Public spending and taxation

Money buys actions of all sorts. With funds, an individual can satisfy hunger, have better living conditions, get a better education and achieve an improved quality of life. As so often with public policy, it is easy to move from the personal to the political and to assume that what the person can do individually translates into collective benefits. By spending more societies can solve public policy problems, like poor education standards, bad health, transport bottlenecks, the environment and security from terrorist attacks. It is a familiar claim. For across the world, there appears to be evidence that even small amounts of spending can have large impacts on outcomes. For example, it has been calculated that a significant proportion of deaths of under-fives in Sub-Saharan Africa and South Asia could be avoided by the expenditure of as little as $8 on immunisation (for each disability life-adjusted life year – see Jamison et al., 2006: 54). If only it were that simple. Spending money on policy problems involves

coordinating bureaucracies (see Chapter 4) and setting into place chains of cause and effect in the wider society at large. These are the topics of other chapters, but it is the effect of the allocation of public finance to a problem that is of interest in this chapter, and how this may interact with other factors, such as the responsiveness of the bureaucracy and the information capacity of citizens. So it is possible spending increases may be authorised, but may not yield much in terms of benefit to those who need the services and may not fully address the problems that require attention. In many cases, the effect depends on how the money reaches the outside world. In some cases it may be possible to hand the money directly to a client group, such as pensioners or single parent families. But even if the group receives the resources, they may not get a long-term benefit from them. Such income changes may not translate into a better quality of life because of the decisions of the individuals who receive the funds, such as spending money on unhealthy lifestyles, or the money could get spent within bureaucracies rather than on the client group. The stimulating effect of money might get wasted on poor investment decisions and/or higher salaries for those working in the bureaucracy. So public spending increases may not necessarily yield benefits or enough

benefit to justify the cost. On the personal level income is fixed, so individuals

face the problem of allocating income to different spending priorities so their overall welfare is maximised. Governments have the advantage they may vary the amount of spending by increasing or reducing taxes, but in practice they are limited in the extent they can do this because of the political pressures to keep the balance the same and limitations on how much debt they can sustain in the long term. The existing balance between government and private spending may represent trade-offs of welfare between different groups, and the political costs of changing that balance are high. If there are welfare gains of increased expenditure these need to be compared with welfare losses among groups that have higher taxes. Those taxation decisions may reflect decisions to incentivise certain groups to do things, such as volunteering for the public good, which may be disrupted by increasing taxation. Reducing taxation may be seen as an expenditure, a form of publicly directed spending to achieve a policy outcome. There are also costs of increasing expenditure to very high levels because

of the negative effect on the private economy. This is a form of crowdingout whereby extra expenditure reduces economic activity by increasing the costs of borrowing, which then reduces investment and in turn depresses economic growth. If there is no growth in tax receipts, public expenditure cannot keep up with the rise in spending need over time caused by socio-demographic changes like ageing and the rising costs of public-sector provision. Thus there may be costs in increasing public-sector expenditure that are not outweighed by its economic and social benefits. So the question becomes: do marginal increases in public expenditure have beneficial outcomes taking into account the costs of such activity in terms of taxes and incentives and other opportunities forgone? This strategy does not rule out switching expenditure to gain benefits. But

again, as with the private consumer, it is possible to assume governments have sought to reach equilibrium point given their best judgements about the costs and benefits. Switching expenditure may be about a different calculation of the costs and benefits or new information about the benefits of a particular line of expenditure. The most plausible way to look at the general issue as to whether increasing expenditure delivers benefits is when a government or administration enters power with the policy option available of increasing public expenditure, such as when a previous administration has kept spending artificially low. Then it is possible to think through the costs and benefits of that decision. It so happens in the United Kingdom there is such an example. In 1997, the Labour government entered power after 17 years of Conservative governments, which had kept public spending low and had sought to reduce it where possible. After two years where the new government had promised to keep within the previous administration’s spending limits, it decided to increase public spending greatly, especially on the services of education and health. This is an instructive case study, which appears at the end of this chapter. The question is whether the Labour governments (1997-2010) achieved sufficient return on their investment and what special conditions

operated in these circumstances. By looking at the general literature and this special case, it is possible to evaluate the contribution of public funding to generating better policy outcomes when there is a change in political preferences.