Sam Peltzman and the great restraint in the growth of government, 1980-2007

From 1950 to 1980 the size of government doubled in the developed world and then stopped dead in 1980. This great restraint on the growth of government happened everywhere. It was not just Thatcher’s Britain or Reagan’s America. It was everywhere, in France and Germany, and even in Scandinavia.

Peltzman’s data below has government spending double between 1950 and 1980, and then nothing much happened in between 1980 and 2007 – the size of government is pretty flat as a share of GDP for 27 years.

Source: Sam Peltzman, The Socialist Revival? (2012).

There is a noticeable reduction in the size of government spending in Scandinavia. Reagan and Thatcher had nothing on those Social Democrats in Scandinavia when it comes to cutting the size of government.

Governments everywhere hit a brick wall in terms of their ability to raise further tax revenues. Political parties of the Left and Right recognised this new reality.

Government spending grew in many countries in the 20th century because of demographic shifts, more efficient taxes, more efficient spending, a shift in the political power from those taxed to those subsidised, shifts in political power among taxed groups, and shifts in political power among subsidised groups.

The median voter in all countries was alive to the power of incentives and to not killing the goose that laid the golden egg.

After 1980, the taxed, regulated and subsidised groups had an increased incentive to converge on new lower cost modes of redistribution.

More efficient taxes, more efficient spending, more efficient regulation and a more efficient state sector reduced the burden of taxes on the taxed groups.

Most subsidised groups benefited as well because their needs were met in ways that provoked less political opposition.

Gary Becker made this warning about the political repercussions of tax reform and economic reform in general for the size of government:

…the greater efficiency of a VAT and its ease of collection is a two-edged sword.

On the one hand, it would raise a given amount of tax revenue efficiently and cheaply.

Since economists usually evaluate different types of taxes by their efficiency and ease of collecting a given amount of tax revenue, economists typically like value added taxes.

The error in this method of evaluating taxes is that it does not consider the political economy determinants of the level of taxes.

From this political economy perspective, the value added tax does not look so attractive, at least to those of us who worry that governments would spend and tax at higher levels than is economically and socially desirable.

Reforms ensued after 1980 led by parties on the Left and Right, with some members of existing political groupings benefiting from joining new political coalitions.

The deadweight losses of taxes, transfers and regulation limit inefficient policies and the sustainability of redistribution.

Peltzman likes to note that at the start of the 20th century, the United States government was about 8% of GDP. The two largest programs were education and highways. The post office was as big as the military.

Government is about five times that now with defence, health, education and income security accounting for 70% of this total. Peltzman makes the very interesting point that:

There is no new program in the political horizon that seems capable of attaining anything like the size of any of these four.

For the time being the future government rest on the extent of existing mega programs.

Health and income security account for 55% of total government spending in the OECD. It is in these two programs where the future of the growth of government lie.

The pressure for that growth in government will come from the elderly. Governments will have to choose between high taxes on the young to fund these programs for the elderly or find other options.

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