Government Spending vs Private Spending

http://www.heritage.org/Research/Bud...es/8533393.gif

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If government spending is zero, presumably there will be very little economic growth because enforcing contracts, protecting property, and developing an infrastructure would be very diffi*cult if there were no government at all. In other words, some government spending is necessary for the successful operation of the rule of law. Figure 1 illustrates this point. Economic activity is very low or nonexistent in the absence of government, but it jumps dramatically as core functions of govern*ment are financed. This does not mean that gov*ernment costs nothing, but that the benefits outweigh the costs.

Costs vs. Benefits. Economists will generally agree that government spending becomes a bur*den at some point, either because government becomes too large or because outlays are misallo*cated. In such cases, the cost of government exceeds the benefit. The downward sloping por*tion of the curve in Figure 1 can exist for a number of reasons, including:

The extraction cost. Government spending requires costly financing choices. The federal government cannot spend money without first taking that money from someone. All of the options used to finance government spending have adverse consequences. Taxes discourage productive behavior, particularly in the current U.S. tax system, which imposes high tax rates on work, saving, investment, and other forms of productive behavior. Borrowing consumes capital that otherwise would be available for private investment and, in extreme cases, may lead to higher interest rates. Inflation debases a nation’s currency, causing widespread eco*nomic distortion.
The displacement cost. Government spend*ing displaces private-sector activity. Every dol*lar that the government spends necessarily means one less dollar in the productive sector of the economy. This dampens growth since economic forces guide the allocation of resources in the private sector, whereas politi*cal forces dominate when politicians and bureaucrats decide how money is spent. Some government spending, such as maintaining a well-functioning legal system, can have a high “rate-of-return.” In general, however, govern*ments do not use resources efficiently, resulting in less economic output.
The negative multiplier cost. Government spending finances harmful intervention. Por*tions of the federal budget are used to finance activities that generate a distinctly negative effect on economic activity. For instance, many regulatory agencies have comparatively small budgets, but they impose large costs on the economy’s productive sector. Outlays for inter*national organizations are another good exam*ple. The direct expense to taxpayers of membership in organizations such as the Inter*national Monetary Fund (IMF) and Organisa*tion for Economic Co-operation and Development (OECD) is often trivial com*pared to the economic damage resulting from the anti-growth policies advocated by these multinational bureaucracies.
The behavioral subsidy cost. Government spending encourages destructive choices. Many government programs subsidize economically undesirable decisions. Welfare programs encourage people to choose leisure over work. Unemployment insurance programs provide an incentive to remain unemployed. Flood insur*ance programs encourage construction in flood plains. These are all examples of government programs that reduce economic growth and diminish national output because they promote misallocation or underutilization of resources.
The behavioral penalty cost. Government spending discourages productive choices. Government programs often discourage eco*nomically desirable decisions. Saving is impor*tant to help provide capital for new investment, yet the incentive to save has been undermined by government programs that subsidize retirement, housing, and education. Why should a person set aside income if gov*ernment programs finance these big-ticket expenses? Other government spending pro*grams—Medicaid is a good example—gener*ate a negative economic impact because of eligibility rules that encourage individuals to depress their incomes artificially and misallo*cate their wealth.
The market distortion cost. Government spending distorts resource allocation. Buyers and sellers in competitive markets determine prices in a process that ensures the most effi*cient allocation of resources, but some govern*ment programs interfere with competitive markets. In both health care and education, government subsidies to reduce out-of-pocket expenses have created a “third-party payer” problem. When individuals use other people’s money, they become less concerned about price. This undermines the critical role of com*petitive markets, causing significant ineffi*ciency in sectors such as health care and education. Government programs also lead to resource misallocation because individuals, organizations, and companies spend time, energy, and money seeking either to obtain special government favors or to minimize their share of the cost of government.
The inefficiency cost. Government spending is a less effective way to deliver services. Gov*ernment directly provides many services and activities such as education, airports, and postal operations. However, there is evidence that the private sector could provide these important services at a higher quality and lower cost. In some cases, such as airports and postal services, the improvement would take place because of privatization. In other cases, such as education, the economic benefits would accrue by shifting to a model based on competition and choice.
The stagnation cost. Government spending inhibits innovation. Because of competition and the desire to increase income and wealth, individuals and entities in the private sector constantly search for new options and oppor*tunities. Economic growth is greatly enhanced by this discovery process of “creative destruc*tion.” Government programs, however, are inherently inflexible, both because of central*ization and because of bureaucracy. Reducing government—or devolving federal programs to the state and local levels—can eliminate or mitigate this effect.
Spending on a government program, depart*ment, or agency can impose more than one of these costs. For instance, all government spending imposes both extraction costs and displacement costs. This does not necessarily mean that out*lays—either in the aggregate or for a specific pro*gram—are counterproductive. That calculation requires a cost-benefit analysis.

