Unravelling the Centre for Policy Studies voodoo economics bigging up small government

IPPR’s Tony Dolphin takes apart today’s Centre for Policy Studies report claiming lower taxes lead to higher economic growth.

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The Centre for Policy Studies (CPS) today publishes a (pdf) claiming lower taxes lead to higher economic growth. The report presents the results of regression analysis covering a number of advanced countries since 1965 to back up this claim.

This is not the first report to argue lower taxes lead to higher growth, and it will not be the last. However, there are also many reports, also backed up by statistical analysis, that refute this claim. At the most basic level, in advanced countries there is no correlation between tax revenues (in relation to overall GDP) and growth in GDP per head.

As Graph 1 shows, looking back over the last 40 years (the results are very similar if a shorter timeframe is used), and across the 22 OECD nations for which data are available, the correlation between average tax revenues as a percentage of GDP and GDP per head growth is zero.

Graph 1:

Correlation-between-average-tax-revenues-as-a-percentage-of-GDP-and-GDP-per-head-growth
The historical record shows that for every country with a small state and above average growth, there is a country with a small state and relatively low growth: Switzerland has the third smallest state in the OECD but also has the lowest per capita growth rate of all 22 countries.

Similarly, countries with the highest tax revenues in relation to GDP also have a mixed record on growth.

The divergent paths of Denmark and Sweden on the one hand and the US on the other are illustrative. In the early 1960s, tax revenues in all three countries were around one quarter of GDP. By the mid-1980s, tax revenues in the two Scandinavian countries were close to half of GDP, whereas in the US they were only a little higher than they had been in 1960.

But per capita growth rates have been very similar in the three countries over the last 50 years.

 


See also:

Debunking the myth that lower taxes for the rich generates more tax revenue 27 Mar 2012

Winning the argument on taxation is the key to reviving the left 8 Aug 2010

Expenditure cuts “will reduce income, savings and investment” 7 Dec 2009


 

The authors of the CPS report will reply that this is a partial account and that their analysis is more sophisticated because it takes into consideration other variables that theory suggests affect growth, such as levels of investment and labour force growth. This would be a valid criticism, were it not for the fact that their results (p.15) show there is no statistically significant relationship between any of these variables (other than the initial level of GDP per capita) and growth.

This must have been a totally unexpected result and yet, surprisingly, there is no mention of it in the report.

The authors could have concluded from their analysis that governments are wasting their efforts when trying to increase levels of investment in the economy because doing so does not boost growth. This would have attracted a lot of attention – but it would also have attracted a lot of criticism because it flies in the face of accepted economic wisdom.

This result highlights the danger of drawing conclusions from regression analysis of this type.

If the results suggest a relationship widely believed to be true – that higher investment spending leads stronger growth – does not hold, then any other relationship that is identified must be thrown into question.

The explanatory power of the equations is also poor, suggesting important explanatory variables have been omitted from the analysis. Some of these may be correlated with the size of tax revenues and this throws further doubt on the purported relationship between taxes and growth.

Many things determine per capita growth rates in advanced economies. Some people believe the level of taxation is one and would like robust statistical evidence to back up their view. This report, despite its claims, does not provide that evidence. A convincing case that a higher level of taxation leads to lower growth has yet to be made – probably because it is not true.

 


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34 Responses to “Unravelling the Centre for Policy Studies voodoo economics bigging up small government”

  1. P McCarvill

    Unravelling the Centre for Policy Studies voodoo economics bigging up small government: http://t.co/z00ZZ5eh by @IPPR’s Tony Dolphin

  2. Foxy52

    Unravelling the Centre for Policy Studies voodoo economics bigging up small government: http://t.co/z00ZZ5eh by @IPPR’s Tony Dolphin

  3. rhianon passmore

    Unravelling the Centre for Policy Studies voodoo economics bigging up small government: http://t.co/z00ZZ5eh by @IPPR’s Tony Dolphin

  4. H. O.

    RT @leftfootfwd: Unravelling the Centre for Policy Studies voodoo economics bigging up small government http://t.co/6mUv0BoU

  5. leftlinks

    Left Foot Forward – Unravelling the Centre for Policy Studies voodoo economics bigging up small… http://t.co/GqoTySHP

  6. Nicholas Ripley

    Unravelling the Centre for Policy Studies voodoo economics bigging up small government http://t.co/O1NqaMy3

  7. Anonymous

    Now do it for government debt and growth. Make sure you include all the debts.

    Greek deficit – 10.5%.

