Posts Tagged ‘Rahn Curve’

It’s not that much fun to be a libertarian, at least if you work in public policy.

You spend your days hoping that “Public Choice” can be overcome, which means you’re laboring to fulfill Sisyphean tasks.

  • Trying to convince politicians and bureaucrats to voluntary give up power and control over the economy. Good luck with that.
  • Trying to convince voters that it’s not right use government coercion to steal other people’s money. An increasingly hard task.

Needless to say, these are not easy tasks, which is why most of my time is spent playing defense. In other words, I’m trying to prevent government from getting even bigger.

But what if there was an opportunity to wipe the slate clean and start all over? Imagine a libertarian fantasy world, where proponents of freedom decide the proper size and scope of government?

Well, that fantasy world exists, sort of. It’s called Liberland, an island in the Danube River that isn’t claimed by either Serbia or Croatia. So a group of libertarians, led by Vít Jedlička, claimed the island and announced the creation of the Free Republic of Liberland.

That’s the good news. The bad news is that neither Serbia nor Croatia recognize Vit’s claim. Indeed, Croatian police arrest people who set foot on the island, which is rather strange since Croatia says the island isn’t Croatian territory (Wikipedia has the details on Liberland’s status).

Notwithstanding these obstacles, the Liberland community is relentlessly hopeful of a good outcome. Indeed, they just held a conference to mark Liberland’s second anniversary.

And I was asked to speak about the ideal fiscal policy for this new country. Here’s my speech, which begins with a discussion of government as a “stationary bandit” and then explores some of the theoretical issues of setting up a freedom-oriented society.

Yes, I realize I’m talking about the theoretical nature of a theoretical state, but I very much enjoyed this opportunity to engage in a Walter Mitty-style dream about how Liberland might operate.

And I even had Liberland’s president as an assistant for my talk.

After spending the first part of my speech contemplating the theoretical nature of a Liberland government (or private governance), I spend the last part of the speech explaining that the public sector should be very small because there are very few genuine “public goods.”

I discussed the Rahn Curve and cited the data showing that the federal government was a very tiny burden for much of America’s history.

I also pointed out that the burden of government was similarly modest in other western nations during the 1800s and early 1900s, which was when those countries went from agricultural poverty to middle-class prosperity.

And I pointed out that taxation would be a trivial issue if Liberland came into existence and has a very small government.

For those interested in the idea of new libertarian societies, there’s “seasteading.”

Seasteading, the concept of building freer societies upon unincorporated parts of the world’s oceans, is one of those so-crazy-it-just-might-work ideas within liberty/stateless circles. Long discussed, presented, talked about, mulled over, most cranks like myself mentally pocketed the idea years ago. Compelling enough, definitely, but it seemed wishful, immediately impractical. …The concept of seasteading really begins in earnest with Patri Friedman, grandson of Nobel Laureate Milton Friedman. The third generation Friedman doesn’t shy away from his famous lineage, which also includes anarcho-capitalist philosopher father David Friedman. …Mr Friedman vowed to take theory into practice. Real world. Right now. He, along with gadfly investor Peter Thiel, founded The Seasteading Institute. …The Seasteading Institute has inked a deal with French Polynesia for a trial city off their shores. It’s happening.

And “special economic zones” are another example of libertarian-style governance.

…two kinds of special jurisdictions — private communities and “Special Economic Zones” — are quietly taking over functions and providing options that traditional polities cannot or will not. This gentle revolution has already brought comparative wealth and better living to millions of people… In a Special Economic Zone (SEZ), a government creates exceptions to its own rules — a select haven from the status quo that prevails elsewhere in the national territory. The goal, says the World Bank, is to create a “business environment that is intended to be more liberal from a policy perspective and more effective from an administrative perspective than that of the national territory.” …The antecedents of modern SEZs date from 166 BCE, when Roman authorities made the island of Delos a free port, exempting traders from the usual taxes in order to stimulate local commerce. …The astonishing growth in SEZs qualifies as a revolution of sorts, but not the usual, political kind. Instead of being imposed by domestic or foreign enemies, this revolution has come from within, allowed or even encouraged by existing authorities.

And here’s a video about Liberland for those interested.

Let’s close with some wonkiness by looking at some academic research about fiscal policy and the evolution of government.

We’ll start with some excerpts from Tanzi and Schuknecht’s analysis of Public Spending in the 20th Century.

