Optimal, ‘Right’ Size of Government Provides New Political Paradigm

Published September 1, 2008

A growing body of research shows there is an “optimal” size beyond which government becomes a drain on a nation’s economy. And government in the United States–local, state, and federal combined–has already grown far beyond that optimal size.

As the presidential debate on government priorities begins to take shape, it presents a great opportunity to call attention to the proper size, role, and functions of government.

A few of the issues driving such a debate include:

  • Sen. Barack Obama’s call for universal health care and a range of other government programs with trillion-dollar price tags and explosive government growth.
  • Congressional Democrats’ refusal to make the Bush tax cuts permanent, threatening to institute the largest tax increase–and government growth–in history.
  • “Cap and trade” energy emissions control legislation that contemplates massive new taxes and spending and huge increases in government’s share of gross domestic product (GDP). The result could be a body blow to U.S. economic growth.
  • The imminent retirement of 78 million Baby Boomers whose demands on Social Security, Medicare, Medicaid, and other government programs will bankrupt America unless U.S. economic growth can be increased rapidly and massively.

High Ground Available

Republicans, who have long argued for controlling the size of government but have nonetheless allowed it to expand enormously in recent years, can now stake out the high ground in pursuit of the limited government goal, as Sen. Tom Coburn (R-OK) has urged.

Their map to that high ground lies in a body of research on the optimal, “right” size of government. The research creates an objective standard and moral imperative for limiting government. It posits that excessive government stunts national economic growth and impoverishes the people.

Government Too Big

Economist Gerald Scully, who has written on “optimal” government for years, has shown that at approximately 35 percent of GDP, governments at all levels in the United States are far beyond the 23 percent of GDP he has identified as optimal. Here are the key elements of Scully’s analysis:

  • Beyond the optimal level of spending, government becomes a net drain on the economy. Up to that level, every dollar spent by government provides more than a dollar’s worth of economic growth. Beyond the optimal level, every additional dollar in spending costs more than a dollar in economic growth. At today’s spending level, the next dollar in taxation costs the nation $2.75 in lost economic growth, economists estimate.
  • Total government spending in 1948 was at about the optimal 23 percent, but it has grown to 35 percent since then. During that time the average annual compound growth rate of the economy was 3.5 percent. If government had not increased its share of GDP, the annual growth rate of GDP would have been 5.8 percent per year. This would have resulted in $37 trillion more real GDP by 2004. The average American family would be three times wealthier as a result.
  • Americans would not have needed to “sacrifice” government largesse to achieve this result. At the 23 percent spending level and comparable tax rates, government at all levels would have collected $61.9 trillion more in taxes, enough to have funded all spending programs without public debt.
  • Going forward, if spending were reduced to 23 percent of GDP and tax rates systematically reduced to maximize growth, by 2030 real GDP would be double what we anticipate under current spending/taxing plans.

Thesis Confirmed Again

The idea of an optimal size of government received additional confirmation in a recent study by British economist Keith Marsden.

In “Big, Not Better?” issued in April of this year by the Centre for Policy Studies, Marsden compared tax revenue and economic growth in 10 relatively low-tax-and-spending industrialized countries with tax revenue and economic growth in 10 relatively high-tax-and-spending industrialized countries.

In all categories of economic benefits, as well as “social progress” (employment rates and family discretionary income), the nations that have downsized government have outpaced those that have stuck to their old, high tax-and-spend ways.

Questions Remain

While those who have theorized about and studied the size of government in the United States agree that we are far beyond optimal, unanswered questions abound. Here are some of them:

  • Do some functions performed by government have a greater return on the investment of public dollars than others? Is there a ranking system?
  • What effect do non-fiscal/spending functions of government–regulation, government planning, etc.–have on the determination of optimal size of government?
  • What role do certain special interests (“rent-seekers”) have in driving government growth beyond the optimal level, and how can they be neutralized? These rent-seeking special interests include government employees and public employee unions; lobbyists; special-interest spenders (farm lobby, defense contractors, etc.); and special-interest “advocates” for the poor and others.
  • To what extent has excessive government “crowded out” private action in reducing societal problems, and what are the relative costs of public and private responses?
  • How should the core (optimal) functions of government be allocated among the federal, state, and local governments, and how should the allocation decisions be made?

Transition Necessary

While pursuing answers to these questions, we should be formulating the transition process, timeline, and methods of “securing the ground we have gained.”

First, we should lay out a 20-year (five presidential cycles) timeline during which total government growth rate is slowed (never cut) so we can reach optimal size as a share of a substantially increased GDP. This would include setting annual targets for total government spending, government spending as a share of GDP, reallocation of all or part of specific functions of government, conversion or privatization of functions, and tax rate reductions and tax reform.

These annual targets must be well understood and agreed to by “stakeholder” groups that realize their personal, family, and retirement expectations depend on the success of this effort.

Second, we must identify the techniques for achieving the annual goals for individual program transfer, conversion, reduction, etc. These would include sunsetting and serious congressional oversight; domestic program commissions that annually review government programs and recommend “packages” of program reductions and eliminations to Congress for a single up-or-down vote (using performance-rating systems and reports from the Office of Management and Budget, Government Accountability Office, and others); and outsourcing and competitive bidding on the performance of government functions in order to obtain real-world pricing and reduce the cost of performing government functions.

Using the welfare reform model, we should control and downsize so-called entitlement programs such as Medicaid, food stamps, Supplemental Security Income disabled, etc., through finite block grants to the states. Also, we should institute, at all levels of government, constitutional spending controls designed to implement and secure the optimal plan and goals and help achieve them.

It Can Be Done

It is by no means utopian to pursue policies and strategies designed to restore government to its optimal size.

Rep. Paul Ryan (R-WI), ranking member of the House Budget Committee, has demonstrated one way to do it in his Roadmap for America’s Future, a proposal to control the nation’s soaring entitlement program burden. (See “Wisconsin Congressman Proposes New ‘Roadmap’ on Entitlements,” Budget & Tax News, August 2008.)

His conclusion matches ours. To avoid doing this is to invite a fiscal train-wreck that will deny our children and grandchildren the America we have enjoyed.

Lewis K. Uhler ([email protected]) is president of The National Tax Limitation Committee, headquartered in Roseville, California. Richard Vedder ([email protected]) is professor of economics at Ohio University. He has written extensively on the optimal size of government.

For more information …

The National Tax Limitation Committee: http://www.limittaxes.org

“Big, Not Better?” by economist Keith Marsden: http://www.cps.org.uk/cpsfile.asp?id=1013