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ECONOMETRIC TESTS INCENTIVIST: Growth negatively related to the marginal tax rate on innovation. ACTIVIST: Growth positively related to state support of R&D and subsidy of the return on capital. Data: growth rate over three decades (1970s, 1980s, and 1990s) for 100 countries; 300 panel observations (some missing).
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Public Spending and Growth
by Patrick Minford and Jiang Wang
TWO VIEWS
• Endogenous growth, public spending and taxes: two views
• R&D, education and infrastructure spending by the state creates new factor input; hence growth. ‘ACTIVIST’
• Incentives generate risk-taking innovation by people/firms. Lower taxes raise incentives; hence growth. ‘INCENTIVIST’
ECONOMETRIC TESTS
• INCENTIVIST: Growth negatively related to the marginal tax rate on innovation.
• ACTIVIST: Growth positively related to state support of R&D and subsidy of the return on capital.
• Data: growth rate over three decades (1970s, 1980s, and 1990s) for 100 countries; 300 panel observations (some missing).
The negative impact of taxation on economic growth
Author Data coverage Main explanatory variables Comment
Barro (1991) 98 countries in the period 1960-1985
Human capital, govt. consumption, political instability indicator, price distortion
1% point of GDP increase in tax to GDP ratio lowers output per worker by 0.12%.
Koester and Kormendi (1989)
63 countries for which at least five years of continuous data exists for the 1970s.
Marginal tax rates average tax rate, mean growth in labour force & population
10% decrease in marginal tax rates would increase per capita income in an average industrial country by more than 7%.
Hansson and Henrekson (1994)
Industry-level data for 14 OECD countries
Govt. transfers, consumption, total outlays; education expenditure; govt. investment
Govt. transfers, con-sumption and total outlays have a negative impact on growth whilst government investment is not significant
Cashin (1995) 23 OECD countries over the 1971-1988 period.
Ratio of public in-vestment to GDP, ratio of current taxa-tion revenue to GDP, ratio of expenditure on transfers to GDP.
1% point of GDP increase in tax to GDP ratio lowers output per worker by 2%.
Engen & Skinner (1996)
US modelling together with a sample of OECD countries.
Marginal tax rates, human capital, investment.
2.5% point increase in tax to GDP ratio reduces GDP growth by 0.2% to 0.3%.
The negative impact of taxation on economic growth
Author Data coverage Main explanatory variables Comment
OECD - Leibfritz, Thornton & Bibbee (1997)
OECD countries over the 1965-1995 period.
Tax-to-GDP ratio, physical and human capital formation and labour supply.
10% point increase in tax to GDP ratio reduces GDP growth by 0.5% to 1%.
Alesina et al. (2002) 18 OECD countries over the 1960-1996 period.
primary spending, transfers, labor taxes, taxes on business, indirect taxes, govt. wage consumption (all in share of GDP).
1% increase in govt. spend-ing relative to GDP lowers the investment-to-GDP ratio of 0.15% and a cumulative fall of 0.74% after 5 years.
Bleaney, Gemmell & Kneller (2000)
17 OECD countries over the 1970-1994 period.
distortionary tax, pro-ductive expenditure, net lending, labour force growth, invest-ment ratio.
1% point of GDP increase in distortionary tax revenue reduces GDP growth by 0.4% points.
Folster & Henrekson (2000)
Sample of rich OECD / non-OECD countries over the 1970-1995 period.
Tax-to-GDP, govt. expenditure-to-GDP, investment-to-GDP, labour force growth, human capital growth
10% point increase in tax to GDP ratio reduces GDP growth by 1%.
Bassanini & Scarpetta (2001)
21 OECD countries over the 1971-1998 period.
Indicators of government size and financing, physical capital, human capital, population growth.
1% point increase in tax/GDP ratio reduces per capita output levels by 0.3% to 0.6%.
