There is little doubt, outside Ottawa anyway, that the country’s tax burden is impeding economic performance by punishing, rather than promoting investment, hard work, risk taking and savings. The average Canadian family now faces a tax burden that consumes some 47% of household income, meaning that Canadian families are working until June 28th just to pay off their federal, provincial, and municipal tax bill. There’s general consensus that for Canada to achieve its economic potential, both personal and business taxes must be reduced. Unfortunately, we tend to separate taxes from government spending. This is regrettable since government spending ultimately drives taxation. Thus, if we want to reduce the burden of taxes on Canadians, we must also reduce government spending, at least as a percentage of the economy.

There is a growing body of academic research supporting the idea that the size of government matters with respect to economic performance. Very few people would argue for zero government or for a completely government-controlled economy. Somewhere between these two extremes exists a point at which economic growth and prosperity are maximized; what’s referred to as the optimal size of government.

A 1998 study by Richard Vedder and Lowell Gallaway for the Joint Economic Committee of the US Congress found that the moderate reduction in the size of the federal government between 1991 and 1997 had resulted in increased rates of economic growth in the US and that further reductions in government would achieve sizable and permanent increases in the economy.

Broader studies have investigated the optimal size of government by examining multiple countries over time. One of the more high-profile studies was completed by Harvard economist, Robert Barro in 1991. Barro found that government consumption “had no direct effect on private productivity ... but lowered saving and (economic) growth through the distorting effects from taxation or government-expenditure programs”. He further found a “significantly negative association” between government consumption relative to the economy (government as a percent of GDP) and the growth of GDP.

More recently, Stefan Folster and Magnus Henrekson examined the growth effects of government spending and taxation in wealthy countries between 1970 and 1995. They found a negative relationship between government spending and economic growth. Specifically, they concluded that a 10 percent increase in government spending, as a percent of GDP is associated with a decrease in economic growth rates by 0.7 to 0.8 percentage points.

A limited number of studies have been completed for Canada, however, those that have been done indicate that the growth-maximizing size of government in Canada is roughly 30 percent of GDP. This should alarm anyone interested in improving Canada’s economy since governments currently consume roughly 40 percent of the economy. In addition, the 30 percent historical mark may well be an overestimate given the rapid advance of technology and information over the last half-century.

Of course those who advocate for more government argue that we’re simply trading off a little economic growth in order to achieve greater social progress. According to the research however, larger governments do not generally lead to increased social progress.

A series of studies by International Monetary Fund (IMF) economists Vito Tanzi and Ludger Schuknecht regarding the size of government and social progress concluded that “countries with ‘small’ governments generally do not show worse indicators of social and economic well-being than countries with ‘big’ government—and often they achieve an even better standard. Countries with ‘small’ governments can provide essential services and minimum social safety nets while avoiding the disincentive effects caused by high taxes and large-scale redistribution on growth, employment, and welfare.” The Tanzi and Schuknecht studies are buttressed by studies completed by Professor Gerald Scully of the University of Texas and more recently the Organization for Economic Cooperation and Development (OECD).

The list of potential areas where Canadian governments could reduce or even eliminate spending with very little, if any, consequences on social progress is rather long: regional development subsidies, corporate welfare, agricultural supports, and broadcast subsidies, to name a few. In addition, there’s an enormous opportunity to reform the delivery of many services, education and health in particular such that services could be vastly improved while spending the same or possibly even less.

International research has confirmed that the size of government matters when it comes to economic growth. In addition, empirical evidence for Canada indicates that the optimal size of government, one that maximizes economic growth and social progress, is much smaller than what currently exists. If Canada wants to enjoy the benefits of a more prosperous economy, one characterized by high levels of investment, strong employment growth, and high average incomes then both government spending and taxes must be significantly reduced.