Moon of Alabama Brecht quote
March 23, 2005

Low Taxes and Growth Not Linked

Here's a strong argument to those that say that taxes are a drain on growth and must be cut: there is no correlation whatsoever between public spending levels and growth per capita, as this graph below shows

050323_pub_spending_growth_per_head

The economic performance of the US over the past 10 years is pretty much identical to that of sclerotic, socialist, rigid France, and significantly worse than that of socialist, statist Sweden and Finland, measured in statistically significant terms, i.e. growth per capita

Martin Wolf: Big spending doesn’t mean less growth (FT, 23 March)

The question [is whether high shares] of public spending in GDP prove economically harmful. Some think that no economy can tolerate taxes higher than those elsewhere if it is to sustain "competitiveness". Others talk as if public spending disappears into a black hole from which nothing of value emerges. Is there anything in these crude arguments? Not much, is the answer. Citizens of the rich countries deserve a more subtle debate. Start then with overall economic performance, particularly the growth in output per hour and GDP per head. The charts [see at the top of the post and below] show both between 1995 and 2004 against the share of general government spending in GDP in 2004. The share of government spending in GDP varies by a ratio of almost two to one, from Sweden on 58 per cent to Ireland on 34 per cent. There is a group of relatively low spenders: the English-speaking countries (except the UK), Switzerland, Japan and Spain. There is a group of extremely high spenders: Sweden, Denmark and France. What, then, do the charts show about the link between government spending and economic performance? There is none, is the answer.

050323_pub_spending_growth_output_per_ho

Ireland's performance generates a small, but statistically insignificant, slope downwards to the right. But Ireland is an exceptional case. What is striking is the slow growth of GDP per head in low-spending Japan and Switzerland and the high growth in high-spending Finland and Sweden. The relatively poor performance of the US may surprise some readers. But remember that US GDP grows faster than those of European countries because its population of working age increased by 1.2 per cent a year, against 0.4 per cent in the European Union between 1994 and 2004. I would not wish to push such crude data too far. Measurement of GDP and so of productivity is increasingly hard to do as output becomes less material. It is particularly hard to measure the output of government services. Yet one overriding point does emerge: the mere fact of a rising ratio of public spending in GDP does not spell doom for the UK (or any other) economy. This is consistent, surprisingly enough, with an analysis from impeccably conservative US sources: the Heritage Foundation and The Wall Street Journal. In the 2005 Index of Economic Freedom, which measures, however roughly, the underpinnings of market economies, Luxembourg (ranked 3rd) and Denmark (8th) are above the US (10th), as is the UK (7th). Sweden (14th), Finland (15th), the Netherlands (17th), Germany (18th) and Austria (19th) all fall in the global top 20. What then of the idea that higher spending (and so taxes) must also spell a lack of global competitiveness? The short answer is that it is nonsense, for reasons elaborated in my book, Why Globalization Works (Yale University Press, 2004). The burden of higher taxation will be shifted on to owners of relatively immobile factors of production. Moreover, no link exists between the size of government spending and a lack of something one could reasonably define as "international competitiveness". What does indeed matter is the efficiency with which money is both raised and spent. But tax levels are only one of many determinants of economic performance. Far more important are: the quality of institutions, particularly of public administration and the judiciary; the security of property; the probity and public spiritedness of politicians; the soundness of money; the quality of education, health and infrastructure; and the extent of arbitrary regulation of economic activities. Monomania is usually a mistake. An exclusive focus on the tax burden is an example. What we must abandon is a debate that takes the form of "public sector bad, private sector good", or the other way round. It is particularly stupid when, as in the UK, the decision has already been made to pay for evidently high social priorities through the state. Health and education do not suddenly become far less important than holidays in Ibiza merely because they are financed through taxation. In making the decision on what to put into the public sector and how much to spend on it, we have to place substantial weight on underlying social and political values. But we must also ask, first, what we must do through the government (defence and law and order, for example); second, what we want,for reasons of social solidarity, to do through government (provision of basic incomes for all, of universal education and of basic health services, for instance); third, whether we wish to pay for services through general taxation or user fees; fourth, what is the least costly way of raising revenue; and, finally, whether we want services to be paid for and provided by government or merely paid for by government and provided by competitive private suppliers. These are the right questions. Labour's higher spending will not destroy the British economy, just as Finland's high spending has not destroyed Finland. What matters here, as elsewhere, is not what you do but the way that you do it. martin.wolf@ft.com Sources for charts: OECD; The Conference Board

Martin Wolf is one of the most respected (and reality-based, to use a term you may be familiar with...) economics columnists around, which is why I copied most of his column here. Let me repeat again: The economic performance of the US over the past 10 years is pretty much identical to that of sclerotic, socialist, rigid France, and significantly worse than that of socialist, statist Sweden and Finland, measured in statistically significant terms, i.e. growth per capita Do not believe everything you read in the press about continental Europe. There are a number of problems, but we are not in terminal decline. Our economic model has its flaws, but being unsustainable or significantly weaker than the Anglo-Saxon one is not one of them. Taxes are not bad - it's a HARD FACT They are used to provide necessary services or socially useful goods which have positive macroeconomic effects. They are not just a drain on productive workers.

