Living with Leviathan Public Spending, Taxes and Economic Performance Living with Leviathan Public Spending, Taxes and Economic Performance DAVID B. SMITH The Institute of Economic Affairs CONTENTS First published in Great Britain in 2006 by The Institute of Economic Affairs 2 Lord North Street Westminster London sw1p 3lb in association with Profile Books Ltd The mission of the Institute of Economic Affairs is to improve public understanding of the fundamental institutions of a free society, by analysing and expounding the role of markets in solving economic and social problems. Copyright © The Institute of Economic Affairs 2006 The moral right of the authors has been asserted. All rights reserved. Without limiting the rights under copyright reserved above, no part of this publication may be reproduced, stored or introduced into a retrieval system, or transmitted, in any form or by any means (electronic, mechanical, photocopying, recording or otherwise), without the prior written permission of both the copyright owner and the publisher of this book. A CIP catalogue record for this book is available from the British Library. isbn-10: 0 255 36579 9 isbn-13: 978 0 255 36579 6 Many IEA publications are translated into languages other than English or are reprinted. Permission to translate or to reprint should be sought from the Director General at the address above. Typeset in Stone by MacGuru Ltd
[email protected] Printed and bound in Great Britain by Hobbs the Printers The author Foreword Summary List of tables, figures and boxes Author’s preface 8 9 12 15 18 1 Public spending and the size of the state The increasing role of the public sector The optimal size of the public sector Where does the money go? Instant versus deferred gratification The waste issue 25 2 Measurement problems, old and new Why democracies need reliable figures on government activities How do we define the ‘public sector’? How do we define national output? General government expenditure measured on a national accounts basis and by economic category GDP includes public spending Measuring government employment Atkinson and all that 42 25 30 34 36 39 42 43 45 47 53 57 61 Annexe: Other measurement problems 66 3 Economic performance and the size of government: evidence from economic models and empirical studies 69 The government’s budget constraint 69 The early model-based evidence 70 Warwick Macroeconomic Modelling Bureau studies 71 Some new model simulations 73 Public spending and taxation: results from cross-section and panel-data studies 77 Annexe: The author’s macroeconomic model 81 4 Economic performance and the size of government: economic theory The Ricardian Equivalence Theorem The damage caused by taxes Supply-side economics Competing theories of economic growth The fiscal stabilisation literature Good, and bad, buys in taxation 5 Does Britain have regional justice in tax and spend? Regions in UK public finance Key differences between the UK regions Regional breakdown of public spending Is high public spending damaging, even when provided free? Regional justice, or regional injustice, in tax and spend Regional conclusions 6 What is the optimal size of the public sector? How the optimal size is less than the maximum tax take Higher government spending . . . more poverty If government is so bad, why do we have so much of it? 7 New Labour, or old fascists? Springtime for Hitler? ‘New Conservatives’, old Tories? Gathering clouds Conclusions Annexe: The interface of fiscal and monetary policy 134 139 139 142 145 149 149 152 156 159 159 85 85 88 93 96 106 8 Policy conclusions The political backgro