Below each parameter estimate, we report its robust standard error. Three asterisks denote statistical significance at the 1% level, two asterisks at the 5% level and one asterisk at the 10% level.lnGadj = ln(G+0.04) due to the possible negative value of G for some countries. Observations with growth less than –0.04 (-4% per annum) are omitted as outliers with special reasons (such as civil wars etc)
Dependent var is lnGadj
Cross-sectional regression
Random country effect (with fixed time effect)
Fixed country and time effects
lnr -0.4131001***0.0660606
-0.4089624***0.0675931
-0.27778890.2114343
constant -3.598126***0.119624
-3.665844***0.1186308
-3.47297***0.2984599
R2 0.1383 0.1596 0.1552
observations 295 295 295
Table 1
Figure1: Correlation between growth rate in real GDP per capita and tax rate
r
G Fitted values
.066607 1.4168
-.091544
.113574
lnr
lnGadj Fitted values
-2.70894 .348397
-8.70034
-1.87357
Table 2: Initial value of GDP per capita ― lnG0 Dependent var is lnGadj
Cross-sectional regression
Random country effect (with fixed time effect)
Fixed country and time effects
lnr -0.4585302***0.077744
-0.450433***0.0914043
-0.31334330.2046511
lnG0 -0.03885170.0463611
-0.03882470.0544193
-0.66156***0.175467
constant -3.343886***0.3531412
-3.200959***0.3710283
2.0365311.429603
R2 0.1403 0.1596 0.0177observations 295 295 295
Table 3: Initial value of human capital variable ― lnhc0 Dependent var is lnGadj
Cross-sectional regression
Random country effect (with fixed time effect)
Fixed country and time effects
lnr -0.3359003***0.0635351
-0.2824532***0.1006879
-0.15139850.1633693
lnhc0 0.0982599*0.0585831
0.191008**0.0859461
0.05577510.1579874
constant -3.605208***0.1316414
-3.506455***0.1541899
-3.141061***0.3213641
R2 0.1533 0.1874 0.1613observations 295 295 295
Table 4: Initial value of physical capital variable ― lnpc0
Dependent var is lnGadj
Cross-sectional regression
Random country effect (with fixed time effect)
Fixed country and time effects
lnr -0.2284145***0.0737142
-0.2201459**0.098377
-0.29422350.2092666
lnpc0 0.01257490.0456652
0.03101930.0414442
-0.01115470.1666652
constant -3.401858***0.3538077
-3.390082***0.30208
-3.147642**1.469304
R2 0.0676 0.1166 0.1018observations 295 295 295
Table 5: Ratio of investment/GDP ― lninvest
Dependent var is lnGadj
Cross-sectional regression
Random country effect (with fixed time effect)
Fixed country and time effects
lnr -0.1853692***0.0658581
-0.2010656***0.0806375
-0.2282440.2120415
lninvest 0.3552623***0.0785507
0.329507***0.0773946
0.2688975*0.1501412
constant -4.227441***0.2126837
-4.076769***0.1814519
-3.944269***0.4867979
R2 0.2060 0.2183 0.2167observations 295 295 295
Table 6: Adding lnG0, lnhc0, lnpc0 and lninvest Dependent var is lnGadj
Cross-sectional regression
Random country effect (with fixed time effect)
Fixed country and time effects
lnr -0.1906314***0.0626646
-0.1770296*0.0963501
-0.03103330.1550151
lnG0 -0.1534513**0.0782778
-0.274614***0.0921151
-1.328827***0.1914185
lnhc0 0.10606420.1085019
0.1394630.1128301
-0.05234430.1963471
lnpc0 -0.04259980.0595577
0.03381310.0710202
0.5468776***0.1519144
lninvest 0.3883018***0.0975898
0.371204***0.1254544
0.4716634***0.1684907
constant -2.790863***0.4433326
-2.349998***0.4931368
2.30601*1.386747
R2 0.1769 0.1859 0.0070
observations 295 295 295
Table 7: Results for the activist approach Dependent var is lnGadj
Cross-sectional regression
Random country effect (with fixed time effect)
Fixed country and time effects
KSUB -0.03288740.0281843