Classical economists thought that the government’s role should be limited to national defense, police, and administration because government “cannot have any other rational function but the legitimate defense of individual rights” (Bastiat, 1944–5). …For classical economists, the government role should be small… The countries’ institutional frameworks, such as the U.S. Constitution, did not specify any other economic role for the state. Consequently, in the last century, public spending was minimal in a number of industrialized countries for which data for 1870 could be found… In the United States, government expenditure was about 7 percent of GDP, and, in most newly industrialized European countries of the period, such as Germany, the United Kingdom, or the Netherlands, expenditure did not exceed 10 percent of GDP. A leading French economist of the time, Paul Leroy-Beaulieu (1888), addressing the question of the proper share of taxes in the economy, suggested that a share of 5–6 percent was moderate while a share beyond 12 percent had to be considered “exorbitant” and would damage the growth prospects of an economy.

Hmmm, I though Bastiat was the only good French economist. But Monsieur Leroy-Beaulieu obviously is a very sensible person.

Now let’s look at historical estimates of tax revenue, as presented in a study from two academics published by the London School of Economics.

…it was states in Europe that were the first to permanently break cycles of gains and losses in centralized fiscal and coercive capacity and build towards the modern state system. …we divide the annual per capita central tax revenues in silver by the daily wages of unskilled workers in silver. …The daily wages of unskilled urban workers in grams of silver…are available annually for most polities and in the absence of reliable estimates for per capita income, are frequently used by economic historians as a proxy for per capita income for this period. …During the first half of the sixteenth century, annual tax revenues per capita did not exceed 5 days of unskilled urban wages in most European countries. The only exceptions were the small and highly urbanized entities such as Venice and Holland. By the end of the eighteenth century, however, …many others had reached the 10 to 15 daily wages range and annual per capita revenues of the central administration in the Dutch Republic exceeded 20 days of urban wages. It is worth noting that the middle group where annual per capita revenues reached 10 to 15 daily wages included not only the more urbanized western European countries such as England, France, Spain and Venice but also the more rural and agricultural countries in central and eastern Europe such as Austria

Here’s a chart from the study that gives an idea of the tax burden in various nations from 1500-1800.

Last but not least, we have a very detailed study about the evolution of the state from economists at George Mason University. I’ve culled some of the key passages.

Recent scholarship in both political economy and development economics has emphasized the importance of state capacity in explaining why some countries have succeeded in achieving economic development whereas others have not. This literature points to the role of state capacity in explaining the durability of institutions that are both conducive to markets and to economic growth. …This literature recognizes both that predatory behavior by states is frequently a cause of economic stagnation and that well-functioning states can provide the institutional framework necessary for sustained economic growth. … Economies governed by strong, cohesive, and constrained states are better able to overcome vested interests and avoid disastrous economic policies, while societies ruled by weak states are prone to rentseeking, corruption and civil war. State capacity, therefore, can complement market-supporting institutions in providing a conducive setting for economic development. This insight was understood by Adam Smith who noted the importance of the provision of peace, justice, and easy taxation (Smith, 1763). …Economic growth in the absence of sufficient state capacity was not self-sustaining precisely because economically successful societies attracted predators. …Greater state capacity enabled the states of western Europe to escape from this violence trap in the eighteenth and nineteenth centuries. …Well functioning markets are not only required for allocative economic efficiency, they also provide the necessary conditions for sustained economic growth over time. But markets cannot operate in an institutional vacuum. They require property rights that are well defined and enforced and rely on governance institutions that can arbitrate claims and disputes. Governance institutions do not have to be provided by a state—that is by an organization that claims a monopoly on the legitimate use of force within a circumscribed territory. Historically there are many instances of market actors developing their own governance mechanisms in the absence of state enforcement through private-order arrangements… The state is certainly not required for either impersonal trade or for the emergence of rules of behavior and the rule of law. What the historical record suggests, however, is that during the relevant centuries prior to the industrial revolution, commerce and trade came increasingly under the purview of the public-order institutions. …State capacity, as we have noted, need not promote economic growth. States with high capacity can pursue destructive economic policies. Rather the point is that state capacity can be beneficial for growth when the state is constrained by law. One of the reasons for this is that high capacity states have the ability to enforce general rules. This ability is closely linked to what social scientists typically mean by rule of law. …What enables some societies to build effective states—states that are able to provide basic public goods but which are constrained and limited in scope and scale? …The origins of modern economic growth are to be found in the expansion of market exchange and trade that gave rise to a more sophisticated and complex division of labor that rewarded innovation and to the cultural and potentially non-economic factors that helped spur innovation (Howes, 2016; McCloskey, 2016; Mokyr, 2016). The importance of the rise of high capacity states to this story is that these states helped to provide the institutional conditions that either enabled growth and innovation to take place or at least prevented their destruction through warfare or rent-seeking. The emergence of sustained economic growth in the nineteenth century was associated with strong but limited states. Twentieth century ambitions to use state power to remold societies either ended in failure or were at least partially reversed. We have focused on the recent literature linking the rise of the modern state to positive economic outcomes, but do not want to give the impression that we are neglecting how easy it is for governments to destroy economies (e.g., Shleifer and Vishny, 1998; Easterly, 2001).

