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Government and economic growth: Does size matter?

4  Size and structure of government in New Zealand

The previous sections highlight that, according to theory and empirical evidence, both the level and mix of government expenditure and revenue matter for growth. This section looks at how the level and composition of expenditure in New Zealand compares with other countries and how it has changed over time.

4.1  Challenges in making international comparisons

Making international comparisons of the size and structure of government is not straight forward. Government impacts on the economy through a range of interventions: it raises and spends money; it legislates and regulates the activities of households and businesses; and it owns social and commercial assets. Though this section focuses on measures of expenditure and revenue, these should not be seen as comprehensive measures of size, for which we do not currently have a single indicator.[10]

Comparisons of total expenditure and revenue across countries are complicated. One issue is that the allocation of responsibilities across government levels can vary significantly (see Figure 4), so that making comparisons of central government expenditure across countries is misleading. In particular, as New Zealand has a very high share of central government expenditure relative to other OECD countries, a comparison that omits lower levels of government would tend to over-estimate our relative size. Therefore, to enable comparisons between countries with different degrees of centralisation, we use measures of government expenditure and revenue that include all levels of government.

There are other complications in ensuring we are comparing like with like that are less easy to resolve. In particular, to make international comparisons we rely on data from international organisations, with the OECD System of National Accounts (SNA) and IMF Government Financial Statistics (GFS) as the most robust sources. However, these organisations are reliant on information provided by member countries and different countries have different conventions for defining the scope of the public sector. To further complicate matters, though they are similar conceptually, there are differences between the OCED and IMF estimates of general government expenditure. Though the differences are relatively small for most countries, they are significant for New Zealand reflecting the different processes through which the measures are complied. We tend to focus on the OECD-sourced data as New Zealand has a more robust ‘bottom-up' process for compiling this data, and it is available on a more timely basis. However, there are still caveats around the OECD measures and limits to their consistency across countries, which mean we can only draw broad conclusions about differences in government size.[11]

Figure 4 – Government expenditure at different levels
Figure 4 - Government expenditure at different levels.

In addition, many countries make use of expenditure mandates and tax expenditures, which are very close substitutes for expenditure and should really be counted as expenditure for the purposes of international comparisons (see Box 4). However, comparable estimates of the value of expenditure mandates and tax expenditures are not typically available.

To compare ‘like with like' we also have to ‘normalise' expenditure and revenue to take account of differences in size and incomes between countries. The main focus of this paper is on expenditure and revenue as a percent of GDP. This seems particularly relevant for looking at the impact of ‘size' of government on the economy as it is a measure of the proportion of the economy's output or income that is being absorbed by government activities.[12] However, we do look at some per capita measures of expenditure for an alternative perspective.

Box 4: Tax expenditures and expenditure mandates

The government can spend in a variety of ways. Instead of directly spending, i.e. through a cash payment, governments sometimes achieve their objectives by reducing tax obligations (tax expenditures) for a specific group or type of economic activity or by regulating households or businesses to spend money (expenditure mandates). Tax expenditures and expenditure mandates aim to achieve economic, social or environmental policy objectives and in some cases may be able to be replaced by a more transparent direct expenditure programme (Fookes, 2009). Therefore, they lead to an under-estimation of the size of government as they create a new programme with no measured spending. As they are a direct substitute for government expenditure, they should really be counted in a measure of size of government (OECD, 2010).

A number of countries attempt to estimate the value of their tax expenditures, although there are less estimates of the cost of expenditure mandates. Even where estimates exist, international comparisons are complicated by the lack of international agreement on the objectives, scope, or methodology for reporting tax expenditures (Adema and Ladaique, 2009). New Zealand published a tax expenditure statement with the 2010 Budget, which focused on tax expenditures that represent a clear policy-motivated exemption to current tax practice (Treasury, 2010b). These expenditures have a fiscal cost through a reduction in tax. However, New Zealand has comparably few tax expenditures or expenditure mandates and many are relatively small in size (Fookes, 2009). Therefore, if we were able to adjust fully for their impact across countries, New Zealand's government would look relatively smaller on international comparisons.

These mechanisms complicate comparisons even just across the Tasman. New Zealand has much higher spending on social protection than Australia. However, much of this difference may reflect the use of different mechanisms for funding retirement incomes. In particular, Australia funds a significant chunk of pensions through a mandated employer and employee contribution scheme. It provides only a means-tested pension through the Budget, while New Zealand has a universal basic pension. Australia also provides a number of tax subsidies to encourage private savings, which are much larger that New Zealand's KiwiSaver subsides. If the value of Australia's expenditure mandates and tax expenditures could be taken into account, then the Australian government may no longer seem so much smaller than our own.

Notes

  • [10]There are some international surveys of regulation in which New Zealand typically rates well. For example, New Zealand ranks first in the OECD, and third in the world, in the World Bank's Ease of Doing Business survey. However, other countries have been doing more to improve some areas of regulation. New Zealand slipped from 4th to 14th in OECD rankings for product market regulation between 1998 and 2008.
  • [11]For example, the OECD measure may over-state the relative level of New Zealand's general government expenditure as we are one of the few countries that do not consolidate transactions between levels of government.
  • [12]Though it is marginal rather than average tax rates or shares that will influence private sector investment or work choices, GDP shares are often used as a proxy in the absence of comparable marginal tax rate data.
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