Appendix A: Deriving the Optimum
Level of Spending and Taxation

Research has shown that government spending in Canada has been most conducive to economic growth when it equalled 34 percent of national income. Spending at lower or higher levels has historically been associated with lower growth rates in Canada.⁴

The figure of 34 percent of GDP refers to total government spending, while the preceding analysis focused on federal spending alone. To estimate what the share of federal spending is when total spending is at 34 percent, we use table A1.

The 1997 spending data are actual. The other figures are simulated under the assumption that total and federal spending remains unchanged at these 1997 levels. GDP is assumed to grow at 2.5 percent annually.

Click here to view Table A1

As table A1 shows, under these assumptions, total spending equals 34 percent of GDP in 2008. At that time, federal spending would be 14.6 percent of GDP (rounded to 15 percent in the discussion above).

Note that the assumed annual growth rate of 2.5 percent in nominal terms is likely to be exceeded, the more so the higher the inflation rate. Higher nominal growth rates have two implications. First, if nominal spending remains constant, the target of 14 percent of GDP will be reached much more quickly than the 8 years implied in the above simulation. Second, if inflation produces strong pressures to increase spending in certain areas by the amount of inflation, such spending can be increased to match the inflation rate. The target rate of 14 percent would still be reached in 8 years. If spending is increased to match inflation, we recommend that it not be universal for all programs. Instead, selective spending increases can be used to rationalize the relative size of programs without the political cost accompanying selective cuts in nominal spending.