The core message is that the key to prosperity is having a state strong enough and effective enough to provide rule of law, but to somehow constrain that state so that it doesn’t venture into destructive redistribution policies.

This is why competition between governments played a key role in the economic development of the western world. When governments have to worry about productive resources escaping, that forces them to focus on things that help an economy (i.e., rule of law) while minimizing the policies that hinder prosperity (i.e., high taxes and spending).

P.S. I got a nice surprise at the conference. I was made a citizens of Liberland.

P.P.S. America’s Founding Fathers dealt with the same issues that I discussed at the Liberland conference. Their solution was a constitution that explicitly limited the size and scope of the federal government. As I noted in my speech, that system worked reasonably well until the 1930s. Now we’ve gone so far in the other direction that the Supreme Court says Washington can compel us to buy things from cronyist companies.

Avoiding the same fate will be a major challenge for Liberland. Assuming, of course, it gets off the ground.

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At the risk of understatement, I’m not a fan of the Organization for Economic Cooperation and Development. Perhaps reflecting the mindset of the European governments that dominate its membership, the Paris-based international bureaucracy has morphed into a cheerleader for statist policies.

All of which was just fine from the perspective of the Obama Administration, which doubtlessly appreciated the OECD’s partisan work to promote class warfare and pimp for wasteful Keynesian spending.

What is particularly irksome to me is the way the OECD often uses dishonest methodology to advance the cause of big government.

But my disdain for the leftist political appointees who run the OECD doesn’t prevent me from acknowledging that the professional economists who work for the institution occasionally generate good statistics and analysis.

For instance, I’ve cited two  examples (here and here) of OECD research showing that spending caps are only effective fiscal rule. And I praised another OECD study that admitted the beneficial impact of tax competition. I even listed several good example of OECD research on tax policy as part of a column that ripped the bureaucracy for some very shoddy work in favor of Obama’s redistribution agenda.

And now we have some more good research to add to that limited list. A new working paper by two economists at the OECD contains some remarkable findings about the negative impact of government spending on economic performance. If you’re pressed for time, here’s the key takeaway from their research.

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. …This paper investigates empirically the effect of the size and the composition of public spending on long-term growth… The main findings that emerge from the analysis are…Larger governments are associated with lower long-term growth. Larger governments also slowdown the catch-up to the productivity frontier.

For those who want more information, the working paper is filled with useful information and analysis.

Here’s one of the charts from the study, showing how government spending is allocated in OECD nations.

The report also acknowledges that there’s a lot of preexisting research showing that government spending hinders economic growth.

There is a vast empirical literature investigating the relationship between the size of the government and economic growth (see Slemrod, 1995; Myles 2009; Bergh and Henrekson, 2011 for overviews). A review by Bergh and Henrekson (2011), based on papers published in peer reviewed journals after 2000, suggested a negative relationship in OECD countries. Likewise, a recent OECD study confirmed a negative relationship between the size of government and GDP growth (Fall and Fournier, 2015). …the link between the size of government and growth may vary with the income level and could be hump-shaped (Armey, 1995). A few studies have found support for the existence of a non-linear relationship between the size of government and growth (e.g. Vedder and Gallaway, 1998; Pevcin, 2004; Chen and Lee, 2005).

By the way, the reference to “hump-shaped” means that the OECD is even aware of the Rahn Curve.

The methodology in the paper is not ideal from my perspective. For all intents and purposes, the economists compare economic performance of the OECD’s big-government nations with the growth numbers from the OECD’s not-quite-as-big-government nations. But even with that limitation, the study generates some powerful results.

…the simulation assumes that in countries where the size of government is above the average level of countries in the bottom half of the sample, the government size will gradually converge to this level (36% of GDP). Similar to the spending mix reforms, this reform is phased in over 10 years. Such a reduction in the size of the government could increase long-term GDP by about 10%, with much larger effects in some countries with currently large or ineffective governments. …a reduction of the size of government has a positive, but moderate, effect on the income of the poor. The average disposable income also rises. However, the rich gain relatively more. Finally, in countries where the government is less effective (such as Italy) the growth effect dominates and a moderate reduction of the size of government would have a large growth effect, so that it would lift all boats.

And here’s a chart showing how much more growth would be possible if the countries with really-big government downsized their public sectors to the somewhat-big level.

Even with the methodology limitations I described, these results are astounding. Potential GDP gains of more than 30 percent for Greece and Italy. Gains of more than 20 percent for Slovenia, France, and Hungary. And more than 10 percent for Belgium, Czech Republic, Portugal, and Poland.