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Good stuff, but.....please tell me this is independent research, 'cause if it's not, the libs/dems will be all over it as republican-sponsored blather.:rolleyes:

Doesn't matter if it's the truth....only matters where it came from.:confused:

We are so screwed regards, :cool:

kg

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Originally Posted by K G

Good stuff, but.....please tell me this is independent research, 'cause if it's not, the libs/dems will be all over it as republican-sponsored blather.:rolleyes:

Doesn't matter if it's the truth....only matters where it came from.:confused:

We are so screwed regards, :cool:

kg

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Let them post a differing view. Liberals have a habit of destroying the messenger, since the message is harder to deal with.

Besides one man's independent research is not for another.

The Rahn Curve (shown in the post above from a column by a magazine editorial writer with virtually no academic credentials) is interesting as a theoretical construct. What makes it especially interesting is that you will see many broad statements saying things about how many experts generally agree that government spending should be around 17-23% (or some other set of numbers) to "optimize" growth. However, you won't find any empirical evidence supporting these estimates.

Actually this is not surprising. How would you come up with such estimates in a manner that would not be hopelessly confused by other factors? Thus, it remains a neat theory, but I could draw the same graph and suggest that the optimal level of government spending was 55% with as much factual basis for my statements as those shown in the pretty picture.

For those who are global warming sceptics, I would point out that there is much less evidence supporting the Rahm Curve theory than there is supporting the notion that we are in deep do do because of global warming attributable to human activity.

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Originally Posted by YardleyLabs

we are in deep do do

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There goes Jeff using those big scientific terms again...can we get that in laymen speak:lol::lol:;)

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Originally Posted by YardleyLabs

The Rahn Curve (shown in the post above from a column by a magazine editorial writer with virtually no academic credentials) is interesting as a theoretical construct. What makes it especially interesting is that you will see many broad statements saying things about how many experts generally agree that government spending should be around 17-23% (or some other set of numbers) to "optimize" growth. However, you won't find any empirical evidence supporting these estimates.

Actually this is not surprising. How would you come up with such estimates in a manner that would not be hopelessly confused by other factors? Thus, it remains a neat theory, but I could draw the same graph and suggest that the optimal level of government spending was 55% with as much factual basis for my statements as those shown in the pretty picture.

For those who are global warming sceptics, I would point out that there is much less evidence supporting the Rahm Curve theory than there is supporting the notion that we are in deep do do because of global warming attributable to human activity.

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Extraction Costs
Not surprisingly, many researchers have determined that government spending has an adverse impact on economic growth because of the taxes that are imposed to finance the budget. This research focuses on the “extraction costs” of government spending.

