12th Annual Public Sector Finance Conference

Government Spending

Roger Kerr

18 August 2008

Spending, Productivity and Economic Growth

• “The literature is indeterminate about the relationship between government spending and economic growth”

• Lazy statement• No OECD country has sustained fast per capita

growth with government spending at 40% of GDP

• New Zealand’s current ratio (central plus local government) now 42.4% of GDP

• Australia 32.9% (second lowest in OECD)• Singapore and Hong Kong below 20%

Some empirical findings

• “Empirical literature increasingly supportive of negative impacts of taxes on GDP, productivity, investment”

– Norman Gemmell, Treasury

• Taxes a major factor in higher productivity of United States relative to Europe

– Ed Prescott

• Winton Bates: How Much Government? The Effects of High Government Spending on Economic Performance

• Keith Marsden: Big, Not Better?

Comments

• Quantity matters

• Deadweight costs of taxation (up to $2 for every $1 of tax at the margin)

• Quality also a problem

• Other impacts: inflation, competitiveness, productivity

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

1992-2000 2000-2007

Labour productivity average annual growth rates

% increase

NZ Measured

Sector

AU Market Sector

AUMarket Sector

NZ Former

MeasuredSector

(Source: Capital Economics Limited, Australian Bureau of Statistics & Statistics New Zealand 2008)

Conceptual basis for government spending

• Need government spending on core roles

• Public goods and a safety net

• Might justify spending of 15% of GDP (Ted Sieper)

• Social outcomes not superior with big government (Tanzi and Schuknecht)

• Winton Bates: Reducing low quality spending from 40% to 30% of GDP could raise growth by 0.5% pa for 10-25 years

Quality

• Widespread view that much spending does not represent value for money

• Audit Office reports

• 95% of base spending not reviewed

• No Treasury criteria for government spending (cf guidelines for regulation)

• Focus must be on programmes (Is the programme justified? At what level? Is it achieving goals?) and cost of inputs (especially labour)

Examples of poorly justified spending

• Middle-class welfare - churning

• Criteria for benefits (US-style reforms)

• Debt servicing (Cullen Fund, SOEs, Reserve Bank FX injection)

• Corporate welfare

• KiwiSaver subsidies

• John Gibson research on pay differentials

• Bureaucracy

Number of Staff in MSD and Number of Benefits

5,000

5,500

6,000

6,500

7,000

7,500

8,000

8,500

9,000

9,500

10,000

2002 2003 2004 2005 2006 2007

FT

E s

taff

790,000

795,000

800,000

805,000

810,000

815,000

820,000

Ben

efit

s

FTE staff in MSD Number of benefits

How to control government spending?

• Across-the-board cuts make no sense– Would you do that with a household

budget? – not all spending of equal value

• Need a focus on quality

plus

• A top-down tax and spending limit

Obtaining better value for money

• Start with Treasury spending guidelines

• Exit private goods activities and contract out

• Introduce choice and competition (eg health, education, ACC)

• Review base spending on basis of guidelines

• Use independent task force (Californian exercise recommended savings of US$32 billion)

• Reform Local Government Act 2002

Introduce top-down constraint

• Fiscal Responsibility Act/Public Finance Act not an effective discipline

• MMP a compounding factor• Business Roundtable favours a Tax and Expenditure

Limit (eg population growth plus inflation) unless taxpayers approve higher spending via a referendum

• Surplus revenue to be returned to taxpayers (cf 2008 Hong Kong budget)

• Many similar concepts: Hong Kong Basic Law, US states, US federal proposal in Friedman’s Free to Choose

• Apply similar rules to local government