Wednesday, December 31, 2014

Government spending: What's the right amount?

Most pundits who talk about government spending do so as a percentage of gross domestic product (GDP). The long term average is roughly 20%, meaning that the amount of government spending in a year is equal to 20% of that year's nominal GDP. But it is not clear to me that government officials should be targeting that long term average as the "normal" level. Take a look at the graph below.

The red line is total federal government spending as a percentage of total GDP and is plotted using the right axis. As you can see it has fluctuated around 18 - 20% since the 1950's. The large spike is World War II. When people talk about maintaining a constant level of government spending they are usually referring to the relatively flat red line.

But why should government spending track productivity? A flat red line means that if GDP increases by 3% government spending increases by 3%. But GDP is a measure of the country's productivity; it does not measure the country's need for government. In fact, I can't think of a compelling reason why the government should spend a constant percentage of GDP.

This brings me to the blue line in the graph. The blue line is plotted using the left axis and it measures the per capita amount of government spending in inflation adjusted dollars. As shown in the graph, it has been increasing steadily from about $2,000 per person in 1950 to $10,000 per person in 2014. So the government spends five times more per person today than it did in 1950. By 1950 we already had the traditional public goods and services that most people think a government should provide: an army, parks, a tax collecting service, the post office and public education to name some of the most common things. Many of the regulatory agencies were also created and funded as well by that time, including the FDA and SEC. In fact, many government services such as national defense, drug and food testing, and parks experience economies of scale. So what have we gotten for this increase in spending?

Since 1950 the government has built and funded the interstate highway system, created the department of education, the EPA, and the Bureau of Alcohol, Tobacco, and Firearms to help fight the war on drugs. Even if you think all of these things should be funded by the government, it only took the government about $5,600 per person in 1980 to do so, about $4,400 less than the government is spending today.

The chart above shows what government spending would be as a percentage of GDP if it had maintained the 1980 per capita level of $5,663. The last row shows that government spending would only be 11.2% of GDP today at that level instead of 20.2%. Maintaining that level of spending would have drastically lowered the national debt, and in my opinion there would have been no reduction in the government services that many people (but not me) think that the government should provide. Looking at these numbers makes one really wonder what the government is spending that extra $4,400 per person on. (Remember, I am not arguing for a constant level of spending. I am arguing for pegging spending to population growth rather than output growth.)

As a country I think we would be better off maintaining a constant blue line at 1980 levels rather than a constant red line. Hopefully when the new Republican congress takes office they implement real spending cuts that bring the blue line down.

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