An article in Public Choice concluded: “[B]ig governments imply large income tax rates. Large tax rates presumably affect work-leisure decisions and could lengthen search time between bouts of unemployment.”[8]
Public Finance Review published an article that stated: “[T]axes negatively affect economic growth, even when they finance certain types of nontransfer spending.”[9]
Another Public Choice article explained: “On the revenue side, when government gets too big, high tax rates discourage whatever activity the tax is on (work, saving, consumption, etc.).”[10]
A study by the European Commission (EC) noted: “[A] first reason for expecting non-Keynesian effects of fiscal policy emerges…when a current expenditure cut is expected to be offset by a reduction in future distortionary taxes.”[11]
A Joint Economic Committee (JEC) report explained: “Like taxes, borrowing will crowd out private investment and it will also lead to higher future taxes. Thus, even if the productivity of government expenditures did not decline, the disincentive effects of taxation and borrowing as resources are shifted from the private sector to the public sector, would exert a negative impact on economic growth.”[12]
A Federal Reserve Bank of Cleveland study found: “Output, however, is lower due to the decrease in the capital stock. The charts show that the convergence to the new steady state is gradual. The new steady-state capital stock is reduced by 7.7 percent, and output by 1.2 percent. Private consumption is 7.3 percent lower than it was before government spending rose. Increases in government expenditure cause output to decline because an income tax is distortionary.”[13]
The study from the Cleveland Federal Reserve also concluded: “In the new long-run steady state, the capital stock is lower by 25.2 percent, and output is reduced by 7.3 percent. This crowding-out effect is much larger than the effect of the balanced-budget increase in government expenditure considered earlier. It reflects the greater distortionary effect of the higher tax rates under deficit financing that are imposed on young and future generations to pay for the redistribution toward the initial older generations.”[14]
An article in the Journal of Money, Credit, and Banking noted: “In the more realistic case, when spending is financed by an income or wage tax, we find a negative effect on long-run growth rates.”[15]
The same study also reported: “When government spending can be financed with few distortions, labor supply rises and growth is higher. When government must finance spending with income or wage taxes, labor supply and growth fall.”[16]
A National Tax Journal article explained: “The appropriate size and role of government depend on how costly it is to transfer funds from taxpayers to the government. That cost includes more than the administrative cost of the government and the time spent by taxpayers to keep records and complete forms. It also includes the loss of real income that occurs because taxes distort economic incentives. Recent econometric work implies that the deadweight burden caused by tax increases may exceed one dollar for every dollar of additional tax revenue that is raised. Such estimates imply that the true economic cost of each extra dollar of government spending is more than two dollars. That is, individuals lose the equivalent of more than two dollars of additional consumption for every extra dollar of government spending.”[17]
Even the International Monetary Fund (IMF) agreed: “This tax induced distortion in economic behavior results in a net efficiency loss to the whole economy, commonly referred to as the ‘excess burden of taxation,’ even if the government engages in exactly the same activities—and with the same degree of efficiency—as the private sector with the tax revenue so raised.”[18]
Equally surprising, the Paris-based OECD also admitted “negative impacts on growth stemming from a too-large government sector (with associated high tax pressure to finance high government expenditure).”[19]
Displacement Costs
Other academic studies focus more on the displacement effects of government spending. “Displacement effects” occur because government spending necessarily uses up resources that otherwise would be available in the productive sector of the economy.

An article in the Journal of Monetary Economics found: “[T]here is substantial crowding out of private spending by government spending.… [P]ermanent changes in government spending lead to a negative wealth effect.”[20]
Public Choice published an article that explained: “[G]overnment spending crowds out private spending, most notably investment spending that would have raised productivity and encouraged technical change.”[21]
The IMF acknowledged: “The financing of any level of public expenditure, whether through taxation or borrowing, involves the absorption of real resources by the public sector that otherwise would be available to the private sector.”[22]
A JEC report noted: “Government spending reduces productivity as resources are withdrawn from the private sector and placed in the unproductive public sector.”[23]
A working paper from the National Bureau of Economic Research (NBER) concluded: “Perhaps more surprisingly, we consistently find a considerable crowding out of investment both by government spending and to a lesser degree by taxation; this implies a strong negative effect on investment of a balanced-budget fiscal expansion.”[24]
A study from the Centre for Economic Policy Research in London noted: “The effects of government spending on economic activity derive from the fact that the government absorbs resources and thus has a negative effect on the representative agent’s wealth.”[25]
A Federal Reserve Bank of Dallas study explained: “Taken as a whole, the three policy cases support two broad conclusions. First, growth in government stunts general economic growth. Regardless of how it is financed, an increase in government spending leads to slower economic growth.”[26]
The OECD recognized “both a ‘size’ effect of government intervention as well as specific effects stemming from the financing and composition of public expenditure. At a low level, the productive effects of public expenditure are likely to exceed the social costs of raising funds. However, government expenditure and the required taxes may reach levels where the negative effects on efficiency and hence growth start dominating.”[27]
An article in Metroeconomica noted: “Assuming that labour is supplied in-elastically a reallocation of public resources from productive to non-productive uses always reduces the balanced growth rate.”[28]
The Congressional Budget Office explained: “Many federal investment projects yield net economic benefits that are small, or even negative. Others yield high returns that would be forgone in the absence of federal involvement, but the number of such projects appears to be limited, and hence their potential impact on growth is small. Increases in federal investment spending that are not targeted toward cost beneficial projects can reduce growth. Federal investment spending can displace investments by state and local governments and the private sector. Displacement is likely to be substantial in some cases, such as roads and bridges, which state and local governments have a strong incentive to fund because the benefits accrue primarily to local users. Federal spending that displaces other investment is unlikely to have a positive effect on growth.”[29]
Measuring the Economic Impact of Government Spending
While some academic studies focus on specific adverse effects of particular government programs, the bulk of research seeks to measure the relationship between the size of government and economic performance. This scholarship is quite convincing, showing that economic growth suffers as government expands.

