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The Adam Smith Institute Blog

Tax and spend destroys living standards

Why do governments keep believing that government spending can buy our way out of economic crises?

By Terry ArthurGuest blogger / December 23, 2010

According to the Austrian school of economics, lower tax rates lead to smaller government and higher living standards. Nonetheless, the tax-and-spend approach remains popular.

Photo illustration / Rafael Ben-Ari / Chameleons Eye / Newscom / File

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Most market sympathisers know that lower are overall taxes, the smaller is government and the higher are living standards, but for support they concentrate on statistical evidence such as the adverse relationship between economic growth and the level of overall taxes. This evidence is very strong, but an underlying theory showing WHY this is the case would make it far stronger.

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Naturally such a theory exists, but it is little known nowadays outside Adam Smith aficionados and the Austrian School of Economics to which both Ludwig von Mises and F. A. Hayek belonged. Even then, I have yet to see a simple and arresting explanation. In The Constitution of Liberty, Hayek refers to the effects of taxation, including “the frequent restriction or reduction of the division of labour”. The Institute of Directors’ Graeme Leach refers to the “deadweight loss” as the loss of output that would have occurred in the absence of the tax – a loss of economic welfare above and beyond the tax revenues collected.

These observations are absolutely correct, but it is probably fair to say that they do not describe in layman’s terms the simple mechanism at work. We must remember what we are up against in the shape of government and the public sector in general (including many schoolteachers and lecturers); the last thing they want is to have their cover blown.

It is nothing short of a scandal that generally respected commentators can still promote government spending as a major plank in getting out of the current recession when (in addition to the fact that such spending was a major plank in creating the recession) it will inevitably reduce output even further. Such a level of ignorance could not possibly exist were it not for the state’s iron grip on the education system via a nationalised school system including a national curriculum. And you certainly won’t find a mention of the topic on the website of the “National School of Government”, the Civil Service training college.

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