Government and GDP

The graph below, from Cato @ Liberty, illustrates how three measures of government size have changed over time. While government production has remained relatively stable as a share of the economy, total government spending has swelled. The growing gap between these two lines, according to Chris Edwards, mainly represents the massive growth in transfer (or subsidy) programs, such as Social Security.”

Click here to read Chris Edwards’ analysis.

Tax Burdens, Around the World

Catherine Rampell explains:

The Organization for Economic Cooperation and Development today released new data on tax burdens in its 30 member countries. Across the organization, overall tax revenue totaled an estimated 35.2 percent of gross domestic product in 2008, down half a percentage point from 2007. The organization expects that tax burdens will fall further in 2009.

Denmark had the highest total tax revenue as a percentage of G.D.P., at 48.3 percent, followed by Sweden at 47.1 percent. Turkey and Mexico had the smallest tax burdens, at 23.5 percent and 21.1 percent, respectively.

In the United States, tax revenues represented 26.9 percent of total output last year.

Government Financing: Heads I win, tails you lose

In Ayn Rand’s Capitalism: The Unknown Ideal, she writes,

Every government interference in the economy consists of giving an unearned benefit, extorted by force, to some men at the expense of others. By what criterion of justice is a consensus-government to be guided? By the size of the victim’s gang.

The logic behind this statement is simple and largely self-evident, though often ignored in policy discussions. It should be noted that the article I write about below has nothing to do with the above quote – which is precisely the problem.

A November 19th article from The Economist ponders the question of how governments can best raise revenue through taxes. To the author’s credit, he states in the first paragraph:

Although spending cuts could, and should, be the preferred route to prudence, taxes are all too likely to be part of the mix—at least judging from the experience of those countries that have already acted.

Unfortunately, the article concludes that developed countries would do best to focus on “efficiency” rather than “fairness.” If a government’s goal is to pursue the utilitarian goal of the “greatest good for the greatest number,” this preference for efficiency over fairness would be correct. However, any government with such utilitarian goals is an abomination.

The author does make some important points about alternate tax systems. Taxes on consumption, including a value-added tax (VAT), are regressive; meaning the lower an individual’s income, the higher he is taxed. Consumption taxes do, as the author points out, encourage saving – but they simultaneously discourage spending. Corporate taxes, it is noted, are particularly market-distorting. The critical numbers of the article can be found in the graph below (click to enlarge).

The author also illustrates an interesting phenomenon that often goes overlooked. Very collectivist (communist, socialist, fascist, etc.) have government revenues that make up a relatively large percentage of GDP, when compared with economically liberal countries such as the U.S. Russia, for example, has government revenues equal to 47.7 percent GDP, while the U.S. has government revenues equal to 33.7 percent GDP. But these percentages do not tell the whole story. It is also important to look at the components that make up these percentages. In Russia, non-tax revenues (largely related to state-owned oil companies) make up 14.5 percent of GDP, while in the U.S. non-tax revenues comprise only 5.7 percent of GDP.

At first, this may seem to be a much more efficient way for governments to raise revenue (though, to be sure, the article never makes this claim). It is easy to understand why a person unfamiliar with the record of history may see no difference between a government-run entity earning revenues and a private firm collecting profits. Is there any real difference between the Russian government selling oil and ExxonMobil selling oil?

The answer is a definite “yes”.

History and economics  both teach us that no central body can determine the amount of goods and services needed by individuals. Only the invisible hand of market forces can provide society any degree of efficiency. So even if government raises its revenue through so-called production instead of taxation, there will still be massive transaction costs and inefficiencies on both the supply and demand side. And of course, the government has incentives that conflict with offering the best product at the best prices. Governments typically have two goals: 1) gain power, 2) create social value. Yes, these are often at odds;  and yes, the second is often a means to the first. Regardless, governments are not motivated by profits. And the profit motive is the driving force behind real economic efficiency.

But all of this talk of efficiency misses the point. I’ll return now to the point of the quote I began with.

When reading such articles, it’s easy  to get wrapped up in the author’s arguments and lose the ability to distinguish the forest from the trees. Though the free market is far more efficient than a centrally-planned market, is that really a concern when so many tax systems and government sources of revenue violate individual rights? ExxonMobil has vast resources at its disposable to best its competition. But the one thing it does not have is the ability to coerce by force. Only by offering its customers the greatest value at the lowest price can it win in a free market. While the Russian government (or any other government) only has to pass laws – backed, of course, by men with guns – to maintain its supremacy. Take the U.S. Post Office, for example. If FedEx and UPS were allowed to carry mail, would the USPS have any chance at remaining viable? Of course not. Only by regulation and force can the USPS continue to provide income for the U.S. government.

So whether you are concerned with efficiency or freedom, the property confiscated by government should be reserved only for the protection of our individual rights.