The working paper also looks at the composition of government spending. In other words, just as not all taxes are equally damaging, the same is true for spending programs.

The results from the estimation of the size of the government and the public spending mix illustrate that public spending matters for long-term growth…pension and subsidy spending [are] the two items with a significantly negative effect on growth. As each regression includes the size of government and one spending share, the estimates provide the effect of increasing this type of spending while decreasing spending on other items to keep the spending to GDP ratio unchanged… larger governments are in several specifications significantly and negatively associated with long-term growth. This is consistent with the literature… Larger governments can impede convergence (Table 8, columns 1 and 3), because they are associated with higher taxation that can discourage business investment including foreign investment and households to supply labour.

Pensions and subsidies seem to cause the most economic harm.

Reducing the share of pension spending in primary spending yields sizeable growth gains with no significant adverse effect on disposable income inequality. This reduction could be achieved by an increase in the effective retirement age or by cutting the replacement rate. …Cutting public subsidies boosts growth, as public subsidies…can distort the allocation of resources and undermine competition. …Education outcomes depend not only on education spending but also on the effectiveness of education policies, and the literature suggest the latter can be more important. Since the seminal work of Coleman (1966), a broad literature suggests that there is no clear link between education spending and education outcomes. …policies aimed at increasing education spending effectiveness can be more appropriate than an across-the-board rise of education spending. …It may be that, beyond a certain point, additional spending on investment has adverse effects, if poorly managed.

For those of you with statistical/econometric knowledge, here’s some relevant data from the study.

And you can match the numbers in Table 6 with these excerpts.

…pension spending reduces growth (Table 6, columns 2, 5, 7 and 10). Increasing the share of pension spending in primary spending by one percentage point (offset by a reduction in other spending) would decrease potential GDP by about 2%. …Public spending on subsidies also reduces growth (Table 6, columns 3, 5, 8 and 10). …increasing the share of public subsidies in primary spending by one percentage point would decrease potential GDP by about 7%.

If you’re not a stats wonk, these two charts may be more helpful and easy to understand.

What jumped out at me is how the normally sensible nation of Switzerland is very bad about subsidies. That’s a policy they obviously need to fix (along with the fact that they also have a wealth tax, which is very uncharacteristic for that country).

But I’m digressing.

Let’s return to the study. One of the interesting things about the working paper is that it notes that bad fiscal policy can be somewhat mitigated by having market-oriented policies in other areas, which is a point I always make when writing about Scandinavian nations.

…countries with a high level of public spending may also be characterised by features that partly offset the adverse growth effect of government size. …in Sweden the mix of growth-friendly structural policies…may have offset the adverse growth effect of a large government sector.

In other words, the moral of the story is that smaller government is good and free markets are good. Mix the two together and you have best of all worlds.

P.S. Even if the OECD published dozens of quality studies like this one, I would still argue that American taxpayers should no longer be forced to subsidize the Paris-based bureaucracy. And even if the OECD’s political types stopped pushing statist policies, I would still have the same view about ending handouts from American taxpayers. This has nothing to do with the fact that the bureaucrats once threatened to have me arrested and thrown in a Mexican jail. I simply don’t think taxpayers should fund international bureaucracies.

P.P.S. Other international bureaucracies, including the World Bank and European Central Bank, also have published good research about the negative effect of excessive government spending.

P.P.P.S. My general disdain for the OECD (notwithstanding my qualified praise today for their new study on spending) may be exceeded by my hostility for the International Monetary Fund. I’ve referred to the IMF as both “the Dumpster Fire of the Global Economy” and “the Dr. Kevorkian of Global Economic Policy.”

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Back in 2011, I shared a video that mocked libertarians by claiming that Somalia was their ideal no-government paradise.

I pointed out, of course, that the argument was silly. Sort of like claiming that North Korea is the left’s version of policy paradise.

But the video was very clever, and I’m more than willing to disseminate anti-libertarian humor if it’s clever and well done.

Some folks on the left, however, confuse satire with serious argument.

Consider the recent New York Times column by Nicholas Kristof. He wants his readers to think that advocates of small government somehow should be saddled with the blame for the dysfunctional nightmare of South Sudan. Seriously.

After hearing Republican presidential candidates denounce big government and burdensome regulation, I’d like to invite them to spend the night here in the midst of the civil war in South Sudan. You hear gunfire, competing with yowls of hyenas, and you don’t curse taxes. Rather, you yearn for a government that might install telephones, hire a 911 operator and dispatch the police. …Ted Cruz…is clamoring for: weaker government, less regulation… In some sense, you find the ultimate extension of all that right here.

Gee, isn’t Kristof clever. If you don’t support a bankrupt entitlement state and inane over-regulation, then you must want chaos and civil war.

