Taxation, Government Spending & Economic Growth: In Brief

Abstract

Taxation and government spending as a proportion of GDP have increased dramatically since World War I. Spending has increased from one-eighth of national income to somewhere between 40% and 45% of GDP today, the actual figure depending on how GDP is measured. Despite widespread hysteria, there has not been a significant reduction in the level of government spending since 2010. Real spending fell by just 0.5% a year between 2010 and 2015 and is planned to increase through to 2020. Overall, spending as a proportion of national income at factor cost is still planned to be historically high at a level of 41% by 2020.The composition of government spending matters for economic growth. Government capital spending can enhance growth, though it should also be judged by its opportunity cost. Government consumption spending tends to harm growth. Badly designed government transfers can undermine growth by worsening incentives. As a proportion of national income, government investment has fallen whilst welfare payments and other government spending have increased since the 1960s. The current UK tax system is a very badly designed system with high marginal rates, huge complexity, taxes that discourage wealth-creating economic activity and wide-ranging exemptions. However, a better tax system can be created. This would entail abolishing twenty current taxes, including corporation tax, national insurance, capital gains tax, inheritance tax, council tax, and a range of duties. The reformed system would comprise a flat-rate income tax at 15 per cent of income above a personal allowance of £10,000, with distributed corporate profits also taxed at this rate; VAT at 12.5 per cent; a new housing consumption tax at 12.5 per cent; a new location land value tax; and fuel duty at around half the current rate.