of their GDP (the value of all goods and services produced in a country) and those that spend in excess of 50 percent of their GDP. One of the striking conclusions contained in the Scully piece is that government spending ceases to yield any social progress, as measured by the 16 social indicators, at 18.6 percent of GDP for advanced countries. There is some variance among countries; for instance, the rate at which government spending ceases to provide any marginal benefits in Canada is 19.5 percent of GDP.
Professor Scully’s findings are very much in accord with those of previous studies. For example, a study by Vito Tanzi and Ludger Schuknecht has come to similar conclusions (Tanzi and Schuknecht, 1998). Specifically, the authors conclude that countries with big governments (where government expenditures exceed 50 percent of GDP), and countries with medium-sized governments (where government expenditures range from 40 to 50 percent of GDP) do not materially out-perform countries with small-sized governments (where government expenditures are less than 40 percent of GDP) in terms of a host of social and economic indicators. The Fraser Institute’s own Herbert Grubel and co-author Johnny C.P. Chao conclude that the optimal size of government spending and taxation for maximizing economic growth is 34 percent of GDP.
This is particularly striking when one considers that according to the Organisation for Economic Cooperation and Development (OECD), Canadian governments are expected to extract 41.8 percent of GDP in receipts in 2000. Regardless of the particular measure used, it is evidently clear that the size of Canadian governments, like many western countries has grown beyond what is socially and economically optimal. In other words, our goalies are encumbered by far too much equipment to be efficient.
The other side of the ledger: raising revenue
Government spending is funded by taxation. Over the long-term, in one form or another, governments must extract enough money from citizens to pay for the expended resources. Where do we currently stand in terms of taxes? The total tax burden faced by the average Canadian family, as measured by The Fraser Institute’s Tax Freedom Day, which includes all types of taxes, has lapsed from May 3 in 1961 to June 30 in 2000 (Emes and Walker). Put another way, the number of days we must all work for government has increased by nearly 2 months (58 days) over the last 39 years. Structural problems with the Canadian tax system (i.e., the way we raise taxes) and problems with the amount of tax we raise could easily constitute their own article. Suffice it to say that Canadians are over- taxed relative to the benefits we receive.
Additional cost: reduced economic growth
There is an additional cost to having government exceed its optimum size: lower rates of economic growth.3 When government exceeds its optimum size the goods and services (and/or redistribution of income) it provides yield a low rate of return, if any. Consequently, the government undertakes activities that produce little or no benefit while at the same time preventing individuals from undertaking more profitable and beneficial activities.
One of the ironies of lower economic growth is that it, and the accompanying decline in income growth, ultimately constrain government’s provision of goods and services since the resources for those goods and services ultimately come from taxation. Increasing rates of economic growth will increase income, which will ultimately finance the goods and services that many want the government to provide. Reducing rates of economic growth will reduce income growth, which means that citizens will bear a higher average tax burden to finance those programs.
US-Canada divide
For instance, as the Canadian and American economic growth rates have diverged, so have income levels. Industry Canada recently concluded that US living standards are between 10 and 50 percent higher than those in Canada (Industry Canada). In fact, on average, Industry Canada found that the US living standard is 22 percent higher than the Canadian average. Other studies by Statistics Canada and Standard & Poor’s have reached similar conclusions.
Today, Canadians face a much higher total tax burden than do our southern neighbours. Specifically, Canadian governments currently extract 41.8 percent of GDP, while the US extracts 31.2 percent of GDP, a difference of 34.0 percent. However, this massive difference in taxation does not result in an equally massive difference in per capita spending. In fact, according to the OECD, Canadian governments are expected to spend only $165 more per person than American governments in 2000. If the actual exchange rate (as opposed to Purchasing Power Parity4) is used, in 2000, American governments are actually expected to spend $1,711 more per person than Canadian governments. The reason for this difference is simple: Americans have higher incomes, and thus less of those incomes need to be taxed to provide a similar level of government spending.
An opportunity
facing us
Today, Canadians have an enormous opportunity. Canada has both the historical experience and the empirical blueprint necessary to significantly reduce government spending and taxation. Paradoxically, by doing so, it can continue the social progress begun over 40 years ago. If we choose to seize this opportunity, then the goals of both limited- and big-government advocates can be satisfied.
Notes
1For more information on the optimal size of government, see: Chao and Grubel; Tanzi and Schuknecht, 1998; Scully; Tanzi and Schuknecht, 1995; and Gwartney et al. These publications are available on the Internet at www.fraserinstitute.ca and www.ncpa.org.
2Indicators include: male/female life expectancy, infant mortality, male/female literacy rates, average household size, military power, energy use, length of roads, persons per telephone, hospital beds, population per physician, daily caloric consumption, persons per radio, crime rate, index of political freedom, index of civil rights, and index of economic freedom.
3The effects of reduced rates of economic growth cannot be understated. For instance, over a mere thirty-year period, an economy will forego 64 percent of its potential GDP if its growth rate averages 2 percent rather than 3 percent. The amount of foregone potential GDP increases as the spread between potential growth and actual growth widens and/or when the time period is extended.
4Purchasing Power Parity (PPP) is the calculated exchange rate intended to equalize price differences across countries.
Bibliography
Chao, Johnny C.P. and Herbert Grubel (1998). "Optimal Levels of Spending & Taxation in Canada." How to Use the Fiscal Surplus. Edited by Herbert Grubel. Vancouver, BC: The Fraser Institute.
Emes, Joel and Michael Walker (2000). "Tax Freedom Day 2000." Fraser Forum. July.
Gwartney, James, and Robert Lawson, with Dexter Samida (2000). Economic Freedom of the World: 2000 Annual Report. Vancouver, BC: The Fraser Institute.
Industry Canada (2000). A Regional Perspective on the Canada-U.S. Standard of Living Comparison. Industry Canada Research Publications Program. Occasional Paper #22, February 2000. Available on the Internet at info.ic.gc.ca/cmb/welcomeic.nsf/icPages/Menu-e.
Klein, Seth (2000), Canadian Centre for Policy Alternatives. "BC Budget 2000 Proposal." Vancouver Sun. March 23.
Scully, Gerald W. (1998). Measuring the Burden of High Taxes. Dallas, Texas: National Center for Policy Analysis.
Standard & Poor’s (2000). DRI The Canadian Economy. McGraw-Hill.
Tanzi, Vito and L. Schuknecht (1995). "The Growth of Government and the Reform of the State in Industrial Countries," IMF Working Paper. Washington, D.C.: IMF.
_____. (1998). "Can Small Governments Secure Economic and Social Well-being?" How to Use the Fiscal Surplus. Edited by Herbert Grubel. Vancouver, BC: The Fraser Institute.
Jason Clemens (jasonc@fraserinstitute.ca) is the Director of Fiscal Studies
at The Fraser Institute. He has a Masters Degree in Business Administration
from the University of Windsor.
Patrick Basham (patrickb@fraserinstitute.ca)
is The Fraser Institute’s Director of the Social Affairs Centre. He is
completing his Ph.D. in Political Science from Cambridge University.
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