Director’s Law of public expenditure and the survival of the modern welfare state

Sam Peltzman pointed out that most of modern public spending is supported by the median voter –  the ‘swinging’ voter. Governments at the start of the 20th century were a post office and a military. At the end of the 20th century, governments are a post office, a larger military and a very large welfare state.

Studies starting from Peltzman in 1980 showed that governments grew in line with the growth in the size and homogeneity of the middle class that was organised and politically articulate enough to implement a version of Director’s Law. George Stigler published an article on this law because Aaron Director published next to nothing for reasons no one understands. Director founded law and economics through teaching at the University of Chicago law school.

Director’s Law of public expenditure is that public expenditure is used primary for the benefit of the middle class, and is financed with taxes which are borne in considerable part by the poor and the rich.

Based on the size of its population and its aggregate wealth, the middle class will always be the dominant voting bloc in a modern democracy. Growth in the size of governments across the developed world took off in the mid-20th century as the middle class blossomed. Peltzman maintained that:

“the leveling of income differences across a large part of the population … has in fact been a major source of the growth of government in the developed world over the last fifty years” because the leveling created “a broadening of the political base that stood to gain from redistribution generally and thus provided a fertile source of political support for expansion of specific programs. At the same time, these groups became more able to perceive and articulate that interest … [and] this simultaneous growth of ‘ability’ served to catalyze politically the spreading economic interest in redistribution.”

After the 1970s economic stagnation, the taxed, regulated and subsidised groups had an increasing incentive to converge on new, lower cost modes of income redistribution.

  • Economic reforms ensued, led by parties on the left and right, with some members of existing political and special interest groupings benefiting from joining new coalitions.
  • More efficient taxes, more efficient spending, more efficient regulation and a more efficient state sector reduced the burden on the taxed groups.
  • Most of the subsidised groups benefited as well because their needs were met in ways that provoked less political opposition from the taxpaying groups.

Sweden, Norway and Denmark could be examples of Gary Becker’s idea that political systems converge on the more efficient modes of both regulation and income redistribution as their deadweight losses grew in the 1970s and 1980s and after. Unlike some of their brethren abroad, more of the Nordic Left and, more importantly, the Nordic median voter were cognizant of the power of incentives and to not killing the goose that laid the golden egg. Taxes on income from capital are low in Scandinavia.

The rising deadweight losses of taxes, transfers and regulation all limit the political value of inefficient redistributive policies. Tax and regulatory policies that are found to significantly cut the total wealth available for redistribution by governments are avoided relative to the germane counter-factual, which are other even costlier modes of redistribution.

An improvement in the efficiency of either taxes or spending reduces political pressure from taxed and regulated groups for suppressing the growth of government and thereby increases total tax revenue and spending because there is less political opposition. Efficient taxes lead to higher taxes.

Improvements in the efficiency of taxes, regulation and in spending reduce political pressure from the taxed and regulated groups in society. This suppressed the growth of government and thus increased or prevented cuts to both total tax revenue and spending since 1980. Economic regulation lessened after 1980 and there were privatisations, but social and environmental regulation grew unabated.

The post-1980 reforms of Thatcher, Reagan, Clinton, Hawke and Keating, Lange and Douglas and others saved the modern welfare state for the middle class. Most income transfer programmes in modern welfare states disproportionately benefit older people. With an aging society, that trend can only continue.

That is why these reforming policies survived political competition, election after election. The political parties on the left and right that delivered efficient increments and streamlined the size of government were elected, and in turn, got thrown out from time to time because they became tired and flabby.

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