Cut government share of the economy

Gene Tunny

27 July 2018 | Ideas@TheCentre

Australian taxpayers are struggling to carry the burden of ever expanding government spending.

Prior to the Whitlam government of 1972-75, total Commonwealth, state and territory government spending in Australia was around 25% of GDP. In the four decades since the Whitlam government, it has been around 35%.

There is no question it would be good for the economy and taxpayers to reduce this burden.

The CIS has previously set a realistic target of reducing government spending to 30% of GDP, as part of its TARGET30 campaign. A new economic research paper presented at the recent 2018 Conference of Economists provides fresh support for this objective.

In The Optimal Size of Government in Australia, Makin, Pearce and Ratnasiri estimated the optimal size of government in Australia is around 31%. This represents the level that maximises economic growth.

The statistical analysis revealed that — all else equal — when the government share increases, real GNI growth falls. Higher government spending can crowd out private sector investment, adversely affecting future economic growth prospects. And it needs to be funded by higher taxes, which also reduce growth prospects through discouraging work effort and investment.

The analysis confirms the importance of monitoring the size of government and keeping it under control, ideally reducing it over time. This will not be easy. The fastest growing, and most expensive government programs are often the most popular. Health, education, pension, and childcare are prime contenders here.

Future spending growth is also likely to threaten budgets. For example, the National Disability Insurance Scheme is predicted to cost in excess of $20 billion a year and is already subject to billion dollar cost blowouts.

It will be challenging to reduce government’s share of the economy, but the economic evidence suggests it would be highly desirable to do so.

Gene Tunny is an economist and policy expert, and the founder of consultancy Adept Economics.

 

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