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An article from the Quarterly Journal of Economics stated: “The basic message of our model is that there will be a strong demand for redistribution in societies where a large section of the population does not have access to the productive resources of the economy. Such conflict over distribution will generally harm growth.”[30]
The JEC published a report noting: “Economic growth is created over the long run by a labor force which possesses the incentive to work and produce, and by entrepreneurs who have incentives to invest in capital stock. Through excessive spending, the government negatively affects the long-run economic growth rate of a free economy. Government spending reduces labor force participation, increases unemployment, and reduces productivity.”[31]
The IMF acknowledged: “[T]he IMF has had a bias towards expenditure reductions rather than tax increases, particularly for more advanced economies with already high tax burdens. Moreover, with a concern to minimize adverse allocative effects and to instill an investment and growth-supporting environment, the IMF often advises countries to both reduce expenditures shares and reduce the overall tax burden.”[32]
A study from the Federal Reserve Bank of Dallas concluded: “Tax increases that reduce the deficit are contractionary whereas spending cuts that accomplish the same goal are expansionary.”[33]
The study from the Dallas Fed also noted: “[G]rowth in government stunts general economic growth. Increases in government spending or taxes lead to persistent decreases in the rate of job growth.”[34]
An EC report acknowledged: “[B]udgetary consolidation has a positive impact on output in the medium run if it takes place in the form of expenditure retrenchment rather than tax increases.”[35]
The EC study also reported: “Fiscal consolidations obtained through expenditure cuts may increase short-run investments,” and “a similar effect would be obtained by means of reductions in government transfers.”[36]
Writing for the Centre for Economic Policy Research, three economists (including two from the IMF) explained: “Those countries which rely primarily on expenditures cuts…are projected to enjoy output gains from their adjustment over the long run, while those countries relying mainly on labour and capital taxes…are projected to suffer output losses.”[37]
More specifically, the same source elaborated: “The projected medium-run recovery reflects the shift of resources from (public) consumption to (private) investment and the reduced burden of taxation.”[38]
An IMF study reached similar conclusions: “[E]pisodes of fiscal consolidation need not trigger an economic slowdown, especially over the medium term. The paper also suggests that structuring fiscal consolidation primarily around spending cuts, rather than tax increases, tends to increase the chances of success.”[39]
The IMF study comments on a specific example: “New Zealand is a recent success case that seems to confirm the policy message of this paper: an industrial country with a serious deficit problem should pursue a strict fiscal consolidation strategy, focused on expenditure cuts.”[40]
A report from the National Center for Policy Analysis noted: “By penalizing success with taxes and subsidizing failure with transfer payments, the United States and other OECD nations have lower standards of living than they would have if tax rates were lowered. The slower rise in various social indicators and the increasing societal disorder since 1960 demonstrate the consequences of higher tax rates. In terms of social progress, increased taxes have not bought very much for the United States. It is true that infant mortality and the overall death rate are down and life expectancy is up since the 1960s, but these gains are small compared with those of the previous 90 years, when government was smaller and tax burdens much less oppressive.”[41]
These conclusions are based on sound theory, but they also are supported by significant empirical evidence.