    UK deficit – 10.4%

  8. David Reagan

    Unravelling the Centre for Policy Studies voodoo economics bigging up small government: http://t.co/abqf1YEw by @IPPR’s Tony Dolphin

  9. Richard Darlington

    Unravelling the Centre for Policy Studies voodoo economics bigging up small government: http://t.co/abqf1YEw by @IPPR’s Tony Dolphin

  10. IPPR

    Unravelling the Centre for Policy Studies voodoo economics bigging up small government: http://t.co/abqf1YEw by @IPPR’s Tony Dolphin

  11. BMetAlevelPolitics

    Unravelling the Centre for Policy Studies voodoo economics bigging up small government: http://t.co/z00ZZ5eh by @IPPR’s Tony Dolphin

  12. Michael

    Unravelling the Centre for Policy Studies voodoo economics – http://t.co/03AisUsU

  13. Neil Courtman

    Unravelling the Centre for Policy Studies voodoo economics – http://t.co/03AisUsU

  14. Shamik Das

    Unravelling the Centre for Policy Studies voodoo economics bigging up small government: http://t.co/abqf1YEw by @IPPR’s Tony Dolphin

  15. Chris Paul

    Unravelling the Centre for Policy Studies voodoo economics bigging up small government: http://t.co/abqf1YEw by @IPPR’s Tony Dolphin

  16. Declan Gaffney

    No statistically significant relationship between investment and growth http://t.co/ore5Drom Tony Dolphin on CPS 'small is good' paper.

  17. Ryan Bourne

    The chart which you guys keep churning out on this is completely meaningless. Nobody thinks government is the only factor. Many of us think there are significant country effects as well. What your averaging over time for each country does is simply eliminate all the within country information given a country’s institutions.

    I’ll reply in more detail on our blog, but am not holding my breath on a reply.

    http://www.cps.org.uk

    Ryan Bourne
    CPS

  18. Nemesis Republic

    Frm earlier: Unravelling the Centre for Policy Studies voodoo economics bigging up small govt: http://t.co/abqf1YEw by @IPPR’s Tony Dolphin

  19. not1fish

    Frm earlier: Unravelling the Centre for Policy Studies voodoo economics bigging up small govt: http://t.co/abqf1YEw by @IPPR’s Tony Dolphin

  20. BevR

    RT @leftfootfwd: Unravelling the Centre for Policy Studies voodoo economics bigging up small government http://t.co/5wILYkIT

  21. JC

    Does anyone in your organisation understand statistics? That graph shows nothing at all. What’s the standard deviation, what are the variables? As Ryan points out, there are a large number of factors involved. In fact, the only conclusion you could reach would be that low tax does not preclude high growth.

  22. Bill Kruse

    Shouldn’t we be asking ourselves why there’s this constant need for growth? Turns out that money is created into the economy as debt by the commercial banks when we get ‘loans’ from them. Since Maastricht that’s the only way we’re allowed to increase the money supply, asking the banks to create money out of thin air into the economy which we then have to give to them plus more on top (interest). To say that, from our POV, is ludicrous is understating the case! So why aren’t we asking ourselves, since we have a Bank of England which can create money for us for free which we wouldn’t have to pay interest to private companies for, why exactly are we doing things this way? All it does is perpteually make the commercial banks far richer than we could ever be. Where’s the sense in that?

  23. Anonymous

    Because of course anything but “come give me hits”…

  24. Ryan Bourne

    Here's @IPPR critique of our 'Small is best' http://t.co/83tzxCi0 and my response: http://t.co/JUharAUY I shall let you judge!

  25. Anonymous

    “All Tony has proved here is that small government doesn’t automatically mean high growth”

    Congratulations, you’ve got it!

  26. Ryan Bourne

    No, because loads of other things also determine it. But small state means HIGHER growth than there would be in the counterfactual big govt world, given all the other country variables.

    It’s not difficult.

  27. Anonymous

    Ah right, those poverty-stricken Nordic nations.
    Oh, wait.

    Typical double dip denial.

  28. BenM_Kent

    That’s a strange response.

    Seems to agree with the article above.

    As for the whine at the start of your response, this kind of bilge requires constant rebuttal given the frequency it is churned out by “think tanks” like yourselves.

    No one believes the small state guff any longer.

  29. Blarg1987

    If we look at the repotrt more closely the question which has not been asked is how much of the extra growth would be eaten up in service provision through private companes in the form of health care, education, infastructure, defence, etc?

    The report also includes countires which have recently sold of state assts so are growing because of the tax subsidies given through the sell offs as we did with North Sea Oil now where has that got us?

  30. Nicholas Bronté

    Unravelling the Centre for Policy Studies voodoo economics bigging up small government: http://t.co/abqf1YEw by @IPPR’s Tony Dolphin

  31. Seren Fuller

    Frm earlier: Unravelling the Centre for Policy Studies voodoo economics bigging up small govt: http://t.co/abqf1YEw by @IPPR’s Tony Dolphin

  32. Anonymous

    Yes, and of course that suits you fine. It gives you excuses for more savage cuts to social infrastructure, to be balanced by increases in your corporate welfare.

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