Tax burdens and the Role of Government

One of the major arguments of economic liberals in the 1990s was that globalisation would force a reduction in the size of the state. I was always sceptical about such claims given that the evidence seemed to go in the opposite direction when considering the fact that small trade exposed developed economies often had high taxation and extensive welfare states.

The latest OECD figures show that tax revenue declined (very) slightly in 2008 but this is not surprising given the economic downturn. Over the previous 30 years or so, as the world has become more globalised, tax revenue as a percentage of GDP has increased.

The figures for 2007 and 2008 make interesting reading showing that Australia is generally a low tax economy.

The welfare state has been remarkably resilient. This should not necessarily be surprising because the association of openness with the growth of the state has a long and varied intellectual pedigree. In a study of 18 capitalist economies in the 1970s, Cameron (1978) argued that “a high degree of trade dependence is conducive to a relatively large expansion of the public economy” and, further, that “a strong positive correlation … exists between the size of the increase in the public economy and a measure of economic equality”. In the mid-1980s, Katzenstein (1985) pointed out that in the ‘neo-corporatist’ countries of Western Europe strong social democratic parties and powerful union movements had led to a strategy of social compensation and had underpinned openness and competitiveness. Openness did not lead to, nor did it require, a small state or increased inequality. Indeed, in the late 1980s, Castles argued that “democratic capitalism is necessarily and unavoidably the progenitor of big government”.


Into the 1990s, many argued that while these views may have once been relevant, globalisation had made them redundant. This pessimistic view, however, has increasingly come up against the evidence. Garrett pointed out that partisanship continued to shape public spending, sound macroeconomic outcomes and higher levels of equality through the 1980s and early 1990s. Weiss argued that the idea of the powerless state was “a myth” and Rodrik reconfirmed and extended Cameron’s thesis, with a study of more than a 100 countries, contending that there is “a robust association between an economy’s exposure to foreign trade and the size of its government”. He concluded, “government expenditures have been and continue to be essential to provide social insurance against external risk”. Garrett criticised the static correlations of Cameron, Rodrik and others, arguing that it was necessary to consider changes in the level of globalisation over time and to analyse the impact of financial globalisation as well as trade. He found that increased trade globalisation over time had led to slower growth in government spending, but that higher levels of capital mobility had no effect on government spending. Responding to the need for a dynamic analysis of changes in the level of globalisation, Cameron and Kim considered changes in a country’s level of trade. They found that the total level of trade was insignificant for year-to-year changes in the relative size of government. Large increases in the volume of trade were associated with only small increases in the level of government taxing and spending, but large and deteriorating trade deficits “exerted a significant expansionary impulse on government spending across the advanced capitalist world”. Dreher, Sturm and Ursprung investigated globalisation’s impact on the composition of government spending in a sample of 60 countries between 1971 and 2001 and the OECD since 1990. They conclude rather prosaically, “our results indicate that none of the investigated expenditure categories has been robustly affected by any of our globalisation indicators”. This, they argue, is because governments match the disciplining effects of globalisation with compensatory spending, or “the effects of globalisation might be exaggerated in the popular discussion and might simply not exist”.

Colin Clark predicted in 1945 “that about 25 per cent of the national income, or possibly rather less” was “the critical limit of taxation”. Subsequent developments proved Clark wrong as some countries in Europe went well over 50 per cent of GDP. Whether there is an upper limit for capitalism around the levels reached by Scandinavian countries in the 1990s remains to be seen. While the ever-expanding state may have been slowed or even halted in some cases and while welfare institutions have been reshaped to bolster productivity, social spending remains pivotal in the first decade of the twenty-first century. As Cameron and Kim summarise, “the fiscal role of the government remains significant in all [countries] and continues to increase in some”. What is considered to be the appropriate limit of state spending continues to vary throughout the world, based on a combination of partisanship, political institutions, historical legacies, culture and ideology. Changes to outcomes and the composition of spending need to be analysed on a comparative or individual basis to understand how states have adapted to the pressures from the international and domestic domains. Although there are subtle but important differences in the various studies of the relationship between globalisation, taxing and spending, their broad thrust is that the retrenchment predicted has not happened. This is particularly the case in the advanced capitalist countries and is true for both welfare and general government spending. Leibfried and Rieger turn traditional arguments about the limits of the welfare state by arguing that there are limits to globalisation. They contend, “Just as government freedom of action is dependent on ‘globalisation’, the fate of globalisation itself is decided by government action”. Although it was not planned, the welfare state was a vital precondition for post-war globalisation. Instead, it was “an ironic twist of world history”. On this basis, it is possible to surmise that into the future liberal democratic support for globalisation may depend on redistribution.

