In 2015, the government spent 46 per cent of national income. Government estimates tend to overstate national income and so understate the government spending ratio, but there is little dispute that we are in the 42 to 47 per cent range.
In the last century or so, the growth of government has been relentless. Before the First World War, government spending was about 10 per cent of national income. By 1920, the figure was 20 per cent; and by 1937, it was 30 per cent. In 1960, at the height of the cult of the welfare state – the era that Ken Loach most admires – government spending was still only 32 per cent.
So-called austerity has made little difference. Spending has only fallen by 0.5 per cent per annum in real terms in the last five years and will actually increase over this Parliament.
Interestingly, people seem to under-estimate how much the government spends. This is true both in opinion polls and in surveys that I have done among large groups of students. There could be two reasons for this. The first is that the government is just so inefficient we cannot believe how much it is costing us. Second, it might be the case that the government has managed to design taxes in such a way that we don’t know we are paying them.
New work published today by the Institute of Economic Affairs suggests that government spending is so high that it is above the maximum taxable capacity of the country – hence the chronic deficit that never seemed to go away despite the determination of George Osborne. And certainly, the government is spending way above the 25 to 30 per cent of national income that would probably maximise welfare.
Government spending is damaging to welfare because an over-large government does things for us that we could better do for ourselves. However, it also reduces economic growth. Perhaps protagonists in the current debate about the stagnation of incomes should turn their attention to the size of the tax burden.
What might happen, for example, if government spending were cut back to a much lower proportion of national income? Say to early 1960s levels or, to take a current-day example, to Australian levels of 35 per cent of national income? If this were done, we might expect to see an increase in economic growth of perhaps one percentage point per annum. This is a huge increase which would benefit rich and poor alike.
The research we have published also suggests that an increase in growth of similar magnitude could be achieved by reducing the top marginal tax rate by 10 per cent or by reducing regulatory barriers to employment which often discourage entrepreneurship in exactly the same way taxes do.
There are other things the government could do to promote growth. Remarkably, as the size of government has grown, its spending on things that tend to increase growth such as investment and infrastructure has fallen.
We know from recent decisions in relation to Hinkley Point and HS2 that government is not a good judge of infrastructure development. Nevertheless, the switch away from forms of government spending that have a tendency to enhance growth and towards those that lead to lower growth – such as welfare spending – has been very marked over the last 40 years or so. Perhaps the time has come to change spending priorities while reducing the overall spending envelope.
Reform should not end there. We also need to change the way in which government raises its money. Our tax code, currently 17,000 pages, should be radically overhauled to make it closer to Hong Kong’s 276 pages. We should have low, flat and simple taxes.
If the government is interested in increasing growth, it should look in the obvious place. It should cut back its own largesse and raise the money that it really does need using a tax system that is fit for purpose.