Freedom in the 50 States

The government consumption variable (Table 1) represents spending on government operations (wages and salaries and goods and services for the state’s own use). We use this variable because extant research suggests that government consumption crowds out private-sector income growth, even when it is funded by rents such as federal grants or mineral revenues rather than by taxation or debt.

A large body of literature exists on the size of government and economic growth. Swedish economists Andreas Bergh and Magnus Henrekson surveyed the literature and found a robust association of government spending with subsequent growth in rich countries: for every additional percentage point of GDP in government spending, annual average growth declines by at least 0.05 percentage points.¹ This correlation is in addition to the effects of taxation. We look at the effects of a standard-deviation increase in government consumption and investment as a share of personal income over 10 years, assuming the 0.05-percentage-point relationship. We calculate the discounted forgone growth over 10 years assuming a social discount rate of 5.0 percent. (Using a finite time horizon is necessary to impose finiteness on the number, but endogenous growth theory also suggests that the growth rate benefit of any exogenous variable dissipates eventually when per capita income reaches a new steady state, which is likely to happen over the course of a business cycle.) Then, we divide by two because government employment presumably captures some of the same effects that other studies found via government spending, and we want to avoid double-counting.

Alaska is number 50 on government consumption despite being number one on state taxes (Table 1). How is this possible? Energy resources. The state earns massive severance revenues on oil and gas, the incidence of which falls on global consumers, and uses those revenues to fund a bloated government. The cost to taxpayers is low, but the hidden cost to the private economy is real and may underlie the international phenomenon often dubbed “Dutch disease.”²