Political Consensus on Public Spending is Damaging Economic Growth and Welfare

An IEA monograph reveals the negative economic impact of current taxation levels

In a major study of public spending and taxation, published by the Institute of Economic Affairs*, David B. Smith** argues that public spending in Britain has seriously overshot its optimal point and is damaging economic growth and national welfare. As a proportion of national income, public spending today is five times the level of 100 years ago (Table 1, page 26). After income tax, national insurance, VAT, council tax and other indirect taxes, a basic rate taxpayer surrenders to the government over 50% of each additional pound earned.

Smith argues that the optimal level of public spending is no more than 30-35% of GDP. This level would allow the government to pay for defence, law and order, redistribution and basic welfare provision. However, he also shows that if public spending had been kept at 30% of GDP over the last 45 years, national income today would be twice current levels because of the faster economic growth that would have occurred in a more lightly taxed economy (pages 77-81 and Table 10).

David Smith comments: “This has relevance to the current political debate. In framing their fiscal policy, the Conservative Party is wrong to refuse to take account of the increased revenue that will result from higher growth if taxes are cut. The three parties have come to a consensus on the one issue, namely the size of government, on which they should differ most sharply.”

Government and opposition are both misguided in making claims that they can painlessly cut government spending by reducing waste. According to Smith the evidence from around the world demonstrates that governments have to be smaller to be leaner. Only those governments that spend around one third of national income are significantly more efficient than the UK government (pages 39-41).

There are also large regional differences between levels of taxation and government spending. The east and south-east of England and London have levels of public spendin