Economic freedom and the size of government, or does paying taxes boost freedom?

That is a new and provocative paper by James Edward Mahon Jr. of Williams College, the abstract is here:

This paper explores the relationship between government size and economic freedom, relating these patterns to theories of fiscal politics. In order to address current political controversies, it uses data on pre-1990 OECD members (minus Norway) for central government tax revenues and spending, as well as indicators of economic freedom derived from the Fraser Institute, ICRG, Heritage Foundation, and the World Bank. It finds that it matters a great deal whether we define size as expenditures or taxation. Spending has no relationship with freedom, or a negative one, across this data set. Initial tax revenue levels, however, positively predict subsequent changes in economic freedom. We find similar patterns using different measures of economic freedom and whether we use annual data (1995-2010) or overlapping six-year averages going back to 1970-75. These results challenge the common preconception that taxes and economic freedom are negatively related. In addition, the divergence between tax revenue and spending in this regard is more consistent with a “fiscal contract” model of the state, in which taxation and economic freedom go together, as governments attend to their legitimacy and the health of the private sector in order to increase revenue, but flag in these efforts when they enjoy sources of income other than taxes.

For the pointer I thank the excellent Kevin Lewis.

Comments

I have a theory on this. I think that the overlapping generations might know each other, even be friends. I have evidence that they might even be family related. Hence the likelihood that they can get the taxes and transfers done fairly if pundits get out of the way.

Predicts changes in or levels of freedom, surely we want the latter?
https://xkcd.com/1102/

If it predicted levels but not changes, that would raise identification concerns. That is, if high tax revenues were only associated with high future freedom, but not high changes in freedom, then that means that the identification is coming only from the contemporaneous correlation between the two. In that case, we wouldn't know which way the causality runs. But if it predicts changes, then that gives us more information.

In short, predicting levels doesn't give any information about causality. Predicting changes does.

Poster boys for this would be the Nordic economies, notorious for their high tax rates, but which consistently come up as among the freest and best for business of any economies in the world, with their big negatives always being their high taxes. Of course, there are some very free economies with low taxes, e.g. Hong Kong and Singapore, so the result is not at all obvious and certainly goes against what most people expect.

The Nordic countries improved on economic freedom, because they got so socialists that their economies were on the brink of collapse in the 90s. Sweden had to scale back due to the economic crisis if 1990. In contrast Hong Kong doesnt have much room left to further improve its economic freedom scores.

Or to put it another way, usually the kid with the most improved award isn't winning any others.

The result also depends on the measure and definition of economic freedom. If low taxes are a criterion of economic freedom, which seems plausible to me since my economic freedom is reduced if a large portion of the product of my labor is taken from me, then high taxes are negatively correlated at least to that measure of economic freedom.

Tax revenue and tax rates are two very different things.

- If high tax rates worked, India would be a paradise:
http://www.devilsdictionaries.com/blog/tax-the-rich-to-kill-the-poor

- So would be Chad:
http://www.devilsdictionaries.com/blog/chad-progressive-paradise

High tax rates do not create prosperity. Freedom, however, brings about prosperity AND high tax revenues.

what the hell is freedom

Perhaps fox is being ironical here, but I think I am seeing more and more of this "but what is freedom" stuff from the left these days. It's as if they have finally given trying to hold that bit of political high ground and are trying to burn the fields as they retreat.

BTW: Freedom is when you are allowed to do stuff you want to do.

Your definition of freedom is fine, as far as it goes, but how does one measure something as amorphous as "doing the stuff you want to do"?

Wouldn't many libertarians object to that definition? I believe "Freedom to not have other people do things that you don't want them to do because they effect you" is closer to what a lot of the people who worry about this the most think. Noses and fists and stuff.

@Enrique, mavery: Yes, even after you raise the banner of freedom there is much left to work out and an endless space for disagreement. Yet the left seems to be retreating from that whole vast space.

Comments like fox' ostensibly make the first point, but they also unwittingly make the second by revealing an insecurity on the left. That's shown by their need to keep pointing out the flexibility of the idea of freedom, while at the same time slyly denigrating it. It ain't libertarians and free marketers who have to remind people "Hey, we're for freedom too, and, what the hell is freedom anyway?".

