Lord Keynes said that – it’s one of my favourite quotes. Why is it important? Well Mother Hubbard’s Dog points us to this post by Martin Wolf.
The focus of US economic policy discussion at present is almost entirely on fiscal deficits and the level of taxes. My view is that these are second or even third order issues. What matters far more is the capacity of the economy to offer satisfactory lives for the citizenry. This depends on far more fundamental forces than deficits and taxes, such as innovation, jobs and incomes. Evidently, I am arguing that taxes and deficits do not determine these outcomes. I am suggesting this because they do not.
I don’t entirely disagree with those views. In a recent talk I gave on productivity and taxation I started off by quoting both Paul Krugman
Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.
and Adam Smith
Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things.
The issue being, what is the meaning of ‘easy’ taxes and ‘tolerable’ administration of justice? If all Wolf is saying that there is more to productivity and long-term prosperity than lowering taxes then he is entirely correct.
But I fear some might interpret his argument as saying there is no relationship between taxation and long term prosperity and productivity and that, I suspect, is not correct.
He shows this graph to illustrate his point.
The first conclusion is that there is no relation between the share of government revenue and the rate of growth of real output per head (that is, productivity) over the 1989-2011 period. The “regression line” is flat.
He doesn’t actually show us a flat regression line – but I can imagine one that is flat and so I am happy to believe him. But looking at his dataset (n = 18), he has OECDitis – those are OECD economies only and there are many more economies in the world and many more in the datasets where he has drawn his data. So I downloaded all the data from the sources he cites and then using his definitions graphed the data and then estimated a regression line (n = 116).
Eviews suggests that the slope of that line is negative and statistically significantly different from zero (p = 0.0005). [Before anyone gets too excited and claims I should do this or that to the data to derive somewhat different results - please remember, this is not my test or regression. I have replicated Wolf's test and regression using a larger data sample.]
So contrary to what Wolf says, there is a relationship between “the share of government revenue and the rate of growth of real output per head (that is, productivity)” once you include all the economies where data are available.
The important thing here isn’t that Wolf has truncated his sample to derive his result but rather that tax itself is only part of the burden of government – wasteful spending and inefficient regulation are also important and the tax debate shouldn’t obscure those issues.
Quite so.
Rabz
3 Jun 12 at 9:47 pm
Having said that, well done for adding the other “inexplicably absent” economies.
Liars.
Rabz
3 Jun 12 at 9:48 pm
What, so now we’re issuing death threats to economists?
Really, Rabz.
sdog
3 Jun 12 at 9:49 pm
So who were the three major outliers? North Korea, China and Thailand?
entropy
3 Jun 12 at 9:49 pm
Only ones who aren’t eebil bald fascist bipads, Dogue!
Rabz
3 Jun 12 at 10:01 pm
Also, wouldn’t this sort of chart be susceptible to the starting base for GDP, and the size of the population?
entropy
3 Jun 12 at 10:15 pm
Our current gubberment being a definitive example of both.
Rabz
3 Jun 12 at 10:24 pm
Reduce taxes
Slash regulation
Free up markets
Sack grublic savants
How difficult is this – do we die or advance?
Rabz
3 Jun 12 at 10:31 pm
its not rocket science, but the temptation to “buy” votes with other people’s money pervades most politicians
Irving J
3 Jun 12 at 10:39 pm
I doubt that such a complicated issue could be sorted by a graph.
The size of government varies between presidential and parliamentarianism, and the plurality rule and proportional representation.
The presidential system, as compared to parliamentary systems, conduct less broad-based income redistribution via social welfare, but more targeted spending and will end up with a lower tax burden.
Plurality rule as compared to proportional representation entails more targeted spending and less broad-based social welfare programs.
Political fragmentation measured by the number of effective political parties has a positive relationship with the size of the government, and with subsidies and transfers. Proportional representation and parliamentary countries favour higher public expenditures.
for becker, government grew in so many countries during the 20th century with different causes having different effects on the amount and structure of taxes, spending, and regulatory programs undertaken.
These include: demographic shifts, more efficient taxes, more efficient spending, a shift in the political power from those taxed to those subsidized, shifts in political power among taxed groups, and shifts in political power among subsidized groups.
there is always Tullock’s conclusion:
Jim Rose
3 Jun 12 at 10:58 pm
Interesting that such a clear trend emerges when you consider all countries, not just the OECD.
Every country where taxes are below 29% of GDP is outside the OECD, and a dozen of these have exceeded 5% growth. Only one OECD country has beaten 2.5%, a pathetic result.
It seems virtually impossible to get 5% growth once taxes exceed 33% of GDP, which they do in practically all OECD countries.
It might be interesting to do the same regression on spending rather than taxation. May not make much difference overall, but the two lowest-growth OECD countries, Japan and Italy, would be shoved well to the right, whereas in the other corner, Finland would move slightly to the left.