Globalisation does not mean the end for the state as the financial crisis has made clear; rather, states have developed new ways to govern and generate economic growth. The coming years will provide new challenges for the state as it attempts to deal with a changing set of pressures from the world economy, interest groups and the electoral process. Gourevitch’s prescient plea for the continuing importance of politics, during the turmoil of the 1970s, is just as relevant today:

However compelling external pressures may be, they are unlikely to be fully determining, save for the case of outright occupation. Some leeway of response to pressure is always possible, at least conceptually. The choice of response therefore requires explanation. Such an explanation necessarily entails an examination of politics; the struggle among competing responses. The interpenetrated quality of international relations and domestic politics seems as old as the existence of states.

Constraints on states are now as intense as they have ever been, but not in the sense that state declinists would argue. Instead, the interaction of global and domestic pressures squeezes governments ever more intensely. Anyone trying to understand the role of government in the 2000s must come to grips with this more elaborate structure of constraints and opportunities and move beyond banal assertions that globalisation weakens the state.


References:

David Cameron (1978) “The Expansion of the Public Economy”, American Political Science Review, 72(4), pp. 1253 & 1258.


Peter Katzenstein (1985) Small States in World Markets.

Francis Castles (1988) Australian Public Policy and Economic Vulnerability, Sydney, Allen & Unwin, 1988, p 2.
William Greider (1997) One World, Ready or Not: The Manic Logic of Global Capitalism, New York, Simon and Schuster.

Philip G. Cerny (1997) “Paradoxes of the Competition State: The Dynamics of Political Globalization”, Government and Opposition, 32(2), pp. 251-74;

Susan Strange (1996) The Retreat of the State.

Robert O. Keohane and Helen V. Milner (eds) (1996) Internationalization and Domestic Politics, New York, Cambridge University Press.

Geoffrey Garrett (1998) Partisan Politics in the Global Economy, Cambridge, Cambridge University Press.

Linda Weiss (1998) The Myth of the Powerless State: Governing the Economy in a Global Era, Cambridge, Polity Press.

Dani Rodrik (1998) “Why Do More Open Economies Have Bigger Governments?”, The Journal of Political Economy, 106(5), p. 997.

Adrian Wood (1994) North-South Trade, Employment and Inequality, Oxford, Oxford University Press;

Dennis Quinn (1997) “The Correlates of Changes in International Financial Regulation”, American Political Science Review, 91(3), pp. 531-51.

Geoffrey Garrett (2001) “Globalization and Government Spending Around the World”, Studies in Comparative International Development, 35(4), pp. 3-29.

David R. Cameron and Soo Yeon Kim (2006) “Trade, Political Institutions and the Size of Government” in David R. Cameron et al (eds) Globalization and National Self-Determination: Is the Nation-State Under Siege?, London and New York, Routledge, p. 43.

Axel Dreher, Jan-Egbert Sturm, Heinrich W. Ursprung (2008) “The Impact of Globalization on the Composition of Government Expenditures: Evidence from Panel Data, Public Choice, 134(3-4), pp. 262-93.

Colin Clark (1945) “Public Finance and Changes in the Value of Money”, The Economic Journal, 55(220), p. 376.

Elmar Rieger and Stephan Liebfried (2003) Limits to Globalization, Cambridge, Polity Press, p. 4.

Michael Keating (2004) Who Rules: How Government Retains Control of a Privatised Economy, Sydney, Federation Press.

Peter Gourevitch (1978) “The Second Image Reversed: The International Sources of Domestic Politics”, International Organization, 32(4), p. 911.

Linda Weiss (2003) “Is the State Being ‘Transformed’ by Globalisation” in Linda Weiss (ed.) States in the Global Economy: Bringing Domestic Institutions Back In, Cambridge, Cambridge University Press.