It's almost as if both sides know that if you start with generally pro freedom stance and then make an honest attempt at working applying it to the real, imperfect, complicated world, then you will end up closer to the people who are generally skeptical of rules and restrictions than your will be to people who want government to control things in detail using whatever restrictions are expedient.

"what the hell is freedom"

Relative to taxes, it would be true "voluntary" payment of money to the government at the citizen's discretion. Most all people willingly pay for goods/services they choose to consume in the non-government sector of the economy; it's not a bizarre concept.

Taxes always imply coercive non-voluntary takings of assets (non-freedom by definition). Governments generally claim their taxation is voluntary overall, but we all know what government tax receipts would look like if the penalties were abolished for non-payment of taxes.

Total Spending is the correct measure of government fiscal activity. Taxes are just the obvious leg of the government revenue triad. Borrowing and Inflation are the other more subtle legs, but the citizens always pay all the government spending costs eventually.

But this study finds that high tax revenues precede increases in freedom. This suggests that the "freedom => tax revenue" story may get the causality backwards, which is what makes the paper interesting.

Dismiss the tunnel vision on "taxes". Key factor is instead how much wealth the government extracts from the private economy; total government spending is the much better metric for that.

And that study stated: "Spending has no relationship with freedom, or a negative one, across this data set."

So key metric of government spending is not positive for economic freedom, in their analysis.

I wonder if it is that countries with higher taxes tend to have a more progressive method for their extraction of wealth from the private economy? Could it be that the fact that they are potentially taking a higher percentage of that "key metric of government spending" from the well-to-do that leads to an overall higher freedom for the (presumably entire) nation?

I suppose it would depend on what those tax revenues are used for: for an army to expand the empire or for public goods that improve both quality of life and productivity (e.g., education and infrastructure). In his zeal to emphasize the issue of aggregate demand and to promote fiscal stimulus, Professor Krugman famously (or maybe not so famously) said aggregate demand is aggregate demand, whether for household goods at Walmart or for yachts and mansions in the Hamptons. To be fair, Krugman made his comment in the context of the Great Recession. But I would argue that what those tax revenues are used for does make a difference, both in the case of economic freedom and aggregate demand (i.e., economic growth and prosperity). Here's the great paradox (for America): as America has become more diverse and as certain groups have promoted diversity (in the university, at work, in the government), the public has become less inclined to support spending for public goods that improve both quality of life and productivity. And here's another paradox: countries with greater cohesion (less diversity) tip the scales at the polar extremes, in the one case spending those tax revenues for an army to expand the empire and in the other case spending those tax revenues on public goods that improve both quality of life and productivity, with less economic freedom in the former case, more economic freedom in the latter. Go figure.

"Economic freedom" as defined, at least partially, by two conservative policy groups seems to be stacking the deck.

Stacking the deck, in favour of high taxes?

Yeah, it would seem that stacking the definition deck in a more conservative direction makes the finding that much more remarkable.

Actually, the Heritage and Fraser indices tend to put a fairly low weight on taxes and spending, 20% of the total score for Heritage, and I think even less for Fraser, which is how countries like Denmark can score fairly high despite insanely high taxes and spending.

More "what is freedom?" from the left.

If I'm reading this right, high revenues but low expenditures results in freedom. In other words, not running a deficit.
That could make some sense.

Yes. A government that doesn't run a deficit and adjusts spending to revenues is open to the discipline tax revenues as a result of it's policies.

This has been a characteristic of the northern democracies resulting from economic stagnation and close to default conditions from the 80's.

The problem is that the inexorable increase in the cost of government, even if constrained, is now a competitive burden in the globalized world. A Swedish manufacturer has to represent the cost of a government that takes more than half of the economic activity. A Canadian manufacturer has 44%, a US manufacturer has just over 40%. Yes there are services provided in that 40%. But that is a pretty big overhead to start with.

The result of this very tight tension is interesting, I live it.

Health care as a service is as bad as it can be, with low price tag items becoming available through third parties, higher priced stuff with waiting lists.
More and more of the services that were paid by government are now either user fees or not offered.
Regulation is more observed in the breach. There are more laws and regulations in my jurisdiction, but the only ones that are enforced are those where a failure results in a fatality or newspaper front page.
Natural resource development is more and more a primary driver of the economy, with much of the other sectors essentially being services to that industry. The oil industry requires a substantial and vigorous financial industry, for example, as well as manufacturing.
Government action is apparent in day to day life only in the aspects that are essential. Border control with the associated passport stuff, tax collection, policing. Environmental stuff is either focused on large industry or as a service to the tourism industry.
Wages for government workers are pretty bad, and no one is being trained.