-0.0428637**0.0192169
-0.0651416**0.026076
HSUB -0.0172619**0.0080792
-0.00742870.007605
-0.00165910.010384
constant 0.0291336***0.0047852
0.0268741***0.0058173
0.0229654***0.0069056
R2 0.0567 0.0454 0.0164observations 122 122 122
Figure 2 Correlation between GDP growth rate and subsidy rate to investment
KSUB
G Fitted values
-.638728 .628834
-.091544
.080092
Figure 3 Correlation between GDP growth rate and subsidy rate to R&D
HSUB
G Fitted values
.029 1
-.039833
.113574
Table 8: Initial value of GDP per capita ― G0 Dependent var is lnGadj
Cross-sectional regression
Random country effect (with fixed time effect)
Fixed country and time effects
KSUB -0.03367050.0280481
-0.0439847**0.0194498
-0.050478*0.0278378
HSUB -0.01505290.0100392
-0.006690.0078479
0.00441650.0104769
G0 1.58e-073.25e-07
1.03e-073.65e-07
-1.36e-069.57e-07
constant 0.0263072***0.0090049
0.0257932***0.0067726
0.0308422***0.0088099
R2 0.0590 0.1510 0.0048
observations 122 122 122
Table 9: Initial value of human capital variable ― hc0
Dependent var is lnGadj
Cross-sectional regression
Random country effect (with fixed time effect)
Fixed country and time effects
KSUB -0.03213320.0260735
-0.0446653*0.0189903
-0.0621612**0.0252276
HSUB -0.00778160.0093707
-0.00107780.0079445
-0.00016380.0105279
hc0 0.0017704**0.0008503
0.0024214***0.0009453
-0.0035290.0029477
constant 0.01206230.009843
0.00912070.0082923
0.0438552**0.0186494
R2 0.0907 0.0991 0.0252observations 115 115 115
Table 10: Initial value of physical capital variable ― pc0
Dependent var is lnGadj
Cross-sectional regression
Random country effect (with fixed time effect)
Fixed country and time effects
KSUB -0.0739059**0.0345323
-0.0763963***0.00223675
-0.0492111*0.0258339
HSUB -0.0227255**0.0115609
-0.0163448*0.0090925
0.01995140.0158965
pc0 -3.46e-07**1.59e-07
-3.67e-071.61e-07
-1.00e-06**4.6e-07
constant 0.0417207***0.0097311
0.0401149***0.00743
0.0275565***0.0104124
R2 0.1684 0.2006 0.0282observations 91 91 91
Table 11: Ratio of investment/GDP ― invest Dependent var is lnGadj
Cross-sectional regression
Random country effect (with fixed time effect)
Fixed country and time effects
KSUB -0.02987950.0222218
-0.0398512**0.0170956
-0.064688***0.0249827
HSUB -0.00019290.0077747
0.00166560.0069521
0.00480420.0100272
invest 0.1299014***0.0192989
0.1271213***0.0217512
0.1330205***0.0530812
constant -0.0077780.0073933
-0.00664790.0077625
-0.01030570.0148337
R2 0.3676 0.3693 0.3524observations 122 122 122
Table 12: Adding G0, hc0, pc0 and invest Dependent var is lnGadj
Cross-sectional regression
Random country effect (with fixed time effect)
Fixed country and time effects
KSUB -0.05964850.0382799
-0.0678567***0.0209594
-0.04005690.0258894
HSUB -0.01143240.0103655
-0.00558150.0090662
0.01881480.0153496
G0 -2.56e-075.12e-07
-5.18e-076.29e-07
-2.98e-06*1.58e-06
hc0 0.00061720.0011025
0.00031540.0012224
-0.00169110.0029981
pc0 -4.22e-07***1.34e-07
-3.78e-072.61e-07
-1.39e-086.35e-07
invest 0.1003211***0.0265871
0.1270069***0.0300039
0.1134434*0.0596572
constant 0.01286210.0123803
0.00453070.01179
0.02302410.0280673
R2 0.3001 0.3406 0.0699
observations 89 89 89
CONCLUSIONS
• Tax elasticity of -0.4; meaning for initial tax rate of 40% and growth rate of 2.5%. Fall in marginal tax of 10% (ie to 36%) raises growth by 0.1% to 2.6%.
• No evidence in this data of effects of state spending on R&D or on subsidy to investment.
• Further work on structural models required.
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