Changes to tax and spending affect the economy. If a pound of extra spending delivers a pound of extra growth, that means the multiplier is 1; if it delivers 50p of extra growth then the multiplier is 0.5. The same ratios apply in reverse when governments are imposing austerity programmes.
The thing is, we actually define £1 of government spending as £1 of GDP.
It\’s right there in the national accounts. Government contribution to GDP is simply and exactly the amount that government spends.
Everything else is determined by the value at market prices of the production from spending. But not government. That\’s defined as the amount spent.
And for years I\’ve felt that there\’s just not something quite right about that. It seems, in a way that I\’m not really able to put my finger on properly, to be wrong.
Does the marginal £ of government spending actually produce a £ of value? I\’m absolutely delighted to agree that the first £ produces much more than a £ in value. Courts, police, legal system, public health measures (real ones, vaccines and sewers, not anti-smoking jeremiads), sure, these add more than £ for £. But the marginal £ at 40, 50% of GDP? Deeply unconvinced.
Questioning this leads to some odd places. The balanced budget multiplier for example. Govt taxes and spends and this boosts the economy. Yet we know that the deadweight cost of marginal tax is somewhere in the 30-50% range. Thus to really, actually, add value the value of what we get for that spending has to be £1.60 to £2, for each £ spent. And as I say, I\’m deeply unconvinced that it\’s even worth £ for £ at the current margin. But we do define it as such.
As I say, I\’m not really sure quite how to walk through all of this properly. At least part of it is because I know so little macro. But I am sure that we\’ve got something wrong going on in here just because we define government spending as having the value of exactly that government spending. Something which I\’m adamant just ain\’t so.