Taxation, Government Spending & Economic Growth: In Brief


Monetary Policy

SMPC minutes November 2016


Abolish twenty taxes and go for growth, says IEA

Abolish twenty taxes and go for growth, says IEA

• Taxation and government spending as a proportion of GDP have increased dramatically since World War I. Spending has increased from one-eighth of national income to somewhere between 40 per cent and 45 per cent of GDP today, the actual figure depending on how GDP is measured.

• This is a similar level to the share of government spending in national income in Germany, but considerably higher than in Switzerland, Australia and Ireland, and somewhat higher than the US and New Zealand. Some UK regions have government spending levels between two thirds and three quarters of regional GDP.

• Despite widespread hysteria, there has not been a significant reduction in the level of government spending since 2010. Real spending fell by just 0.5 per cent a year between 2010 and 2015 and is planned to increase through to 2020. Overall, spending as a proportion of national income at factor cost is still planned to be historically high at a level of 41 per cent by 2020.

• The composition of government spending matters for economic growth. Government capital spending can enhance growth, though it should also be judged by its opportunity cost. Government consumption spending tends to harm growth. Badly designed government transfers can undermine growth by worsening incentives. As a proportion of national income, government investment has fallen whilst welfare payments and other government spending have increased since the 1960s.

• Taxation required to finance spending can reduce the size and growth rate of the economy by reducing incentives to save, invest and innovate, or by distorting economic decisions and deterring transactions. Analysis suggests that the growth maximising share of government spending in GDP is between 18.5 per cent and 23.5 per cent of national income at market prices. The welfare maximising share is likely to be somewhat higher than this at between 26.5 per cent and 32.5 per cent. The maximum
sustainable level of government spending is around 37 per cent to 38 per cent of national income. It appears that the UK government is aiming for that level rather than the welfare maximising level.

• A wide body of evidence suggests that high levels of government spending and taxation undermine growth. Growth regression analysis tends to show that a 10 percentage point increase in the burden of each is associated with a 1 percentage point fall in the annual growth rate.

• New modelling, which overcomes some of the problems of the earlier work, finds that a 10 percentage point fall in a combined index of top marginal tax rates and regulation relative to its trend produces a rise in output over about thirty years of 24 per cent. This is equivalent to an increase in the growth rate over the thirty years following the cut of about 0.8 percentage points per annum.

• The design of the tax system to finance government spending affects growth too. Taxes on mobile capital and high marginal rates of tax on income tend to affect growth disproportionately, whereas taxes on land, consumption and so-called ‘externalities’ have less of an impact and may even increase welfare.

• A good tax system should have low negative effects on growth and welfare, low administration and compliance costs, and be nondiscriminatory and transparent.

• The current UK tax system does not live up to these ideals. It is a very badly designed system with high marginal rates, huge complexity, taxes that discourage wealth-creating economic activity and wide-ranging exemptions.

• A better tax system can be created. This would entail abolishing twenty current taxes, including corporation tax, national insurance, capital gains tax, inheritance tax, council tax, and a range of duties. The reformed system would comprise a flat-rate income tax at 15 per cent of income above a personal allowance of £10,000, with distributed corporate profits also taxed at this rate; VAT at 12.5 per cent; a new housing consumption tax at 12.5 per cent; a new location land value tax; and fuel duty at around half the current rate. On a static basis this reform would lead to significant income gains across the income distribution, with particularly significant gains for the poorest.

For the full version of the report, please click here.

The paper featured in The Daily Express, The Daily Mail, The Guardian, City AM and The Mail on Sunday. Following the paper’s release Mark Littlewood wrote for Prospect Magazine, Ryan Bourne wrote for The Telegraph, Philip Booth wrote for City AM and Rory Meakin wrote for Conservative Home.

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Academic and Research Director, IEA

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

Head of Public Policy and Director, Paragon Initiative

Ryan Bourne is Head of Public Policy at the IEA and Director of The Paragon Initiative. Ryan was educated at Magdalene College, Cambridge where he achieved a double-first in Economics at undergraduate level and later an MPhil qualification. Prior to joining the IEA, Ryan worked for a year at the economic consultancy firm Frontier Economics on competition and public policy issues. After leaving Frontier in 2010, Ryan joined the Centre for Policy Studies think tank in Westminster, first as an Economics Researcher and subsequently as Head of Economic Research. There, he was responsible for writing, editing and commissioning economic reports across a broad range of areas, as well as organisation of economic-themed events and roundtables. Ryan appears regularly in the national media, including writing for The Times, the Daily Telegraph, ConservativeHome and Spectator Coffee House, and appearing on broadcast, including BBC News, Newsnight, Sky News, Jeff Randall Live, Reuters and LBC radio. He is currently a weekly columnist for CityAM.