Posted by Jérôme à Paris on March 23, 2005 at 08:14 AM | Permalink

Comments

Ireland is pretty much an outlier on that graph, I would have thought. It's economic growth is related to the structural revolution enabled by transfers in the EU and by alterations in the business landscape which minimise the effects of being stuck out in the Atlantic with only euro-sceptic barbarians between us and Paris. Dropping Ireland flattens the best-fit a lot.

Incidentally, if anyone should bring it up, relatively low Irish tax rates post-date the growth by several years, not pre-date it. We have low taxes because we have such a high growth rate, not the other way around. Services suffer as a result, and the disparity between rich and poor is growing, never a good thing for a country.

Posted by: Colman | Mar 23, 2005 9:53:11 AM | 1

Note also that this is in terms of the crappy GDP measure of performance. I wonder how the graph would look if we had a more balanced measure?

Posted by: Colman | Mar 23, 2005 9:57:25 AM | 2

In Geneva, in the past 20 (30?, more?) years almost none of the practically incessant Right’s initiatives to lower taxes, even very modest ones (2%!) have found favor with the voters - No, Nein, Non, go home. The Left’s proposals to hike them up have done a little better, but the successful proposals have tended to be specific: tax pools, tax cars, tax dogs - you get the picture.

Their latest proposal is a big hike on incomes of over about 120.000 dollar-a-year incomes, with millionaires getting hit hard. It won’t be adopted, not a chance.

The Left and the Right and all the creatures in between joined hands some years ago in favor of a modest VAT - around 5%. Everyone was dead keen on this tax (we even had flag wavers!) except the Left Alliance, which groups together Troskyists, etc. They said: Not fair to the poor, etc.

The successful Right proposals have been:

1) To get rid of inheritance tax (up to a certain large amount.)

2) To lower taxes by 12 % across the board immediately. (There were of course all sorts of details of application etc. that I have forgotten.)

At the time, the minister of finance was a Socialist (M. Calmy-Rey, now Foreign Minister of CH and flirting with Powell, Sharon, and the like..).

She said her party’s position was opposition to the proposal but her personal position was that it could be done without too much pain. This is permitted in CH, nobody can be forced to go against “son ame et conscience.” So she tread a contra- and pro- line, giving plenty of arguments for both sides.

The voters said, OK. Yes. Let’s do it. Let's try that experiment.

And so it came to pass, in the space of just a few weeks all taxpayers got a letter, saying, you need to pay less. You can skip one monthly payment or go on the internet (etc. etc.) It made a big difference, a noticeable one. And the diff. has endured, it has not been slowly nibbled away by pesky arcane calculations and rules.

What happened? Basically, nothing much. The State did manage to cut budgets, save money, etc. I work for them so know how that went.

Since then learned studies (both from the Left and the Right if one ignores the rethoric that is reserved for the conclusions) have shown that it did not affect ‘growth’ (sloppy notion that), that it may have contributed to increasing the State’s debt (huge and growing) but it may not have! And so on...Really, no-one can quite figure it out, but what seems clear (to a non-economist like me) is that growth was not affected.

“Growth”, in this small place, is dependent on image, on Gvmt. charisma, on trumpeted quality of life, public transport, air services (attracting foreign companies), education (a market after all), tech /other innovation, start-ups (not affected by these rules), productivity hikes, and so on - even the weather (skiing).

Leaving consumers a bit more money is a negligible factor. About 60% of people did not even notice the change. Of course, in GE that includes many people who pay no taxes anyway. People are more affected by health costs (insurance and/or personal payments), the cost of education (rising all the time), and transport costs (these go up and down in peculiar ways.) Housing is the most important.

All this stuff about taxes is a a right-wing obsession that means little.

It is not how much taxes one pays but how they are spent that counts!

Hope the local tale was of interest.

Posted by: Blackie | Mar 23, 2005 12:14:00 PM | 3

Corporate profits are not recirculated the way taxes are.

Posted by: pb | Mar 23, 2005 11:05:41 PM | 4

"They said: Not fair to the poor, etc."

Countries that have VAT's or GST's (Canada)have rebates for the less fortune-ate.

Posted by: pb | Mar 23, 2005 11:13:49 PM | 5

Quote:
Leaving consumers a bit more money is a negligible factor. About 60% of people did not even notice the change. Of course, in GE that includes many people who pay no taxes anyway. People are more affected by health costs (insurance and/or personal payments), the cost of education (rising all the time), and transport costs (these go up and down in peculiar ways.) Housing is the most important.

All this stuff about taxes is a a right-wing obsession that means little.

It is not how much taxes one pays but how they are spent that counts!
***

Blackie it was interested and I totally agree with you.
It is same here...People just don't understand that...I wonder if they are just stupid or what?
The only real effect I can see is that rich are richer and poor are poorer and gap between them is greater. On the other hand lower middle class is disappearing in to the sea of poverty ... people just do not realize how poor they actually are because they are STILL allowed to borrow beyond their actual “credibility”…

Posted by: vbo | Mar 24, 2005 7:48:29 AM | 6

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