Executive Summary: The Impact of Government Spending on EconomicGrowth
A growing government is
contrary to America's economic interests because the various
methods of financing government-taxes, borrowing, and printing
money-have harmful effects. This is also true because government
spending by its very nature is often economically destructive,
regardless of how it is financed. The many reasons for the negative
relationship between the size of government and economic growth
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
spending displaces private-sector activity. Every dollar that
the government spends 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
The negative multiplier
spending finances harmful intervention. Portions 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.
The behavioral subsidy
spending encourages destructive choices. Many government programs
subsidize economically undesirable decisions. Welfare
encourages people to choose leisure. Unemployment insurance
programs provide an incentive to remain unemployed.
The behavioral penalty
spending discourages productive choices. Government programs often
discourage economically desirable decisions. Saving is
important to help provide capital for new investment, yet the
incentive to save has been undermined by government programs that
subsidize retirement, housing, and education.
The market distortion
spending hinders resource allocation. Competitive markets
determine prices in a process that ensures the most efficient
allocation of resources. However, in both health care and
education, government subsidies to reduce out-of-pocket expenses
have created a "third-party payer" problem.
spending is a less effective way to deliver services.
Government directly provides many services and activities such
as education, airports, and postal operations. However, there is
considerable evidence that the private sector could
provide these important services at higher quality and lower
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 opportunities.
Government programs, however, are inherently
The common-sense notion
that government spending retards economic performance is
bolstered by cross-country comparisons and academic
research. International comparisons are especially useful.
Government spending consumes almost half of Europe's economic
output-a full one-third higher than the burden of government in the
U.S. This excessive government is associated with sub-par economic
Per capita economic output in the
U.S. in 2003 was $37,600-more than 40 percent higher than the
$26,600 average for EU-15 nations.
Real economic growth in the U.S.
over the past 10 years (3.2 percent average annual growth) has been
more than 50 percent faster than EU-15 growth during the same
period (2.1 percent).
Job creation is much stronger in
the U.S., and the U.S. unemployment rate is significantly lower
than the EU-15's unemployment rate.
Living standards in the EU are
equivalent to living standards in the poorest American
states-roughly equal to Arkansas and Montana and only slightly
ahead of West Virginia and Mississippi, the two poorest
The global evidence is augmented by dozens
of academic research papers. Using varying methodologies,
academic experts have found a clear negative relationship
between government spending and economic performance. For instance,
a National Bureau of Economic Research paper found: "A reduction by
one percentage point in the ratio of primary spending over GDP
[gross domestic product] leads to an increase in investment by
0.16 percentage points of GDP on impact, and a cumulative increase
by 0.50 after two years and 0.80 percentage points of GDP after
five years." According to a New Zealand Business Roundtable study,
"An increase of 6 percentage points in government consumption
expenditure as a percentage of GDP, (from, say 10 percent to 16
percent) would tend to reduce the annual rate of growth of GDP by
about 0.8 percent."
An International Monetary
Fund study confirmed that "Average growth for the preceding
5-year period…was higher in countries with small governments
in both periods." Even the Organisation for Economic
Co-operation and Development admitted:
Taxes and government
expenditures affect growth both directly and indirectly through
investment. An increase of about one percentage point in the tax
pressure- e.g. two-thirds of what was observed over the past decade
in the OECD sample- could be associated with a direct reduction of
about 0.3 per cent in output per capita. If the investment effect
is taken into account, the overall reduction would be about 0.6-0.7
This is just a sampling of
the academic research presented in the main paper. While no single
research paper should be viewed as definitive, given the difficulty
of isolating the impact of one policy on overall economic
performance, the cumulative findings certainly bolster the
theoretical and real-world arguments in favor of smaller
Daniel J. Mitchell,
Ph.D., is McKenna Senior Research Fellow in the
Thomas A. Roe Institute for Economic Policy Studies at The Heritage