Just in case you think I’m taking him out of context to make his argument look foolish, here are more excerpts.

No regulation! No long lines at the D.M.V., because there is no D.M.V. in the conflict areas. In practice, no taxes or gun restrictions. No Obamacare. No minimum wage. No welfare state to breed dependency. …In a place that might seem an anti-government fantasy taken to an extreme, people desperately yearn for all the burdens of government…that Americans gripe about. …One lesson of South Sudan is that government and regulations are like oxygen: You don’t appreciate them until they’re not there.

Notice how he wants to make it seem like the choice is South Sudan on one hand versus “all the burdens of government” on the other.

To be fair, Kristof does attempt a serious argument later in his column.

Two political scientists, Jacob Hacker and Paul Pierson, argue that America’s achievements rest on a foundation of government services… “We are told that the United States got rich in spite of government, when the truth is closer to the opposite,” they write. Every country that journeyed from mass illiteracy and poverty to modernity and wealth did so, they note, because of government instruments that are now often scorned. …What we Americans excel at are our institutions. We have schools, laws, courts, police, regulators, bureaucracies, safety nets — arms of a government that is often frustrating but always indispensable. These institutions are the pillars of our standard of living. …Government, laws and taxes are a burden, indeed, but they are also the basis for civilization.

I haven’t read the work of Hacker and Pierson, but there’s been extensive research about the factors that produce economic growth. So if Hacker and Pierson are merely claiming that certain things traditionally provided by governments – such as rule of law, protection of property rights, enforcement of contracts, courts and police, and national defense – are associated with economic growth, then we’re on the same page.

But that’s an argument for a small state. Indeed, I’ve pointed that the United States (and other nations in the western world) became rich in the 1800s when there was a limited government providing these core “public goods.”

And at the time, there was virtually no redistribution. Not only in the United States, but in other developed nations as well.

The problem is that Kristof and other statists want large welfare states with lots of redistribution. And those are the policies that lead to less prosperity. And perhaps even fiscal chaos.

Indeed, that’s the argument behind the Rahn Curve. A small amount of (properly focused) government is associated with growth. But once the public sector gets too large, then government spending saps a nation’s economy.

To conclude, perhaps there is common ground. If Kristof is willing to admit that a bloated welfare states is misguided, then I’ll be willing to say that no government can lead to South Sudan.

P.S. There are serious scholars who argue “public goods” can be provided privately. Click here for a good introduction to the issue.

P.P.S. Leftists like to share the quote from Justice Oliver Wendell Holmes about “taxes are the price we pay for a civilized society.” This statement is even etched in stone at the headquarters of the internal revenue service.

What folks conveniently forget, though, is that Holmes reportedly made that statement in 1904, nine years before there was an income tax, and then again in 1927, when federal taxes amounted to only $4 billion and the federal government consumed only about 5 percent of economic output.

As I wrote in 2013, “I’ll gladly pay for that amount of civilization.”

P.P.P.S. In his column, Kristof uses Trump as a foil even more than Cruz. Since I’m unconvinced that Trump believes in smaller government, I didn’t include those excerpts (while Cruz, even while he has some views I don’t like, seems to be a sincere and principled advocate of economic liberty).

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As a fiscal policy economist who believes in individual liberty and personal responsibility, I have two goals.

1. Replace the corrupt and punitive internal revenue code with a simple and fair flat tax that raises necessary revenue in the least-destructive and least-intrusive manner possible.

2. Shrink the size of the federal government so that it only funds the core public goods, such as national defense and rule of law, envisioned by America’s Founding Fathers.

Needless to say, I haven’t been doing a great job. The tax code seems to get worse every year, and even though we’ve made some progress in recent years on spending, the long-run outlook is still very grim because there’s hasn’t been genuine entitlement reform.

But I continue with my Sisyphean task. And part of my efforts include educating people about the Rahn Curve, which is sort of the spending version of the Laffer Curve. it shows the non-linear relationship between the size of government and economic performance.

Simply stated, some government spending presumably enables growth by creating the conditions (such as rule of law and property rights) for commerce.

But as politicians learn to buy votes and enhance their power by engaging in redistribution, then government spending is associated with weaker economic performance because of perverse incentives and widespread misallocation of resources.

I’ve even shared a number of videos on the topic.

The video I narrated explaining the basics of the Rahn Curve, which was produced by the Center for Freedom and Prosperity.

A video from the Fraser Institute in Canada that reviews the evidence about the growth-maximizing size of government.

A video from the Centre for Policy Studies in the United Kingdom that explores the relationship between prosperity and the size of the public sector.

Even a video on the Rahn Curve from a critic who seems to think that I’m a closeted apologist for big government.

