6 April 2017

The effect of the size and mix

of public spending on growth and inequality

http://www.oecd.org/eco/the-effect-of-the-size-and-mix-of-public-spending-on-growth-and-inequality.htm

ECOSCOPE blog: oecdecoscope.wordpress.com

Quality of Public Finance workstream

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Public finance database • A public spending and revenue breakdown designed for economic analysis • Combination of national account data with OECD databases on social expenditure

and government revenue to broaden the coverage.

The effect of public spending size and mix on growth and inequality • New empirical estimates on the effect of public spending size, effectiveness and mix

on growth and inequality • Illustrative simulations combining growth and inequality effects.

The effect of taxation on growth and inequality • Work in progress: • Laffer curve estimates to build a link between tax rates and tax revenues. • Investigation of the effect of taxes on growth and inequality (in progress).

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1. Public finance database

Social benefits and transfers

in kind (D62_D631XX)

Wages (D1)

Intermediate consumption

(P2)

Subsidies (TSUB)

Investment (IGAA)

Interest payments (YPEPG)

Inventory changes

Capital transfers

Other primary expen-ditures

1 1 1 8 9 11 10 10 10

2 2 2 8 9 11 10 10 10

Sickness and disability (1001) 5 5 5 8 9 11 10 10 10

Family and children (1004) 7 7 7 8 9 11 10 10 10

Old age and survivors (1002 + 1003) 4 3 3 8 9 11 10 10 10

Unemployment (1005) 6 3 3 8 9 11 10 10 10

Other social protection (1006-09) 10 3 3 8 9 11 10 10 10

10 3 3 8 9 11 10 10 10

10 3 3 8 9 11 10 10 10

10 3 3 8 9 11 10 10 10

10 3 3 8 9 11 10 10 10

10 3 3 8 9 11 10 10 10

10 3 3 8 9 11 10 10 10

10 3 3 8 9 11 10 10 10

Economic affairs (040)

Environment protection (050)

Housing and community amenities (060)

Recreation, culture and religion (080)

Social protection

(100)

Public order and safety (030)

Defence (020)

General public services (010)

Education (090)

Health (070)

Function

Transaction

A public spending database for macroeconomic analysis

4 Source: Bloch et al. (2016), “Trends in Public Finance: Insights from a New Detailed Dataset”, OECD Economics Department Working Paper, No. 1346.

Changes to the spending and tax mix have gone in the wrong direction between

2007 and 2013

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Source: OECD Public Finance Dataset, forthcoming.

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2. New estimates of the effect of public spending

size, effectiveness and mix on growth and inequality

Impact of different instruments on growth and equity

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Policy Growth Equity Income of the poor

Countries with the most room for growth gains

Decreasing the size of government

Low to moderate government effectiveness

+ - + BEL, CZE, FRA, GRC,

HUN, ITA, POL, PRT, SVN High government effectiveness n.s. - -

Increasing government effectiveness + + + FRA, GRC, HUN, ITA, SVN

Increasing education outcomes + 0/+ + CHL, GRC, MEX, PRT, TUR

Increasing public investment (including R&D) + n.s. + BEL, DEU, GBR, IRL, ISR, ITA, MEX, TUR

Pension reform + n.s. + AUT, DEU, FIN, FRA, GRC, ITA, JPN, POL, PRT, SVN

Increasing family benefits n.s. + + CHE, ESP, GRC, PRT

Decreasing public subsidies + - n.s. BEL, CHE

Note: + stands for a positively significant, – for a negatively significant and n.s. for non-significant effect. Source: Fournier and Johansson (2016), “The Effect of the Size and the Mix of Public Spending on Growth and Inequality”, OECD Economics Department Working Papers, No. 1344.