An article in the European Journal of Political Economy found: “We find a tendency towards a more robust negative growth effect of large public expenditures.”[42]
A study in Public Choice reported: “The results indicate that the level of government consumption, transfers and total spending as a share of GDP has a strongly negative effect on the growth of TFP [total factor productivity] in the nongovernment sector.”[43]
Another study, published in the Journal of Macroeconomics, concluded “that growth in government size is negatively associated with economic growth.” Interestingly, the study also found that “the negative effects are greater in nondemocratic socialist systems than in democratic market systems.”[44]
The Quarterly Journal of Macroeconomics published an article stating: “[W]e find that both increases in taxes and increases in government spending have a strong negative effect on private investment spending. This effect is consistent with a neoclassical model with distortionary taxation, but more difficult to reconcile with Keynesian theory.”[45]
A study in Public Finance Review noted: “[H]igher total government expenditure, no matter how financed, is associated with a lower growth rate of real per capita gross state product.”[46]
Even an article sympathetic to the Keynesian view, published by the Centre for Economic Policy Research in London, reported: “[W]e show that following an increase in government spending real wages decline.” The article also admitted that “expansion in government spending financed with distortionary taxes is always contractionary.”[47]
Research from the EC specifically explained that positive effects of fiscal balance are due to smaller government: “Fiscal adjustments based on expenditure cuts rather than tax increases have expansionary effects,” and “The impact on output of budgetary consolidation depends on whether it takes place on the revenue or expenditure side. Tax increases are likely to have a negative impact on output both in the short and medium run. By contrast, the short-run negative impact on output of permanent expenditure cuts is likely to turn positive in the medium to long run.”[48]
A study in Public Choice notes: “[T]he evidence supports the conclusion that the distortionary effects arising from government generated misallocation of resources are not insignificant.”[49]
A JEC report concluded: “Even after adjusting for cross-country differences in investment rates, both level of the government expenditures and change in size of government during the decade remain highly significant. This provides additional support for the hypothesis that a larger public sector reduces economic growth.”[50]
An NBER article found: “Both increases in taxes and increases in government spending have a strong negative effect on investment spending.”[51]
A Federal Reserve Bank of Dallas study discovered “that an increase in the size of federal government leads to slower economic growth, that the deficit is an unreliable indicator of the stance of fiscal policy, and that tax revenues are the most consistent indicator of fiscal policy,” and “Our analysis of the 1983–2002 period suggests that tax cuts are consistently expansionary, spending increases are consistently contractionary, and deficit increases can be either expansionary or contractionary, depending on their impact on government size.”[52]
The same study also reported: “As the upper figure shows, an increase in spending and taxes leads to a decrease in employment growth that is significant for two years. As the lower figure shows, this increase in the size of the public sector leads to a persistently slower rate of job growth.” The study also stated: “[B]oth Sims–Zha experiments confirm the joint-shock analysis. An increase in government spending and taxes persistently reduces the rate of job growth.” Moreover, “an increase in the deficit that finances a spending increase rather than a tax cut…leads to a decline in employment growth.”[53]
A German economist, writing for the Institute for German Economics, concluded: “[T]he state nowadays is oversized in many western countries. Having less state, the economic growth could be accelerated.”[54]
An NBER study found: “Empirical results using data on growth rates over the period 1970–84 suggest a significant and negative impact of government fiscal activity on output growth rates in both the short-term and the long-term.”[55]
A JEC report concluded: “Like that for the United States, the evidence from OECD countries indicates that increases in the size of government retard both investment and economic growth.”[56]
An article from the Journal of Money, Credit, and Banking explained: “A permanent increase in the share of government spending…reduces social welfare. When government spending is financed with an income tax, a permanent increase in spending reduces the long-run growth rate. The same result applies when the spending increase is financed only with wage income taxes.”[57]

