How Big is Government?

For years the great economist Milton Friedman used to say that the correct measure of the size of government is not total taxes, but total spending. That is because spending is a truer measure of the resources government is taking out of society, especially when there is a large budget deficit. However, in a time of budget surpluses, Prof. Friedman's analysis needs updating. Simply looking at spending is no longer an adequate measure of the size of government. Nor is just looking at on-budget revenues a sufficient measure of taxation.

How is the cost of government growing? Let me count the ways.

According to the federal budget, next year the federal government will spend only 19.7 percent of gross domestic product compared to 22.6 percent in 1991. Thus, looking only at spending, we are misled into thinking that government is shrinking. But while spending, especially for defense, has fallen, taxes have risen sharply upwards–total federal revenues consumed just 18 percent of GDP in 1991; next year they will consume 20.6 percent. Thus while government may appear to be somewhat smaller today than it was a few years ago, the decline in spending has been largely offset by higher taxes.

Just looking at the revenues listed in the budget, however, greatly understates how much the federal government takes out of peoples' pockets. That is because the budget excludes many payments people make to the federal government that are not counted as revenues; rather they are treated as "offsetting receipts" or "negative spending". For example, Medicare Part B premiums paid by taxpayers are treated this way, thus reducing government receipts by more than $20 billion per year. When you add together all of the excluded receipts, total federal revenues are actually more than $100 billion higher than indicated in the budget.

Another way the budget understates the burden of taxation is by excluding what economists call the "excess burden" or "deadweight cost" of taxes. These terms refer to the economic output that is reduced by having a tax system that discourages work, saving and investment. A common estimate is that the economy is reduced by about 10 percent of revenues collected. With federal revenues at $1.8 trillion this year, that means we are losing at least $180 billion in GDP. In other words, if we collected this same $1.8 trillion in a way that made economic sense–such as a flat-rate consumption tax–we would have $180 billion more output this year. This figure should also be counted as part of the tax burden.

Of course, government regulation is also a kind of tax. If the federal government forces a business to spend thousands of dollars to comply with some regulation that adds nothing to the business' output, then that outlay is little different from a tax to that firm. Similarly, if an individual has to spend dozens of hours filling out his tax forms or spend hundreds of dollars paying an accountant to do it, then this is also a form of implicit taxation. Estimates commonly put the burden of federal regulation at $100 billion per year. So this too is a part of the tax burden.

Finally, the government takes resources out of the private economy through various off-budget programs. These mainly consist of credit and insurance programs. For example, the government has numerous programs that provide credit to homebuyers and others at below-market rates. That subsidy is paid for by other borrowers who have to pay higher interest rates than they would pay if the government credit program did not exist. It is impossible to quantify how much additional interest businesses and individuals pay each year. However the amount must be large since the federal government controls more than one-third of all the credit in the U.S., and this figure has been rising despite a decline in the budget deficit. And given the size of the U.S. capital market, even adding hundredths of a percent to the interest rate we pay quickly adds up to billions of dollars in higher interest payments by individuals and businesses.

Thus we see that simply looking at revenues or spending as a share of GDP really gives us a very incomplete picture of the burden of government. A more complete picture must include offsetting receipts, the excess burden of the tax system, the cost of regulation and various off-budget programs as well. All are legitimately part of the burden of government because they force us to spend our money or time in ways decided by government rather than ourselves.

Looking at the burden of government in this broader sense, the government has not gotten any smaller, but in fact has grown despite what the raw budget figures tell us.

The National Center for Policy Analysis is a public policy research institute founded in 1983 and internationally known for its studies on public policy issues.