Government effectiveness and growth

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The adverse effect of government size on potential GDP decreases with government effectiveness

GDP gain of one spending point increase of public spending, in per cent

Perception of government effectiveness

-20

-15

-10

-5

0

5

10

0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2

Government effectiveness and growth

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Size of government and citizens’ perception of their effectiveness

AUS

AUT

BEL

CAN

CHE

CZE

DEU

DNK

ESP

EST

FINFRA

GBR

GRC

HUN

IRL

ISLISR

ITA

JPN

KOR

LUX

NLD

NOR

NZLPOL

PRT

SVK

SVN

SWE

USA

30

35

40

45

50

55

0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2 2.2

Perception of government effectiveness

Size of government (primary spending, % of potential GDP)

Long-term GDP gains from reducing the size of government

10

0

5

10

15

20

25

30

35

Size of governmentPer cent

Note: In countries where the size of government is above the average level of countries in the bottom half of the sample, the government size will gradually converge to this level (36% of GDP). The figure reports the effect after 45 years of a reform phased in over 10 years.

Illustrative gains from reducing government size on poor, average and rich households

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Effect of a reduction in government size on household disposable income

Note: In countries where the size of government is above the average level of that of countries in the bottom half of the sample, the government size will gradually converge to this level (36% of GDP).

Rich and average households tend to gain from a reduction of government size, while the effect on the poor depends on government’s effectiveness.

-30

-20

-10

0

10

20

30

40Average effects Effects on the poor Effects on the rich

Per cent

Decreasing returns to public investment?

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The effect of public investment on potential GDP decreases with the level of capital stock

GDP gain of one spending point increase of public investment, in per cent

Public capital stock, per cent of potential GDP

The analysis suggests that all OECD countries, except Japan, have room for additional public investment.

-15

-10

-5

0

5

10

15

20 40 60 80 100 120

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3. The effect of taxation on growth and inequality (in progress)

A first step: Laffer curve estimates that depend on structural features

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Corporate income tax revenues as a percent of GDP

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More information

Fournier, J-M. and A Johansson (2016), “The effect of the size and mix of public spending on growth and inequality”, OECD Economics Department Working Papers, No. 1344.

Bloch et al. (2016), “Trends in public finance: Insights from a new dataset”, OECD Economics Department Working Papers, No. 1345. Johansson, A. (2016), “Public finance, economic growth and inequality: A survey of the evidence”, OECD Economics Department Working Papers, No. 1346.

Fournier, J-M. (2016), “The positive effect of public investment on potential growth”, OECD Economics Department Working Papers, No. 1347. Disclaimers: The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law. This document and any map included herein are without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area.

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Additional slides

Long-term GDP gains from improving government effectiveness

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0

5

10

15

20

25

30

35

Effectiveness of governmentPer cent

Note: In countries where the effectiveness of government is below the average level of countries in the top half of the sample, government effectiveness will gradually converge to this level. The figure reports the effect after 45 years of a reform phased in over 10 years.

Long-term growth effects of an increase in the education level

18

0

5

10

15

20

25

30

Quantity of education (years of schooling) Quality of education (PISA)Per cent

Note: In countries where the mean PISA score or average years of schooling are below the average level of countries in the top half of the sample, educational attainment is assumed to gradually converge to this level. The figure reports the effect after 45 years of a reform phased in over 45 years.

Long-term GDP gains from decreasing pension spending

19

0

5

10

15

20

25

30

Old age and survivors pensionsPer cent

Note: In countries where spending to the potential GDP ratio on pensions is above the average level of countries in the bottom half of the sample, spending will gradually decline to this level. The figure reports the effect after 45 years of a reform phased in over 10 years.

Illustrative gains from raising family and child benefits on disposable income

20

Note: In countries where family benefits to potential GDP is below the average ratio of that of countries in the top half of the sample, family benefits will gradually converge to this average ratio.

-10

0

10

20

30

40

Average effects Effects on the poor Effects on the rich

Per cent

Illustrative gains from decreasing public subsidies

21

Note: In countries where subsidies to potential GDP are above the average ratio of that of countries in the bottom half of the sample, subsidies will gradually decline to this ratio.

-10

0

10

20

30

40Average effects Effects on the poor Effects on the rich

Per cent