Overgrown government
Third in a series: The right way to measure the size of government is with adjusted per capita numbers. Revenue and spending are at record levels
Mark Mullins
National Post
Thursday, January 30, 2003
An illustration of a pig with a lampshade on its head, holding a bottle and throwing money.
Government is one of our great Canadian growth industries. Just look at the latest data. All levels of government took in over $470-billion in taxes and other income in the third quarter of 2002. By today, midway through the first quarter of 2003, government has grown by another $10-billion, based on recent growth rates. It is equivalent to 41% of GDP. For context, this measure was closer to 5% at the time of Confederation.
The compound revenue growth rates (after inflation) over the past five, 10, 25 and 50 years are 2.5%, 2.8%, 3.2% and 4.8%, respectively. Federal government revenues alone have grown 4.7% annually for 100 years and are up 360-fold since 1870. That is growth!
All of us are aware of the great industry success stories of the past quarter-century. In real terms, only electrical equipment, telecommunications, auto and aerospace production, chemicals, wholesale trade and finance outstripped government. The government take is large, has grown rapidly, is still expanding, and outstrips the productive capacity of most of the economy.
The story is essentially the same for spending. The key difference between the two is that, from 1975 until recently, habitual deficit spending was the norm. That has incurred enormous interest payments on the accumulated debt that now drive a wedge between revenues and program spending. In addition, the federal government, in particular, has turned to running habitual large surpluses which keep revenues above the level required for today's program spending.
It seems that moderation is not a virtue when it comes to public finance, with governments swinging from excess deficit spending to surpluses generated from excess taxation. In any case, revenues are the best measure of government size, since they must be raised to pay for all program spending, debt interest and any remaining surpluses.
Many people, perhaps most, express the size of government as a ratio to GDP. They point to a three-point decline in the ratio since 1998 and suggest that we are making great progress in reducing the burden on the economy and enhancing our purchasing power.
The revenue-to-GDP ratio is an inappropriate measure.
First, government does not own GDP; neither does government have a proportionate call on society's resources. The revenue base is determined by tax rates, set in the political arena with the (grudging) consent of the governed. After those are decided, revenues are generated (often in a distortionary way) as a direct implication of economic growth.
Second, we measure public sector productivity incorrectly. An extra dollar spent on civil service salaries is a dollar added to GDP, regardless of the ultimate output or any other impact on the economy. Thus, a growing government sector automatically boosts GDP without accounting for its effect on wealth generation.
Third, a focus on GDP misses out on the fact that the economy increases naturally due to population growth and inflation. These items must be considered when assessing the real financing burden on taxpayers.
Finally, there is no reason why government should grow with the economy over time. We live in a sophisticated economy and society. Technological advances and market forces should lower costs. Modern notions of individual freedom should point to less interference from bossy social planners. That government grows irrespective is a tribute to the general isolation of public service delivery from notions of efficiency and accountability. It is also an indication of the extent to which the scope of government has expanded and been redefined over time.
The attached chart shows a better approach to measuring the size of government. It takes total revenue and spending and rescales them to an inflation-adjusted per capita metric. The two lines, revenues per person and program spending (excluding debt interest) per person, unmistakably demonstrate that government continues to thrive in Canada.
In fact, program spending per person has never been higher. Now, factor in the likely outcome of federal-provincial negotiations over health-care system expansion. Add hints for greater spending on defence and the environment federally, and education trends provincially, and spending can do nothing but rise. And, of course, the financing burden (now momentarily depressed owing to the corporate tax take) must rise in line with spending to keep budgets balanced.
We could go one stage further and ask what we receive in return for these government programs. That would be a fuller measure of the costs and benefits of the government sector. Unfortunately, here we run into a great weakness: There is little information available and little incentive to produce relevant data. We do have some international comparisons to rely upon, however, and they show that we should be getting much more bang for our tax buck.
For example, health is one-fifth of total government spending, excluding debt interest. The World Health Organization, in regular rankings, ranks our health system poorly in spending effectiveness compared to other industrial nations. Elementary and secondary education accounts for one dollar in 10 of public spending, but our children rank behind many other jurisdictions in Asia and Europe, where spending is much less. Post-secondary education accounts for another large tranche of public spending -- but we deliberately underinvest in our people by excluding the private sector.
We spend as much on protection of persons and property (defence, police, courts, etc.) as we do on general government services (mostly administration) and employee pensions. Does that sound like the right balance between public safety and the costs of bureaucracy, even setting aside the extra costs of regulation that are not counted in these numbers?
A call for reform from this all-time record taxation and spending would highlight three issues: size of government, burden of government and accountability of government. Here are some reform approaches.
Most studies of optimal government size -- that required to maximize our national growth in living standards -- point to a required reduction in Canada's taxes and spending by almost one-quarter. We need to reverse the trend lines in the chart.
The burden of government can be addressed through tax reform and spending reallocation. We need to drop high marginal and average tax rates on income and savings and remove fixed taxes on capital and labour. Spending on counterproductive industrial and regional subsidies can be reduced. All spending should be subjected to a basic productivity test, such that reformed programs tangibly contribute to our broader standard of living. None of this must necessarily harm lower-income Canadians. In fact, a thorough structural reform can boost lower-end incomes in a less intrusive manner than today.
Finally, accountability requires information and appropriate incentives. Too many government services are delivered outside of market channels and without information to help people judge the effectiveness of delivery. We need more competition between service providers and more power for taxpayers and those receiving services. Restrictions on foreign and private sector providers are particularly onerous in this country.
Indisputably, government can be a force for good in society. But an ever-rising tax burden doesn't square with a more prosperous future. The recent evidence is not heartening -- too much government and not enough economic growth -- but, as with many dysfunctional systems, the scope for improvement is vast.
Mark Mullins is an economic consultant and financial markets analyst.
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