One final thought from Ayn Rand on the subject:

There can be no compromise between freedom and government controls; to accept “just a few controls” is to surrender the principle of inalienable individual rights and to substitute for it the principle of the government’s unlimited, arbitrary power, thus delivering oneself into gradual enslavement. As an example of this process, observe the present domestic policy of the United States.

One way to boost GDP

From the Wall Street Journal:

South Africa has found an interesting way to bolster its gross domestic product: include illegal activities.

Stats SA in its latest GDP report expanded its survey to include previously uncovered areas of the economy such as crime, the drugs trade and illegal mining. The “non-observed element” of the economy accounted for 0.2% of GDP in 2008, it said.

“Information was obtained from administrative and enforcement records of the South African Police Service (SAPS), South African Revenue Service (SARS), other associations (e.g. SWEAT for prostitution) and information on other country experiences,” Stats SA said.

The contribution to GDP from the non-observed economy is seen steady at around 0.2% from 2002 through 2008, though it dipped to 0.1% in 2007. The calculations are used for its benchmarking revisions, but isn’t included in its regular quarterly numbers. On Tuesday, the country reported that GDP grew 0.9% in the quarter ended September, marking an end to its first post-apartheid recession.

Pressure has mounted on President Jacob Zuma, elected in April on a populist platform of poverty reduction and job creation. Unemployment rose to 24.5% in the third quarter after 484,000 jobs were lost during the three months, Statistics South Africa said last month.

Maybe the country should consider counting people who work in illegal activities to bring down its unemployment rate.

Chávez Wants a New ‘Socialist-Friendly’ Economic Gauge

Venezuelan President Hugo Chávez didn’t appreciate the recently released data that showed the Venezuelan economy has slipped into a recession. So what’s a Socialist leader to do? Create a new economic gauge, one that is “Socialist-friendly.”

“We simply can’t permit that they continue calculating GDP with the old capitalist method,” President Chávez said during a televised speech to members of his party Wednesday night.

“It’s harmful,” he added.

So what caused Mr. Chávez’s deep displeasure? For one, new data showed Venezuela’s GDP fell 4.5 percent in the third quarter compared to the same period last year making it the second consecutive quarterly decline. This data, moreover, was provided by the Venezuelan central bank.

It remains unclear what Chávez’s new measure would look like. Either way Chávez’s push for an alternate to the GDP is far from innovative.

In 1972, for instance, Bhutan’s former King Jigme Singye Wangchuck coined the term “Gross National Happiness” (GNH) as an alternate to GDP. This measurement sought to quantify well-being and happiness through measuring economic wellness, environmental wellness, physical wellness, mental wellness, workplace wellness, social wellness, and political wellness.

The GNH never really caught on, due largely to the (intentionally) subjective nature of the measurements. I have a feeling what led to the GNH’s failure will be exactly what attracts Chávez.

Did the stimulus work?

Jeffrey Miron and Russ Roberts tackle the question of whether or not the stimulus worked. Their answer? Not quite.

Miron:

Research finds more evidence for the efficacy of monetary as opposed to fiscal policy in ending recessions. And the studies on fiscal stimulus have shown more impact from tax cuts than from spending increases.

We also do not know whether the positive G.D.P. growth resulted partially or mainly from natural equilibrating mechanisms, rather than from monetary or fiscal policy. Much discussion of the recession presumes it will end only because government comes to the rescue.

In fact, the U.S. economy recovered from significant recessions before 1914, when monetary and fiscal policy had not even been invented. Economies can and do recover on their own, and intervention might make things worse by generating uncertainty and distorting the economy’s allocation of resources.

Roberts:

I once thought that spending money was the government’s strong suit. But as of October 20, only $120 billion of the $290 billion available so far from the stimulus package has been spent. Despite the early rhetorical emphasis on shovel-ready projects, the Department of Health and Human Services, the Department of Labor, and the Department of Education accounted for two-thirds of the total spent.

The Department of Transportation, a source of spending that is likely to be rich in shovels, has $30 billion available but has only managed to spend $4 billion. So perhaps it is not surprising that construction workers and manufacturing workers (who make up half of the job losses since the beginning of the recession) are struggling to find jobs.
I think the Keynesian narrative is right about one thing — consumers lack confidence. The crucial question is whether a large increase in government spending financed with borrowed money that swells the deficit to $1.4 trillion is good for confidence or bad for it. No one knows the answer.

The arguments against the stimulus are rooted in basic economics. Unfortunately, basic economics rarely make for an inspiring campaign speech.

The other side of Israel, continued

From the Economist:

Last year Israel, a country of just over 7m people, attracted as much venture capital as France and Germany combined. Israel has more start-ups per head than any other country (a total of 3,850, or one for every 1,844 Israelis), and more companies listed on the NASDAQ exchange, a hub for fledgling technology firms, than China and India combined. It may not have the same comforting ring as “the Swedish model” or “the polder model”, but when it comes to promoting entrepreneurship, “the Israeli model” is the one to emulate.

