Ryan Bourne

There are economic reasons to cut the state, irrespective of the deficit

There are economic reasons to cut the state, irrespective of the deficit
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Treasury Select Committee Chairman Andrew Tyrie recently explained he would support cutting back the size of the state even if our public finances were in balance. I doubt whether the leadership of the Conservative party agrees. Cameron and Osborne seemed settled on the Brownite consensus until the financial crisis threw them a curved ball.

This, in many ways, makes the so-called ‘austerity’ programme more difficult for them to implement. Without the argument that they genuinely believe in smaller government for economic or moral reasons, the party has had to adopt the ‘we wish we weren’t doing this but we have to’ line. It’s meant they’ve been unable to spell out a positive vision for where they want the economy to be in future, or bind together a coherent narrative that a smaller state need not result in bad public services in the medium-term.

This is disappointing. As the IOD/TPA 2020 Tax Commission outlined in detail, there is a wealth of evidence that smaller government countries, given other control variables, see faster economic growth. What’s more, key objective social outcomes across a range of advanced countries appear completely detached from government size.

Today, the CPS has added to this evidence. In our latest pamphlet, we use regression analysis to test whether lower tax burdens lead to higher growth for advanced countries. Controlling for several variables, we find that an increase in the tax-to-GDP ratio of 10 percentage points lowers annual per capita GDP growth by around 1.2 to 1.4 percentage points. The same effect is found for high spending-to-GDP ratios. Over the past ten years, advanced countries with tax- and spending-to-GDP ratios above 40 per cent have grown significantly more slowly than their smaller counterparts.

Intuitively, this makes sense. Most advanced countries put between 25 and 33 per cent of their total government spending towards things that modern growth theorists think add positively to growth (education, health and R&D). Much of the rest, aside from law and order, is government transfers and non-growth expenditure. Not only does this create distortions to private investment decisions, but it has to be paid for. The high taxes it requires depress enterprise and risk-taking and create deadweight costs in the economy, lowering national income.

This doesn’t mean big immediate cuts to the state would be a silver bullet given our current economic health — our report certainly doesn’t prove that a smaller state will always lead to high growth. But the evidence suggests that reducing the size of the state and the tax burden can be a means of increasing the growth rate from what it would otherwise have been.

Ryan Bourne is Head of Economic Research at the Centre for Policy Studies.