Research that shows why lower taxes are good for growth

IT is often wrongly asserted that there is no evidence that high levels of tax and public spending have a negative effect on economic growth. Whether the state spends and taxes 30 per cent of GDP or 50 per cent is irrelevant, it is argued, and should merely be seen as a question of taste. I disagree. There have been dozens of complex, statistically rigorous papers written by top academics from around the world that have investigated these relationships and found that big government is bad for prosperity.

These economists have also looked at other, related questions: the optimal size of government and the effect of marginal and average tax rates on economic performance, job creation and productivity. It is a tragedy that such research is overlooked in the UK political debate, especially at a time such as this when we desperately need to relearn what the sources of economic growth are.

These studies are rigorous. They often look at well over 100 countries and adjust for many variables, such as country size or level of development or the business cycle. Such scientific approaches differ dramatically from the usual arguments, which rely on picking one or two countries, or a particular historical episode, emphasising certain features and then (wrongly) trying to derive general conclusions from them. For example, it is often said that Sweden’s high levels of public spending and its relative wealth mean that large states aren’t bad for GDP – but this omits all other possible factors and fails to hold all other variable constant. Crucially, it also conveniently doesn’t mention that Swedish growth rates only accelerated when public spending was slashed by around 20 per cent of GDP. The advantage of scientific approaches to trying to test economic theories is that they allow us to try to cut through the fog – economies are affected by thousands of different variables – and to try and isolate the key forces that really matter.

Here are a few of the studies. A 2011 paper by Davide Furceri and Ricardo Sousa studying 145 countries over 47-years found every one per cent of GDP rise in government spending reduces private consumption and private investment by 1.9 per cent. A 2011 study by António Afonso and João Tovar Jalles of 108 countries over 38-years found that there is a significant negative effect of size of government on growth. A 2008 study by Asa Johansson and colleagues of 21 OECD countries over a 35-year period found that every one per cent rise in tax as a share of GDP is associated with a 0.14-0.27 per cent fall in GDP. A 2009 study of 15 EU member states by Mihai Mutascu and Marius Milos found that the optimal public spending share of GDP was 30 per cent. Others have found that the level of spending that maximises performance on the Human Development Index is 30-35 per cent of GDP. Public spending in the UK is close to half of GDP today.

These and many other excellent papers are reviewed in the 2020 Tax Commission’s final report, a major investigation into the tax system I chaired and which launched yesterday (see www.2020tax.org). For those with eyes to see, there is oodles of evidence that a smaller state and lower taxes are good for growth.

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