Economics Department

The effect of the size and mix of public spending on growth and inequality

 

The size and mix of public spending can have a considerable effect on growth and inequality. For instance, too large governments tend to reduce growth, unless governments function in a highly effective way. On the other hand, large governments tend to redistribute more, thereby reducing inequality. Also the spending components, such as government investment, family benefits or subsidies matter for growth and inequality. Simulations combining both growth and distributional effects illustrate that most reforms can deliver considerable growth gains and benefit the poor.

Quicklinks to working papers:

 

 

BlogpostMost countries have room to increase public investment 

 

This research is closely linked to Using the fiscal levers to escape the low-growth trap

Background papers

The effect of the size and mix of public spending on growth and inequality

by Jean-Marc Fournier and Asa Johansson


‌Governments in the OECD spend on average about 40% of GDP on the provision of public goods, services and transfers. The sheer size of the public sector has prompted a large amount of research on the link between the size of government and economic growth. Much less is known about the composition of spending for long-term growth and inequality. Reflecting differences in policy 
 objectives, the provision of public services including the degree of redistribution differs considerably among countries. In turn, the composition of spending and its design can have repercussions for growth and the distribution of income. This paper shows that cross-country differences in the size and the composition of spending can potentially explain sizeable differences in the level and distribution of income.

   

 

The positive effect of public investment on potential growth

by Jean-Marc Fournier

This paper provides evidence that the effect of public investment on growth is sizeable, in line with economic theory and the empirical evidence. There is also evidence that in most countries the public capital stock is below its optimal level. This paper also illustrates that the effect of public investment depends on circumstances. It is the highest in fields that are associated with large externalities, such as research and development or health. And it is the lowest in countries where the public capital stock is already high such as Japan. 

 

Trends in public finance: Insights from a new dataset

by Debbie Bloch, Jean-Marc Fournier, Duarte Gonçalves and Álvaro Pina


As governments endeavour to promote growth and address income inequalities in their societies, they turn increasingly to the analysis of the quality of public finance in order to identify the optimal mix of spending and revenue instruments to achieve their goals. A comprehensive set of public finance data, accompanied by related structural indicators, has been assembled in order to facilitate the study of the quality of public spending and receipts, and to assist policy makers in shaping their fiscal policy to promote growth and improve equity. Examples of the potential of these data to provide policy insights have been offered. Characteristics of both country groupings and individual country public finance profiles have been highlighted, along with a sample of cross-country analyses, both over time and across a variety of policy-specific areas. 

 

Public finance, economic growth and inequality: A survey of the evidence

by Asa Johansson

This paper reviews the key issues concerning the impact of public spending and taxation on long-run growth and inequality and takes stock of existing theoretical and empirical studies. Overall, the evidence highlights that too large governments may undermine growth through the cost of financing public spending. A reallocation of public spending towards infrastructure and education would raise income in the long run, whereas increasing social welfare spending can reduce inequality as such spending increases redistribution and risk sharing. Similarly, the available evidence also supports the hypothesis that some taxes are more distortionary than others, with income taxes found to be more harmful for growth than consumption and property taxes. However, a tax shift from income towards consumption taxes has equity implications, since income taxes are generally more progressive than other taxes.

 

Further reading:

 Using the fiscal levers to escape the low-growth trap

 

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