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A government€™s primary objective in spending money should be to enable it to serve the people €“ to defend them, to maintain law and order, and to make a variety of benefits, services and facilities available. To do this it extracts a proportion of the wealth that has been created within its jurisdiction, through taxation. The moral and political justifications for government spending, and the mechanisms for reaching agreement on its magnitude, are subjects for later chapters; this section examines its economic impact.
Government spending displaces commercial activity in several ways:
· It is funded by taxation, which reduces the money in the pockets of consumers and thereby reduces demand for goods and services.
· Taxation also increases the costs of the commercial sector, thereby increasing the prices that companies need to charge and making them less competitive than similar companies in other countries.
· Government spending competes for resources €“ labour, materials and finance €“ so that less of each is available to the commercial sector and the prices are therefore higher.
These factors, taken together, mean that any increases in government spending will inevitably reduce the size and the competitiveness of the commercial sector €“ as well as reducing consumers€™ ability to choose what they want to buy.
The economic impact of government spending differs by category:
1. Transfer payments for some benefits, including pensions, welfare, and tax credits, are made to people who don€™t earn enough to support themselves and their dependents. The recipients then spend the money as consumers. Transfers neither consume nor create wealth in terms of the economy as a whole €“ they redistribute it from taxpayers to the beneficiaries, so that the latter can consume.
2. When the State provides funding for ongoing purchased services which are provided to the people, it is creating demand for the suppliers in the commercial sector or civil society. These services might be provided free of charge to everyone in the society, or only to those who could not otherwise afford them.
3. When a State provides services with its own employees it has full management responsibility and it can ensure standardisation across the country. As with the previous category, it may decide that some people should pay for the use of these services.
4. Investment projects in infrastructure or research, which can be carried out by employees of the State or by chosen suppliers, differ from ongoing services in two important ways:
‒ They come to an end when the project is delivered.
‒ Some projects, e.g. to provide infrastructure, may yield wider economic benefits later.
5. The State has to have some administrative functions €“ including procurement, regulation, tax collection and benefit allocation €“ to exert management control over its finances and the services it provides. Administration can be seen as a category of cost that should be minimised because it doesn€™t directly deliver a service to the public, but it cannot be totally eliminated. If it is done well, it can improve the cost-effectiveness of the other four categories of government spend.
Later sections in this chapter examine the economic impacts of these different categories of government spending:
· The wealthy contribute more than most people towards government spend, in a form of economic reciprocity (3.5.1).
· The difference between categories 2 and 3 €“ the choice between using purchased services or government employees €“ can be treated as a question of value for money (3.5.3).
· A government can invest in infrastructure projects which are difficult for industry to organise (3.2.8).
All government spending, though, needs funding, and the question of affordability has to be considered in total; it depends upon how much tax can be raised (3.2.4.6). Individualists and collectivists have sharply differing views for economic reasons (3.5.2), as well as the political reasons which are discussed in the relevant chapter (6.7.1).
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