Now we have another video to add to the collection.

Narrated by Svetla Kostadinova of Bulgaria’s Institute for Market Economics, it discusses research from a few years ago about the “optimal size of government.”

If you want to read the research study that is cited in the video, click here. The article was written by Dimitar Chobanov and Adriana Mladenova of the IME

The evidence indicates that the optimum size of government, e.g. the share of overall government spending that maximizes economic growth, is no greater than 25% of GDP (at a 95% confidence level) based on data from the OECD countries. In addition, the evidence indicates that the optimum level of government consumption on final goods and services as a share of GDP is 10.4% based on a panel data of 81 countries. However, due to model and data limitations, it is probable that the results are biased upwards, and the “true” optimum government level is even smaller than the existing empirical study indicates.

Two points in that excerpt are worth additional attention.

First, they understand that not all forms of government spending have equal effects.

Spending on core public goods (rule of law, courts, etc) generally are associated with better economic performance.

Spending on physical and human capital (infrastructure and education) can be productive, though governments often do a poor job based on a money-to-outcomes basis.

Most government spending, though, is for transfers and consumption, and these are areas where the economic effects are overwhelmingly negative.

So kudos to the Bulgarians for recognizing that it’s particularly important to restrain some types of outlays.

The other point that merits additional emphasis is that the growth-maximizing size of government is probably far lower than 25 percent of economic output.

Here’s what they wrote, citing yours truly.

…the results from the above mentioned models should not be taken as the “true” optimal level of government due to limitations of the models, and lack of data as already discussed. As Dan Mitchell commented, government spending was about 10% of GDP in the West from the end of the Napoleonic wars to World War I. And we do not have any data to think that growth would have been higher if government was doubled or tripled. However, what the empirical results do show is that the government spending should be much less than is the average of most countries at the moment. Thus, we can confidentially say the optimum size of general government is no bigger than 25% but is likely to be considerably smaller because of the above-mentioned reasons.

And here’s their version of the Rahn Curve, though I’m not a big fan since it seems to imply that government should consume about one-third of economic output.

I much prefer the curve to show the growth-maximizing level under 20 percent of GDP.

Though I often use a dashed line to emphasize that we don’t really know the actual peak because there unfortunately are no developed nations with modest-sized public sectors.

Even Singapore and Hong Kong have governments that consume about 20 percent of economic output.

But maybe if I someday achieve my goal, we’ll have better data.

And maybe some day I’ll go back to college and play quarterback for my beloved Georgia Bulldogs.

P.S. Since I shared one video, I can’t resist also including this snippet featuring Ronald Reagan talking about libertarianism.

What impresses me most about this clip is not that Reagan endorses libertarianism.

Instead, notice how he also explains the link between modern statism and fascism.

He had a much greater depth of knowledge than even supporters realize. Which also can be seen in this clip of Reagan explaining why the Keynesians were wrong about a return to Depression after World War II.

And click here if you simply want to enjoy some classic Reagan clips. For what it’s worth, this clip from his first inauguration is my favorite.

Given my man crush on the Gipper, you also won’t be surprised to learn that this is the most encouraging poll I’ve ever seen.

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What’s the relationship between the Rahn Curve and the Laffer Curve?

For the uninitiated, the Rahn Curve is the common-sense notion that some government is helpful for prosperous markets but too much government is harmful to economic performance.

Even libertarians, for instance, will acknowledge that spending on core “public goods” such as police protection and courts (assuming, of course, low levels of corruption) can enable the smooth functioning of markets.

Some even argue that government spending on human capital and physical capital can facilitate economic activity. For what it’s worth, I think that the government’s track record in those areas leaves a lot to be desired, so I’d prefer to give the private sector a greater role in areas such as education and highways.

The big problem, though, is that most government spending is for programs that are often categorized as “transfers” and “consumption.” And these are outlays that clearly are associated with weaker economic performance.

This is why small-government economies such as Hong Kong and Singapore tend to grow faster than the medium-government economies such as the United States and Australia. And it also explains why growth is even slower is big-government economies such as France and Italy.

The Laffer Curve, for those who don’t remember, is the common-sense depiction of the relationship between tax rates and tax revenue.

The essential insight is that taxable income is not fixed (regardless of the Joint Committee on Taxation’s flawed methodology).

When tax rates are low, people will earn and report lots of income, but when tax rates are high, taxpayers figure out ways of reducing the amount of taxable income they earn and report to government.

This is why, for instance, the rich paid much more to the IRS after Reagan lower the top tax rate from 70 percent to 28 percent.

So why am I giving a refresher course on the Rahn Curve and Laffer Curve?

Because I’ve been asked on many occasions whether there is a relationship between the two concepts and I’ve never had a good answer.

