In the pre-World War I era, the fiscal burden of government was very modest in North America and Western Europe. Total government spending consumed only about 10 percent of economic output, most nations were free from the plague of the income tax, and the value-added tax hadn’t even been invented.
Today, by contrast, every major nation has an onerous income tax and the VAT is ubiquitous. Those punitive tax systems exist largely because—on average—the burden of government spending now consumes more than 40 percent of GDP.
To be blunt, fiscal policy has moved dramatically in the wrong direction over the past 100-plus years. And thanks to demographic change and poorly designed entitlement programs, things are going to get much worse, according to Bank of International Settlements, Organization for Economic Cooperation and Development, and International Monetary Fund projections.
While those numbers, both past and future, are a bit depressing, they also present a challenge to advocates of small government. If taxes and spending are bad for growth, why did the United States (and other nations in the Western world) enjoy considerable prosperity all through the 20th century? ...Mitchell gives two basic reasons: (1) the private sector can withstand a lot of damage, until it reaches a tipping point where the poor fiscal policy causes massive damage; and (2) poor fiscal policy has been offset by improvements in other types of policy such as economic or monetary policy, regulatory policy, trade policy, and rule of law/property rights. He then discusses some charts and statistics supporting his claim.
The moral of the story is that we’ve been lucky. Bad fiscal policy has been offset by better policy in other areas. We’re suffering from bigger government, but at least we’ve moved in the direction of free markets. That said, we may now be in an era when bad fiscal policy augments bad policy in other areas.I would note two other factors that occurred simultaneously with prosperity in the 20th Century in the face of greater fiscal burdens--a huge investment in infrastructure and rapid increases in worker productivity.