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An article in the Quarterly Journal of Economics reported: “[T]he ratio of real government consumption expenditure to real GDP had a negative association with growth and investment,” and “Growth is inversely related to the share of government consumption in GDP, but insignificantly related to the share of public investment.”[58]
An NBER study found: “An increase in redistribution to the retirees financed by an increase in the income tax rate leads to: an increase in the price of exportables, i.e., a decrease in competitiveness; an increase in the relative price of nontradables, provided the elasticity of substitution between goods is sufficiently high; a decrease in employment in both sectors. An increase in redistribution to the unemployed, regardless of how it is financed, leads to: the same.”[59]
A Public Choice article reported: “Economies with relatively high levels of government expenditures as a fraction of GDP in 1960 and with increases in the size of the government sector during the period experienced a decline in the efficiency in transforming inputs into outputs.” The article also explained, “The size of the government share coefficients in the regression were of sufficiently large magnitude to conclude that the rise in the size of the government has had a substantial depressing effect on economic growth.”[60]
Another NBER study concluded: “We find a sizable negative effect of public spending—and in particular of its public wage component—on business investment. The effects of government spending on investment are larger than the effects of taxes.” The study also stated: “This paper shows that in OECD countries changes in fiscal policy have important effects on private business investment. Interestingly, the strongest effects arise from changes in primary government spending and, especially, government wages.”[61]
An OECD economic study found: “There is also evidence that the ‘size’ of government may be negatively associated with the rate of accumulation of private capital.”[62]
A study in the Journal of Political Economy concluded: “[T]here is an indication that an increase in resources devoted to non-productive government services is associated with lower per capita growth.”[63]
The same article from the Journal of Political Economy contained this useful summary of statistical findings: “Grier and Tullock extended the Kormendi–Meguire form of analysis to 115 countries, using data on government consumption and other variables from Summers and Heston (1984). The concept of government spending is the same as that employed by Kormendi and Meguire. The Grier-Tullock study was a pooled cross-section, time series analysis, using data averaged over 5-year intervals. They found a significantly negative relation between the growth of real GDP and the growth of the government share of GDP, although most of the relation derived from the 24 OECD countries. Landau (1983) studied 104 countries on a cross-sectional basis, using an earlier form of the Summers-Heston data. He found significantly negative relations between the growth rate of real GDP per capita and the level of government consumption expenditures as a ratio to GDP. Barth and Bradley found a negative relation between the growth rate of real GDP and the share of government consumption spending for 16 OECD countries in the period of 1971–83.”[64]
A study published by the New Zealand Business Roundtable noted: “Economic performance, as measured by indicators such as GDP growth and unemployment levels, has been better on average in countries with small governments than in countries with big governments.”[65]
A study in Public Choice concluded: “From a sample of 19 industrialized countries, it is found that economic growth is inversely related to public sector size over the period 1960–1980. The results of this paper suggest that shrinking private sectors not only pose threats to future over-all economic growth but constrain the future ability of public sectors to consume private resources at accelerating rates.”[66]
The OECD acknowledged: “The overall tax burden is estimated to have a negative impact on output per capitaand, controlling for the overall tax burden, there is an additional negative effect coming from a tax structure focusing on direct taxes.… [T]he omitted factors on the expenditure side, i.e. public transfers, are driving the negative effects on total financing.”[67]
A National Chamber Foundation study by two George Washington University economists found: “[T]he empirical results based upon three sets of international data consistently reveal a negative and statistically significant relationship between the scale of government and economic activity. This finding holds for all levels of government as well as all types of government spending. When examining separately federal or central government spending, the same finding was also obtained.”[68]
A Southern Economic Journal article reported: “The results of this study suggest a negative relationship exists between the share of government consumption expenditure in GDP and the rate of growth of per capita GDP. The negative relationship was found for the full sample of countries, unweighted, or weighted by population, for all six time periods examined, and excluding or including the major oil exporters. It was also found for the top and middle halves of the set (sorted by per capita income) and for the third world.”[69]


And I can provide more.....

Christ, how about a summary.....I can't read all of that :confused::confused:

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Originally Posted by badbullgator

Christ, how about a summary.....I can't read all of that :confused::confused:

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There's no such thing as a free lunch