Why do so many Americans believe that big government is injurious to economic growth? A close examination of economic data from wealthy nations shows there is no relationship between the size of government or the degree of taxation and the level or rate of growth of national income and gross domestic product. Yet the myth that welfare states hinder growth persists.
This is largely due to decades of widespread, unwarranted claims based on research that exaggerates the costs of social safety nets. They are the result not of any new facts but of dubious research assumptions and techniques, and in some cases, outright deception.
What follows is a summary of five misleading tactics used by conservative researchers, fostering current myths about the relationship between government and economic growth.
1. Theoretical models instead of facts. A disturbing tendency in economics has been to present a purely theoretical exercise as if it uncovered new facts about the world. This trend is quite evident in the anti-government studies emanating from the right. For example, two models cited by Nobel Prize winner Robert Lucas claimed to “show” that eliminating capital income taxes would make Americans 15 percent better off in terms of consumption, and that France would be 20 percent richer if it adopted lower US capital gains rates.
But these models are not based on real-world data. The anti-government advocates who use them simply take for granted that no economic good can come from government’s spending its people’s tax money. Or that government spending is always pure economic waste. A softer variation on the tactic assumes that tax revenues are handed back to the population in lump-sum payments and therefore neutral in terms of social benefits. These models ignore the solid evidence showing that government spending on education and healthcare, for example, promotes economic growth. They also gloss over the social and economic benefits of taxing pollution or alcohol and cigarette addiction.
Data compiled over many years for my book Growing Public consistently show that higher taxes and robust social spending are not a drag on overall growth in the real world. While the availability of unemployment compensation may reduce work and output somewhat, this loss is offset by the positive effects on productivity of government support to social goods like early education, maternal leave and health insurance.
2. Guilt by definition. A current example of this ploy is the Economic Freedom Index (EFI) funded by the Fraser Institute and other free-enterprise lobbying groups. This index supposedly compares the degree of economic freedom in a variety of nations. But the EFI automatically assigns a lower freedom score as the size of government increases. Thus, any welfare state’s safety net programs are assumed to reduce economic freedom, despite the obviously greater freedom enjoyed by recipients of government aid in education, healthcare and so on. The EFI simply assumes without evidence that any increase in government spending undermines economic freedom for the nation as a whole.
3. Who’s in the sample? Another way to make big government and the welfare state look bad is to include in the statistical sample governments with unusually bloated and wasteful military budgets and patronage payments compared with their revenues. Thus, the top five “government consumption” countries in the widely cited global growth research of Robert Barro and Jong-Wha Lee are Israel, Jordan, Papua New Guinea, Zambia and Zaire. Based on this skewed sample, Barro concludes that “big government” hinders economic growth. But his measure of big government is simply “government consumption” by the military and people in patronage or civil service positions; it does not include most social welfare expenditures. So it is incorrect to cite this anti-government statistical result as evidence against the welfare state.
4. Riding the cycle. The aggregate data have a built-in cyclical bias. That is, they suggest a false negative effect of rising safety net expenditures during economic downturns. The bias is particularly marked in the cases of unemployment compensation, means-tested benefits like Social Security or food stamps, and labor market policies that subsidize the retraining and relocation of displaced workers. Obviously, such safety net programs will increase overall public spending in a recession when unemployment rises and incomes fall. In 2009, for example, average social spending in thirty-four Organization for Economic Co-operation and Development countries hit an all-time peak of 22.5 percent of GDP. But blaming the rising social spending for the economic weakness, as is often done, is like blaming the doctor who is trying to treat a heart attack victim for the high-cholesterol diet that caused it.
Economists have tried to eliminate this bias, but it’s hard to quantify the impact of outside factors. Take the demand for labor. The collapse of Finland’s economy in the early 1990s was largely due to its fixing of its currency to the fast-rising German mark, making exports less competitive. The resulting drop in the GDP was paralleled by a rising share going to social programs to combat unemployment. Lacking any precise way to quantify the impact of that external shock for Finland during those years, we cannot eliminate a bias toward concluding that heavier social spending “was accompanied by” a loss in output and jobs, even though social spending did not cause those losses.
5. The “high taxes reduce work” fallacy. Many studies simply assume that high taxes will result in less effort because they reduce incentives to work. They then compute the implied loss of GDP, assuming away any net gains from spending the tax revenues. But empirical studies, as opposed to theoretical models, show that higher tax rates have little effect on effort. People change their work patterns very little when tax rates go up.
Economics is difficult to understand at times. Well-trained economists can mislead policy-makers, the media and the public. That’s why it’s important we learn to spot the weaknesses in otherwise plausible-sounding theories that have helped create unjustified antagonism to the role of government in modern society.