The Impact of Fiscal and Other Economic Freedoms on Economic Growth: An Empirical Analysis

Article excerpt

Abstract This empirical study investigates the impacts on economic growth of reduced fiscal freedom from both the taxing and spending sides. After controlling for nominal long term interest rates, net exports, federal government budget deficits, and other factors, panel two stage least squares estimations using a 4-year panel data set for the OECD nations as a group reveals that reduced fiscal freedom leads to a reduced rate of economic growth; furthermore, it is found that reduced freedom from excessive government size also leads to a reduced rate of economic growth.

Keywords Fiscal freedom Economic freedom Economic growth

JEL R11 * P10 * P16 * E60 * F43 * H61

Introduction

The 2012 budget proposed by United States President Barack Obama resembles that for 2011 in several respects. Total projected outlays of $3.73 trillion are proposed (roughly the same as in the 2011 proposed budget), with a projected federal budget deficit of $1.1 trillion. Moreover, in view of the December, 2010, passage of the Middle Class Tax Relief Act of 2010 (hereafter MCTRA) and the expressly temporary extension of the Bush-era tax cuts included in this legislation, the 2012 budget speaks repeatedly of future federal income tax increases (as well reduced tax deductions), especially for the rich, in the U.S. In other words, despite passage of the MCTRA (and perhaps because of the passage of the MCTRA), it remains noteworthy that imbedded in the Administration's 2012 budget, and, implicitly, anticipated future budgets, are (a) increased federal government spending levels, (b) significantly increased taxation (through higher tax rates, more taxes, and reduced tax deductions and other means), and (c) accompanying continued high budget deficits.

The 2012 budget proposal, which was rejected by the U.S. Senate, retains many of the Bush tax cuts, but not for single taxpayers earning over $200,000 ($250,000 if married filing jointly) once the MCTRA has expired. Thus, the Obama administration has an agenda in which the proposed level of federal government outlays (nearly 27% of GDP) are reported to be accompanied by future personal marginal income tax increases (along with diminished tax deductions) that will begin as soon as 2013. Of course, the latter policy outcome will require reversal of many of the election losses the Democratic Party suffered in November of 2010.

In addition to the above, the health care/insurance bill, also known as The Patient Protection and Affordable Care Act (HR 3590), is projected to elevate taxes sufficiently to raise an additional $409.2 billion for the U.S. Treasury by 2019. Indeed, according to Kiplinger (2010, pp. 1-2), there are 13 federal tax changes integrated into this health care reform legislation, 10 of which constitute tax increases.

Within the context of the global economic and financial crisis, several distinct policy concerns of the OECD have surfaced. One of these concerns is reflected in the words of OECD Secretary-General Angel Gurria (OECD, 2009a, p. 1), who has stressed that [w]e must ensure that today's policies to manage the crisis not be the source of tomorrow's problems ... " The OECD has been working with its own members and, to a degree, with non-member governments and other organizations, to get economies back on the path of economic stabilization and expansion. Interestingly, as a central part of this effort, the OECD (2009a, p. 1; 2009b, p. 1) advocates the position that governments must be cautious not to jeopardize or sacrifice economic freedoms as they pursue policies to strengthen and revitalize their economies.

This study begins with the observation that, based on proposed government economic policies as summarized above for the U.S., what is referred to as fiscal freedom in the U.S. appears destined to decrease. Fiscal freedom (hereafter FF) is a measure of freedom from the tax burdens of government. Technically, as constructed by the Heritage Foundation (2009, p. …