Jun 16, 2008

Lower Taxes + Slimmer Government = Higher Growth

Interesting opinion piece by Keith Marsden (ex World Bank and ILO) in today's World Street Journal.

Marsden reports the results of some research he has undertaken

My study, "Big, Not Better?" (Centre for Policy Studies, 2008), looks at the performance of 20 countries over the past two decades. The first 10 have slimmer governments with revenue and expenditure levels below 40% of GDP. This group includes Australia, Canada, Estonia, Hong Kong, Ireland, South Korea, Latvia, Singapore, the Slovak Republic and the U.S.
I compared their records to the 10 higher-taxed, bigger-government economies: Austria, Belgium, Denmark, France, Germany, Italy, the Netherlands, Portugal, Sweden and the United Kingdom. Both groups cover a representative range of large, medium and small economies measured by their gross national incomes. The average incomes per capita of the two groups are similar ($27,046 and $30,426 respectively in 2005).
Most governments have reduced their top tax rates and spending-to-GDP ratios over the last decade or so, according to data published by the OECD, IMF and World Bank. But slimmer governments have done so at a faster pace, and to significantly lower levels. Their highest tax rate on personal income fell to a group average of 30% in 2006 from 36% in 1996. Top corporate rates were lowered to an average of 22% from 30%. Their average ratio of total government outlays to GDP fell to 31.6% in 2007, from an average peak level during the previous two decades of 40.4%
Investment growth jumped to an average annual rate of 5.9% in 2000-2005, from 3.8% over the previous decade. Exports have risen by 6.3% annually since 2000. The net result was a surge in economic growth. The IMF reports that GDP soared in the slimmer-government group at a 5.4% average annual rate from 1999-2008 (including its forecast for the current year), up from a 4.6% rate over the previous decade.
Over that same period, the bigger-government group was more timid in its tax reductions. Their highest individual rates declined to an average of 45% from 49%, and corporate rates to 29% from 35%. Furthermore, their average spending-to-GDP ratio only fell to 48.3% from a peak of 55.2%.
The bigger-government group therefore failed to gain any competitive advantages in global markets by generating or attracting larger investment funds. Their investment growth slowed to an average annual rate of 0.8% in 2000-2005, from 4.1% in 1990-2000. Their export growth rate almost halved to 3.1% annually in 2000-2005, down from 6.1% in 1990-2000. The bottom line is a drop in their average annual GDP growth rate to 2.1% in 1999-2008, from 2.3% over the previous decade.
Nor did they balance their books. They ran budgetary deficits averaging 1.1% of GDP in 2006, whereas slimmer governments generated an average surplus of 0.3% of GDP. Their net government debt averaged 39.2% of GDP in 2006, more than four times higher than the latter's. Interest payments on their debt took 2.3% of their GDP, compared with an average of just 0.5% in the slimmer-government group.
Slimmer-government countries also delivered more rapid social progress in some areas. They have, on average, higher annual employment growth rates (1.7% compared to 0.9% from 1995-2005). Their youth unemployment rates have been lower for both males and females since 2000. The discretionary income of households rose faster in the first group. This allowed their real consumption to increase by 4.1% annually from 2000-2005, up from 2.8% in 1990-2000. In the bigger-government group, the growth of household consumption has slowed to a 1.3% average annual rate, from 2.1% during the 1990-2000 period.
Faster economic growth in the first group also generated a more rapid increase in government revenue, despite (or rather, because of, supply-siders suggest) lower overall tax burdens.
Slimmer-government countries seem to have made better use of their smaller health resources. Total spending on health programs reached 9.5% of GDP in the bigger government group in 2004, 1.6 percentage points above the average in the slimmer-government group. Yet slimmer-government countries have raised their average life expectancy at birth at a faster pacer since 1990, reaching an average level of 78 years in 2005, just one year below the average for bigger spenders. Average life expectancy is now 80 years in Singapore, although government and private health programs combined cost only 3.7% of its GDP.
Finally, spending by bigger governments on social benefits (such as unemployment and disability benefits, housing allowances and state pensions) was higher (20.3% of GDP in 2006) than that of slimmer governments (9.6%). But these transfers do not appear to have resulted in greater equality in the distribution of income. The Gini index measuring income distribution is similar for both groups.
Other forces clearly helped to narrow income disparities in slimmer-government economies. These forces include wage-setting practices, saving habits, the availability of employer-funded pension schemes, and income sharing among extended families.
Both groups reduced the share of defense spending in GDP over the past decade. The slimmer-government average fell 0.1 points to 2.2% in 2005, but this level was 0.5 percentage points above the bigger-government average. The average share of armed forces personnel in the total labor force in the bigger-government group fell to 1.1% from 1.5% in 1995, whereas it grew to 1.7% from 1.5% in the slimmer-government group.
Information on public order and safety expenditures is incomplete. But for the 11 countries for which data are available, slimmer governments seem to take their responsibilities more seriously. They spent an average of 1.8% of GDP on these functions in 2006, compared with 1.5% by bigger governments.
The early supply-siders were right. My findings firmly reject the widely held view that lower taxes inevitably result in cuts in public services, slower growth and widening income inequalities. Today's policy makers should take note of how tax cuts and the pruning of inefficient government programs can stimulate sluggish economies.