Click here to read ‘The other side of Israel.‘

The other side of Israel

Dan Senor (Council on Foreign Relations) and Saul Singer (Jerusalem Post) write:

For all the press coverage of the Middle East, there is one side of Israel that gets scant attention: the country’s economy has the highest concentration of innovation and entrepreneurialism in the world today. For years, multinational technology companies and global investors have been beating a path to Israel. Even in 2008—a year of global economic turmoil—per capita venture investments in Israel were 2.5 times greater than in the United States, more than 30 times greater than in Europe, 80 times greater than in China, and 350 times greater than in India. And Israel still boasts the highest density of start-ups in the world (a total of 3,850 start-ups, one for every 1,844 Israelis). More Israeli companies are on NASDAQ than companies from all of Europe, China, India, Korea, and Japan combined.

…In fact, according to the Organisation for Economic Co-operation and Development (OECD), 45 percent of Israelis are university-educated, which is among the highest percentages in the world. And according to a recent IMD World Competitiveness Yearbook, Israel was ranked second among sixty developed nations on the criterion of whether “university education meets the needs of a competitive economy.”

Click here to read the full article.

TABOR

Gerald Prante of the Tax Foundation has an interesting take on what TABOR means for the foundations of the American political system.

TABOR, for those unfamiliar with the term, refers to Colorado’s Taxpayer Bill of Rights provision that imposes exogenous limits on the amount state and local government spending can grow in a state. Similar provisions are being proposed in those two states. But is it necessary?

If government always acted in the best interest of society, TABOR would never be needed. Therefore, the supposed need for TABOR is derived from a lack of trust of the representative democratic system. TABOR is kind of like the Bill of Rights in the U.S. Constitution: the Founding Fathers imposed restrictions on Congress (representatives of the people) from passing laws that restrict speech, establish religion, etc. If the Founding Fathers thought that Congress would always do what’s in society’s best interest, we wouldn’t have needed a 1st Amendment that starts with the phrase “Congress shall make no law…” The Bill of Rights is inherently anti-democratic.

Maybe as a first-best solution (in a world of a purely benevolent government), the First Amendment isn’t the best policy. But it’s probably a second-best solution given that Congress isn’t to be trusted when it comes to actively regulating speech, religion, etc.

And that’s the ultimate question with TABOR. If government was purely benevolent, the first-best solution would be some optimal tax-spending mix. But if government is pre-disposed to get larger and larger (when left to its own devices) and be at a size that is far above optimal, a TABOR has the potential to improve societal well-being. It’s likely not to lead to a perfect outcome, but it shouldn’t be compared to what a perfect, purely benevolent government would do. It should be compared to what an imperfect government is actually doing (and likely to do in the future).

That being said, for TABOR to be successful at improving social well-being, it must be the case that there is a significant amount of waste in the state’s spending. If politicians aren’t interested in maximizing social well-being (which is the necessary condition for TABOR in the first place), then who is to say that the spending cuts they make in response to TABOR are going to be right ones?

If the politicians decide to cut funding for some wasteful project as a result of TABOR, then society wins. Resources that were being wasted are now being put to better use (via lower taxes). But if those politicians, in response to TABOR, cut spending that actually has a high marginal social value (higher than the total marginal cost from taxation), social well-being could be made worse off as a result of TABOR. (Just saying that because government spending / GDP fell that such a policy change is good is nonsense. It depends on what type of spending was cut.)

In summary, TABOR would undoubtedly improve social well-being if politicians cut the least valuable government service in response to TABOR’s enactment. But given that TABOR is necessary because we can’t trust the politicians in the first place to do what is right for society, what is the probability that they are going to cut spending in response to TABOR that has a value to society less than the taxes that TABOR would be cutting? That’s the second-best question for both TABOR opponents and TABOR supporters that is most important, yet rarely asked.

The main point here is one that is rarely brought up but extremely important. All government spending is not created equal. Some government spending is absolutely necessary (i.e. police, fire protection, and military spending), some is beneficial but not critical (education spending), and some is no better than putting money into a pile and burning it (subsidies for failing industries). Unfortunately, it seems that the more useless – or even harmful – the type of spending, the more effective a tool it is for politicians to buy votes from various groups (rather than representing the interests of the individual).

This brings us to the issue of TABOR as an “anti-democratic” measure – which it absolutely is, as is the Bill of Rights. But this anti-democratic nature is by no means a negative. Democracy, by its very nature, is anti-freedom. Democracy is rule by the majority, and if history has taught us anything, it is that a majority will frequently find cause to violate the rights of the minority. Freedom can only mean one thing: individual liberty. The concept of  “collective rights” is an absurdity. No group of people, no matter the number, can possess rights. Only individuals possess rights. And when we are dealing with questions of government spending and taxes, we are dealing with one of the most sacred category of rights: property rights. Any legislative body that has any control over its citizens property (i.e., any legislative body that levies taxes) must be subject to severe anti-democratic measures.

Government Spending in U.S. as a Percentage of GDP Over the Last 107 Years

HT: The Coffee Shop