But I’m happy to call attention to the good work of other folks, so here’s a very well done depiction of the relationship between the two curves (though in this case the Rahn Curve is called the Armey Curve).

I should hasten to add, by the way, that I don’t agree with the specific numbers.

I think the revenue-maximizing rate is well below 45 percent and I think the growth-maximizing rate is well below 30 percent.

But the image above is spot on in that it shows that a nation should not be at the revenue-maximizing point of the Laffer Curve.

Since I’m obviously a big fan of the Rahn Curve and I also like drawing lessons from cross-country comparisons, here’s a video on that topic from the Center for Freedom and Prosperity.

Well done, though I might quibble on two points, though the first is just the meaningless observation that the male boxer is not 6′-6″ and 250 lbs.

My real complaint (and this will sound familiar) is that I’m uneasy with the implication around the 1:45 mark that growth is maximized when government spending consumes 25 percent of economic output.

This implies, for instance, that government in the United States was far too small in the 1800s and early 1900s when the overall burden of government spending was about 10 percent of GDP.

But I suppose I’m being pedantic. Outlays at the national, state, and local level in America now consume more than 38 percent of economic output according to the IMF and we’re heading in the wrong direction because of demographic changes and poorly designed entitlement programs.

So if we can stop government from getting bigger and instead bring it back down to 25 percent of GDP, even I will admit that’s a huge accomplishment.

Libertarian Nirvana would be nice, but I’m more concerned at this point about simply saving the nation from becoming Greece.

P.S. I’ve shared numerous columns from Walter Williams and he is one of America’s best advocates of individual liberty and economic freedom.

Now there’s a documentary celebrating his life and accomplishments. Here’s a video preview.

Given Walter’s accomplishments, you won’t be surprised to learn that there’s another video documentary about his life.

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I’ve shared lots of data and evidence about the harmful economic impact of government spending.

Simply stated, budgetary outlays divert resources from more productive uses. And this results in labor and capital being misallocated, leading to less economic output.

The damage is even more pronounced when you look at how politicians finance the budget. Whether they use taxes or borrowing (or even printing money), there are additional distortions that hinder the private sector.

Today, we’re going to look at the economic impact of a particular type of government spending. A new working paper by two academics at the University of Miami has revealed a negative relationship between government consumption spending and economic growth.

But before digging into the details, what do public finance economists mean when they talk about “consumption spending”? At the risk of over-simplifying, it’s the part of the budget used to purchase goods and services. Everything from soldiers to housing and from jails to education.

It’s basically the so-called discretionary portion of the federal budget, minus “investment spending” (which would be things like roads).

Anyhow, here are some of the key findings.

This paper tests the Mundellian hypothesis that too much government spending reduces economic growth… In this paper, we analyze annual panel data from 1999 to 2011 for 31 OECD countries to examine the role of government spending in determining economic growth. In particular, we will focus our attention on government consumption spending on non-market goods such as defense and justice for collective consumption and its effect on growth in real GDP growth. …We find that government consumption spending on non-market goods signifi cantly reduces economic growth. A one percentage point increase in government consumption of non-market goods as a percent of GDP is associated with a 0.86 percentage lower growth rate in GDP. …This result is compatible with Barro (1990)’s fi nding for the Summers and Heston database, but suggests a stronger negative eff ect of government consumption on economic growth.

That’s a big number, which implies that we’re definitely on the downward-sloping portion of the Rahn Curve.

By the way, just in case you’re wondering why Obama’s “stimulus” was such a flop, the study also notes that “the 2009 American Reinvestment and Recovery Act envisaged less than 5% spending on public investment, and over 95% on consumption.”

In other words, Obama increased the type of government spending with the worst impact on the economy. Something to keep in mind when politicians, lobbyists, interest groups, and other insiders argue that there’s no need to cut back on discretionary spending.

But it’s also important to note that the study has some findings that may distress libertarians and small-government conservatives. It finds, for instance, that “government investment spending is positively related to growth.”

Also, it’s important to realize that the study is limited to only certain forms of discretionary spending. As the authors explain, they examine, “the impact of government consumption spending net of health, education and housing service.”

But even with those caveats, we have another strong piece of evidence that our economy would grow much faster if we reduced the burden of government spending.

And if you need more evidence on the harmful effect of government spending (either generally or specific types of outlays), allow me to call your attention to research even from normally left-leaning international bureaucracies such as the Organization for Economic Cooperation and Development, International Monetary Fund, World Bank, and European Central Bank.

And you can find similar findings in the work of scholars from all over the world, including the United States, Finland, Australia, Sweden, Italy, Portugal, and the United Kingdom.

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There’s an old saying that there’s no such thing as bad publicity.

