New analysis uses regression techniques across a long time period, and cross sectional analysis for the past ten years, to examine 34 countries defined as advanced by the IMF:
Econometric analysis of advanced OECD countries for the period 1965-2010 finds that a higher tax to GDP ratio has a statistically significant, negative effect on growth. For example, an increase in the tax to GDP ratio of 10 percentage points is found to lower annual per capita GDP growth by 1.2 percentage points. A similarly statistically significant negative effect on growth is found with a higher spending to GDP ratio. Detailed regression analysis stripped out the impact of variables such as investment as a proportion of GDP, the growth rate of the labour force, and the growth rate of human capital.
For the last 10 years, advanced small government countries have, on average, seen significantly higher growth rates than advanced big government countries. Between 2003 and 2012, real GDP growth was 3.1% a year for small government countries (i.e. where both government outlays and receipts were on average below 40% of GDP for the years 1999 to 2009), compared to 2.0% for big government countries.
There is little evidence that small government countries have worse social outcomes:
Health outcomes are mixed: in the past 10 years, life expectancy in small government countries has been higher than in big government countries. Infant mortality has been lower in big government countries.
Statistical evidence from the last 10 years suggests that small government countries achieve higher academic outcomes in reading, maths and science.
Employment growth and youth unemployment are not statistically different.
Tim Knox, Director of the Centre for Policy Studies, comments
“This paper shows that smaller government results in higher growth – making a mockery of the current austerity vs. growth division. This should give our politicians confidence to pursue a smaller state to achieve long-term, lasting prosperity.”
Ryan Bourne is the Head of Economic Research at the Centre for Policy Studies. He previously worked for the economic consultancy firm Frontier Economics. He graduated from the University of Cambridge with an undergraduate degree and an MPhil in Economics. He is the author of Adrenalin Now: funded, popular tax cuts to boost the economy (CPS, 2011).
Thomas Oechsle is a graduate of Ludwig Maximilian University of Munich (Germany) with a BA Economics in 2009. He completed work placements amongst others at the Kiel Institute for the World Economy (Kiel, Germany) and the Macroeconomic Policy Institute (Düsseldorf, Germany). In 2010/11 he completed the MPhil in Economics programme at the University of Cambridge.
Ryan Bourne and Thomas Oechsle - Friday 25th May 2012