August 16, 2009

Government size and tax


Countries differ substantially in government sizes
In the post What's important is that it works, I quoted Barack Obama who said: "The question we ask today is not whether our government is too big or too small, but whether it works." As a non-economist, I am usually a bit reluctant to write about economic issues because of my limited grasp of the subject. But I would like to make an exception for the issue of government size because I came across some views which influenced mine a bit. There are several reasons I like Obama's statement. One reason for liking this statement is that it reflects the solution-focused principle of doing what works (see subtitle of this blog). Whether a government is effective or not can hardly only be a matter of how large it is. A government may have any size but if it makes unwise policy decisions based on erroneous information or thinking, chances are it won't be effective. Having said this, it is evident that government size matters, too. Countries differ substantially in government sizes. For instance, many Western European governments are much larger than the US government. Federal state and local government revenues in the US are about 33% of gross domestic product, compared with 45% in Europe; Spending stands at 39% of GDP in the US and 46% in Europe. Yet because US taxes are lower than spending as a share of GDP, US deficits are chronically higher (source).

The argument over which size of government is best
Advocates of a rather large government argue that this would help government perform its basic functions better, like establishing legislation and rule of law, education, national defense, social security, environmental security and healthcare. Advocates of a smaller government argue that a small government would increase economic efficiency and would therefore be better for long term economic performance. The argument goes that a minimal government, in which many public services (healthcare, education, etc) would be privatized to a large degree, would benefit by being submitted to the forces of the market. Also, more government spending would amount to more waste of money. There is much logic in this argument; the invisible hand of the market is usually great for establishing prices and efficient allocation of resources. To many this logic is attractive and the prospect of very low taxes, understandably, is too. But as economist Robert H. Frank explains in his book The Economic Naturalist's Field Guide: Common Sense Principles for Troubled Times, gains promised by tax cutters are often illusionary. He says: "Paradoxically, a tax cut could actually leave Americans with less to spend on themselves. Money spent on a tax cut instead of repairing a road means not only having to spend two to five times as much to fix that same road in the near future, but also having to pay an average of $120 per car to repair the damage that bad roads inflict each year." In other words, government spending can actually increase overall efficiency within an economy.

Tax is the price of civilization, it will rise
I would not be surprised if taxes in the US will eventually rise again substantially. I would also not be surprised if there will come a time when the idea that government spending should always be minimized and that politicians can only be elected if they promise tax cuts will be behind us. Economist Jeffrey Sachs is outspoken on the issues of taxes: "The United States has built in, like most rich countries, a lot of entitlement spending, especially on pensions and on health. Those are the two big items, the Medicare and the social security. We want to run our country without paying taxes, that's the other side. So, this is the tension that they're agonizing over. 'We're al going to go broke because we have all these medical bills and pensions! What are we going to do?' Well, what we're going to do is grow up and pay taxes. And we will be more like Europe, more like The Netherlands. And taxes, as one of our great Supreme Court Justices said: "Taxes is the price of civilization. And this is something that was forgotten in this country since Ronald Reagan..[..] To sneer at paying taxes, that is really one of the things that is wrong in America. [...] But there is no tragedy ahead. The thing that lies ahead is higher taxes. But that is because American taxes are the lowest of all of the high-income countries in the world. That is our -quote- pride. It is just very short-sighted." Also read: Paying for what government should do.

5 comments:

  1. I would rather not express my opinions on this one: I am not an economist, and therefore my thoughts on the matter are 100% political.

    I just want to point out a distinction that I grasped only recently, in the hope of making the debate (if any) more interesting.
    When talking about government here, in the US, there is a distinction to be made between the federal government and the local (State and County) government.
    This is a distinction often lost on European observers (at least I did not fully get it until recently).
    Most Americans that do not want a big government do not want a big FEDERAL government. Which does not necessarily mean less local government - where representation is more direct (e.g. here in California voters are sometimes asked to express themselves about some tax increases to pay for specific services).

    I think a way we could frame the issue in terms more understandable to Europeans (and I know this is a very imperfect analogy) would be advocating a stronger and bigger EU vs. advocating a smaller EU and more power to the States.

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  2. Hi Paolo, I think that is a useful distinction indeed and one I, as a European, was not so aware of, I admit.

    But it does not take away the fact that overall government, local or federal is smaller in the US. And the difference in taxes between US and Europe are even larger than the differences in government sizes, which is a major reason of the large US deficits.

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  3. True, overall government is smaller in the US.

    Not necessarily differences in taxation lead to healthier budgets.
    In Italy we have much higher taxes than the US AND a a larger deficit than the US.
    (and the higher taxation rate is the reason why about half of Italian taxpayers declare 15,000 euros or less, which is total bullshit).

    Spaghettieconomics!!

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  4. Today (December 29, 2010): A New Year's Resolution for the Rich (http://huff.to/hdqifR)

    While the United States has suffered the worst recession in living memory, I find that I have very few financial concerns. Many of my friends are in the same position: Most of us attended private schools and good universities, and we will be able to provide these same opportunities to our own children. No one in my immediate circle has a family member serving in Afghanistan or Iraq. In fact, in the aftermath of September 11th, 2001, the only sacrifice we were asked to make for our beloved country was to go shopping. Nearly a decade has passed, with our nation's influence and infrastructure crumbling by the hour, and yet those of us who have been so fortunate as to actually live the American dream--rather than merely dream it--have been spared every inconvenience. Now we are told that we will soon receive a large tax cut for all our troubles. What is the word for the feeling this provokes in me? Imagine being safely seated in lifeboat, while countless others drown, only to learn that another lifeboat has been secured to take your luggage to shore...

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  5. http://bit.ly/ijkCWu - Shigehiro Oishi, Selin Kesebir, and Ed Diener: “Income disparity has grown a lot in the U.S., especially since the 1980s. With that, we’ve seen a marked drop in life satisfaction and happiness.” “The implications are clear: If we care about the happiness of most people, we need to do something about income inequality.” One way to accomplish that end, is with more progressive taxation.

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