Monday, January 28, 2008

New European Central Bank research on the economic effects of big government

The European Central Bank has, today, released a new study "Government size, composition, volatility and economic growth" (PDF) which examines the effect of big government on the rate of economic growth. It finds a substantial effect:

"In particular, a percentage point increase in the share of total revenue (total expenditure) would decrease output by 0.12 and 0.13 percentage points respectively for the OECD and for the EU countries."

This is big. The numbers might sound small but Chris Dillow explains how, if correct, the study implies that the growth of Government here in the UK in recent years is set to put a big dent in our national wealth:

"This implies that the rise in government spending we've had in the UK since 2000 (from 37.2% of GDP to 42%) would, if sustained take half a point off GDP growth, making us more than 5% worse off in 10 years' time than we would have been had spending stayed at 2000's levels."

One surprising result is that indirect taxation, such as VAT, does the most to undermine growth. Other work, such as the dynamic model (PDF) commissioned by the TaxPayers' Alliance from the Centre for Economic and Business Research has suggested that cutting corporation tax would be particularly effective.

This is a powerful contribution to the debate over the size of Government and shows the medium to long-term price we pay for the expansion of Government spending over time. It makes the case for tax cuts more pressing.

Cross-posted from the TaxPayers' Alliance blog.

1 comment:

Praguetory said...

I agree with your conclusion.

The Telegraph also reports that there is a tax effect so not only does the added expenditure lead to lower growth, but the related higher taxes do too.

When it comes to economic growth (or indeeed any growth) the impact of compounding is deadly as it can magnify apparently small differences over time.