David Brewer
3 Jun 12 at 11:27 pm
Martin Wolf is basically claiming that a) deficits do not matter and b) (significant) deadweight losses as a cost of taxation do not exist.
History is littered with counterfactuals proving this wrong. Sinclair has provided some empirical evidence.
It is astounding how far people will go to support large scale intervention in the economy. The delusions they have to support such a strongly statist worldview are phenomenal.
.
3 Jun 12 at 11:40 pm
A graph is simply another way of presenting information.
Some of what you have said would be very presentable in graph form.
I think Sinc is onto something. If he were to estimate the model in the full process, I believe he’d find an inverse relationship between Government spending and growth. Perhaps even you end up with something like y = (1/ax) – bx +c
.
3 Jun 12 at 11:44 pm
Interesting.
JC
3 Jun 12 at 11:47 pm
I assume that we all mean productive in useful/desirable things, I mean the current Labor government has actually produced more legislation than the previous Liberal one but I’m not sure that’s the sort of productivity that enhances life quality.
Simon
3 Jun 12 at 11:51 pm
Does the share of government revenue graph thingy take into account the size and type of government? Great Britain has both a new and old state apparatus running concurrently but is still considered an “advanced democracy”. It would be interesting to see how much of the GDP growth is generated by the older institutions and ways of doing business? Looking at the samples in the first graph I would say that agricultural success seems to indicate a surer upward movement of GDP growth than the tax regime.
Simon
4 Jun 12 at 12:23 am
Actually I think the graph can show a lot about such a complicated issue, and the trend is more significant than the simple least squares regression suggests.
A boundary line around those data points, perhaps described by a 95th quantile and non-linear curve, suggests (as David Brewer indicated) that greater than 5% growth is impossible once taxes exceed 33% of GDP, and greater than 2.5% growth is impossible once taxes exceed 45% of GDP. Below 33% tax, higher growth is possible, but other factors come into play here, as both high and low average growth is seen.
A boundary line highlights the constraint to growth that higher taxes become, while recognising that at lower tax rates, other factors are more important in determining growth.
Least squares regression, although ‘statistically significant’ and a common way of analysing the data, does not highlight the constraint effect of higher taxes.
(BTW long time lurker avid catallaxy reader)
MD
4 Jun 12 at 12:23 am
Does Martin Wolf work for the Commonwealth Treasury?
He uses the same deceit that Sinclair has stung the once reputable Cwth Treasury with.
johno
4 Jun 12 at 7:12 am
JC – that’s why I titled the post everything depends on everything else. Simple analysis like this shouldn’t show much.
Sinclair Davidson
4 Jun 12 at 7:14 am
I’m with Rabz on this. Be interesting if you could graph red tape vs GDP growth.
Roger Bootle has an oped in the UK Tele today saying it might be no bad thing if the UK could be more like Switzerland in their relation with the EU, and says:
Which is exactly the point. Very hard to extract (tax) feathers from the hissing goose when its buried under a mountain of red tape.
But as for the Swizerland comment…some astonishing news in the same pages:
So much money is fleeing Spain et al to anywhere safe that Switzerland is trying to keep it out !
Bruce
4 Jun 12 at 8:39 am
It would be interesting to see the OECD-only graph with the regression line and then a separate graph with non-OECD-only.
The impact of competition among the world’s largest economies will tend to create a flat regression line, I would have thought.
Jack Lacton
4 Jun 12 at 10:36 am
You see Jack, I’d agree but in the last couple of decades, global growth accelerated – precisely because fast growing countries competed for capital etc.
If the OECD was a tax cartel you’d be correct.
There isn’t much competition in Western Europe. They are just not dynamic. Except for at a rapidly and destructively inward rate.
.
4 Jun 12 at 10:59 am
Good to see you rising to the challenge, Sinc. I have to agree with you that it is far too complex an issue to be dismissed that easily. The amount and type of regulation, certainty of property rights, the extent of corruption, the mobility and cost of capital and labour must all have a substantial influence.
Mother Hubbard's Dog
4 Jun 12 at 2:14 pm
What would be really interesting, and probably more useful, Sinclair, is a graph of rate of growth of productivity versus rate of growth of tax revenue as % of GDP. I suspect this would show a very strong inverse proportion. Eg, some high taxing states becoming less taxing, might show high productivity growth, versus a moderate taxing state becoming more taxing, which have have little productivity growth. This would not show up on your graph.
Stan.
Stan
4 Jun 12 at 3:04 pm
Once I see “OECD” in anything, I know its bullshit. You take a group of counteries making the same mistakes and compare them to say “see – we are all great!”.
This is like studies that show that alcohol increases live expectancy – but only in the west – because the average person is overweight. If you take only healthy people the life expectancy decreases.
mundi
5 Jun 12 at 12:04 pm