It has been a pretty good run, and the growth in the worldwide economy has allowed the growth of government expenditures paid by increased economic activity. I think it has run it's course however. The EU structures were similar and have worked ok, but now are being challenged fundamentally. The things they haven't been buying, such as provision for the defense of the realm, training of the next generation of managers, infrastructure maintenance and construction have been put off because it could be put off. Now the bills are due, but the money is spent.

Hmm, "minus Norway," saying that "enjoy[ing] sources of income other than taxes" is bad. So essentially, "the resource curse is real, but Norway seems to have escaped it so we'll exclude them?" Norway's oil money makes them an outlier in lots of ways.

High taxes may indicate the government has used the tax system to achieve certain policy ends, rather than keeping taxes low but achieving those ends through extensive regulation. For instance, a pollution tax versus detailed emissions and building regulations for your factory

Yep.

Lets say that some law of electoral dynamics means that the government every rich democracy must do roughly the same amount of stuff. Then raising taxes as buying your desired outcome requires only one form compulsion. Whereas regulating it into existence involves myriads.

The avatar for economic freedom has for decades been Hong Kong. The Heritage Foundation, for one, chooses to ignore the fact that one cannot own land in HK, it can only be leased from the government--this functions essentially as a surrogate for taxation that would otherwise be tallied as a detriment to economic freedom. Shouldn't this revenue be taken into account? (Not to mention that a statist fiat declaring land ownership verboten is kind of anti-freedom in the first place.)

"kind of anti-freedom"

More like antithetical to the fundamental Western understanding of freedom and liberty predating the US and French revolutions, which both viewed property rights as fundamental to freedom (though the French revolution moved quite a bit from thin some respects in the months and years after The Declaration of Rights of Man came out).

Don't pay your property taxes around here and you'll find out if you own your land or not.

At least you can improve it and sell for a profit though.

Freedom could be stuff they have in Europe like school choice, freedom of speech without tax authority retribution, a private health insurance sector that is not a mere extension of the public health industry, the ability to open a business without having to bribe local zoning authorities, comprehensible and non-arbitrary regulations, reasonable penalties for criminal actions, a percentage of the population in jail that is not shameful, functional bankruptcy operations which are not overridden for politically connected parties, you know, the kind of stuff we can only dream of in the US.

This seems to be a very odd mix of things that either 1) varies greatly by which European country you're referring to or 2) is just as 'bad' if not worse in most European countries.

This fits in with how I feel. I don't find paying taxes particularly annoying. The fact is that I'm left with most of my money and government does do things I support. What I find onerous is being told that I can't do something that I find meaningful or beneficial without being penalized by the government for it. Of course, I understand that I can't always have my way, but some petty tyrants seem determined to never let me be ( a bit exaggerated ).

Roughly true, but there is a Good Trick embedded in income tax.

I don't find paying tax annoying, because I think of my after tax income as my salary. I don't usually think of the much larger amount of euros that my employer pays. I only get annoyed about taxes when I try to put myself in his shoes -- but since I can't help being me as well, I see both ends and the gap between them.

I think it was Pat Buchanan, of all people, who said this for the United States. When taxes are low, people see government as cheap, and want more of it, and so the leviathan grows.

But when people see that government is expensive, they get out the knives to pare it down.

IIRC he was saying it to discourage borrowing, which seems a key distinction that the paper also makes.

I guess Canada must be an outlier then. We have improved our economic freedom ranking while cutting the size of government dramatically and lowering taxes. We also ended deficit spending and as of this fiscal year will be running surpluses again.

We used to rank far below the United States when our tax rates were much higher and our government consumed 53% of GDP and our debt was 70% of GDP. Now we rank significantly above the United States, which has increased government spending and taxes while we reduced ours. The U.S. has fallen completely out of the top 10 countries on the economic freedom scale, while raising taxes, tax revenue, and increasing the debt to GDP ratio.

So unless both countries are outliers, this seems rather hard to reconcile.

One implication of this argument is that the poor should pay more taxes.

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