Almost 30 years ago World Bank economist Keith Marsden published a groundbreaking study comparing the growth rates of low-tax and high-tax nations. Marsden found that the low-tax nations grew faster. Perhaps not a surprise. But Marsden also found that the low-tax nations increased their government spending three times faster than the high-tax nations. How? Because the low-tax nations grew some six times as fast.
Now, Marsden is back with a new study for Britain's Centre for Policy Studies called "Big, Not Better?: Evidence from 20 countries that slim governments work better. "
When Marsden first compared the high-tax and low-tax nations three decades ago, the worldwide tax-cutting revolution was just commencing. Ronald Reagan and Margaret Thatcher were the leading Western innovators, and although it was not fully appreciated at the time, China's Deng Xiaoping was watching -- and emulating -- the shining example of Hong Kong. So it's fitting, after several decades of global tax-cutting catalyzed today's global boom, to revisit the high-tax/low-tax debate.
Marsden's key finding, now as then, will confound not just high-tax liberals but many "starve the beast" conservatives as well.
Faster economic growth in the first [low-tax] group also generated a more rapid increase in government revenue, despite (or rather, because of, supply-siders suggest) lower overall tax burdens.
Strategic tax cutting is thus not a wrenching zero-sum trade-off but a positive-sum investment that ripples through every crucial metric of a nation's economic health.
The bigger-government group therefore failed to gain any competitive advantages in global markets by generating or attracting larger investment funds. Their investment growth slowed to an average annual rate of 0.8% in 2000-2005, from 4.1% in 1990-2000. Their export growth rate almost halved to 3.1% annually in 2000-2005, down from 6.1% in 1990-2000. The bottom line is a drop in their average annual GDP growth rate to 2.1% in 1999-2008, from 2.3% over the previous decade.
Nor did they balance their books. They ran budgetary deficits averaging 1.1% of GDP in 2006, whereas slimmer governments generated an average surplus of 0.3% of GDP. Their net government debt averaged 39.2% of GDP in 2006, more than four times higher than the latter's. Interest payments on their debt took 2.3% of their GDP, compared with an average of just 0.5% in the slimmer-government group.
Slimmer-government countries also delivered more rapid social progress in some areas. They have, on average, higher annual employment growth rates (1.7% compared to 0.9% from 1995-2005). Their youth unemployment rates have been lower for both males and females since 2000. The discretionary income of households rose faster in the first group. This allowed their real consumption to increase by 4.1% annually from 2000-2005, up from 2.8% in 1990-2000. In the bigger-government group, the growth of household consumption has slowed to a 1.3% average annual rate, from 2.1% during the 1990-2000 period.
Slimmer-government countries seem to have made better use of their smaller health resources. Total spending on health programs reached 9.5% of GDP in the bigger government group in 2004, 1.6 percentage points above the average in the slimmer-government group. Yet slimmer-government countries have raised their average life expectancy at birth at a faster pacer since 1990, reaching an average level of 78 years in 2005, just one year below the average for bigger spenders. Average life expectancy is now 80 years in Singapore, although government and private health programs combined cost only 3.7% of its GDP.
At a time when most American politicians, and even economists across the ideological spectrum, are arguing over not whether tax rates will increase but by how much, Marsden's new study should point them in just the opposite direction. The U.S. led the first wave of global tax-cutting. We should now double down on this winning strategy.