That may be true if you’re in Hollywood and visibility is a key to long-run earnings.

But in the world of public policy, you don’t want to be a punching bag. And that describes my role in a book excerpt just published by Salon.

Jordan Ellenberg, a mathematics professor at the University of Wisconsin, has decided that I’m a “linear” thinker.

Here are some excerpts from the article, starting with his perception of my view on the appropriate size of government, presumably culled from this blog post.

Daniel J. Mitchell of the libertarian Cato Institute posted a blog entry with the provocative title: “Why Is Obama Trying to Make America More Like Sweden when Swedes Are Trying to Be Less Like Sweden?” Good question! When you put it that way, it does seem pretty perverse.  …Here’s what the world looks like to the Cato Institute… Don’t worry about exactly how we’re quantifying these things. The point is just this: according to the chart, the more Swedish you are, the worse off your country is. The Swedes, no fools, have figured this out and are launching their northwestward climb toward free-market prosperity.

I confess that he presents a clever and amusing caricature of my views.

My ideal world of small government and free markets would be a Libertopia, whereas total statism could be characterized as the Black Pit of Socialism.

But Ellenberg’s goal isn’t to merely describe my philosophical yearnings and policy positions. He wants to discredit my viewpoint.

So he suggests an alternative way of looking at the world.

Let me draw the same picture from the point of view of people whose economic views are closer to President Obama’s… This picture gives very different advice about how Swedish we should be. Where do we find peak prosperity? At a point more Swedish than America, but less Swedish than Sweden. If this picture is right, it makes perfect sense for Obama to beef up our welfare state while the Swedes trim theirs down.

He elaborates, emphasizing the importance of nonlinear thinking.

The difference between the two pictures is the difference between linearity and nonlinearity… The Cato curve is a line; the non-Cato curve, the one with the hump in the middle, is not. …thinking nonlinearly is crucial, because not all curves are lines. A moment of reflection will tell you that the real curves of economics look like the second picture, not the first. They’re nonlinear. Mitchell’s reasoning is an example of false linearity—he’s assuming, without coming right out and saying so, that the course of prosperity is described by the line segment in the first picture, in which case Sweden stripping down its social infrastructure means we should do the same. …you know the linear picture is wrong. Some principle more complicated than “More government bad, less government good” is in effect. …Nonlinear thinking means which way you should go depends on where you already are.

Ellenberg then points out, citing the Laffer Curve, that “the folks at Cato used to understand” the importance of nonlinear analysis.

The irony is that economic conservatives like the folks at Cato used to understand this better than anybody. That second picture I drew up there? …I am not the first person to draw it. It’s called the Laffer curve, and it’s played a central role in Republican economics for almost forty years… if the government vacuums up every cent of the wage you’re paid to show up and teach school, or sell hardware, or middle-manage, why bother doing it? Over on the right edge of the graph, people don’t work at all. Or, if they work, they do so in informal economic niches where the tax collector’s hand can’t reach. The government’s revenue is zero… the curve recording the relationship between tax rate and government revenue cannot be a straight line.

So what’s the bottom line? Am I a linear buffoon, as Ellenberg suggests?

Well, it’s possible I’m a buffoon in some regards, but it’s not correct to pigeonhole me as a simple-minded linear thinker. At least not if the debate is about the proper size of government.

I make this self-serving claim for the simple reason that I’m a big proponents of the Rahn Curve, which is …drum roll please… a nonlinear way of looking at the relationship between the size of government and economic performance. And just in case you think I’m prevaricating, here’s a depiction of the Rahn Curve that was excerpted from my video on that specific topic.

Moreover, if you click on Rahn Curve category of my blog, you’ll find about 20 posts on the topic. And if you type “Rahn Curve” in the search box, you’ll find about twice as many mentions.

So why didn’t Ellenberg notice any of this research?

Beats the heck out of me. Perhaps he made a linear assumption about a supposed lack of nonlinear thinking among libertarians.

In any event, here’s my video on the Rahn Curve so you can judge for yourself.

And if you want information on the topic, here’s a video from Canada and here’s a video from the United Kingdom.

P.S. I would argue that both the United States and Sweden are on the downward-sloping portion of the Rahn Curve, which is sort of what Ellenberg displays on his first graph. Had he been more thorough in his research, though, he would have discovered that I think growth is maximized when the public sector consumes about 10 percent of GDP.

P.P.S. Ellenberg’s second chart puts the U.S. and Sweden at the same level of prosperity. Indeed, it looks like Sweden is a bit higher. That’s certainly not what we see in the international data on living standards. Moreover, Ellenberg may want to apply some nonlinear thinking to the data showing that Swedes in America earn a lot more than Swedes still living in Sweden.

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