Price versus Income Effects as Sources of Growth in Government's Share of GDP

Abstract

A demand-based model of public sector spending is used to identify the economic determinants of the relative size of government in the United States for the period 1949 to 1998. The government's share of GDP is hypothesized to be a function of income growth (Wagner's Law), relative prices for public sector output (Baumol/Beck hypothesis), and several demographic, cyclical, and budget variables. Although nondefense, noninterest government spending as a share of GDP has not grown in recent decades, the results support both income and price explanations of increasing government size. It is shown that the income and price effects are sensitive to the degree of disaggregation used to define government spending shares. Higher relative prices outweigh economic growth as a factor behind increasing shares for government consumption. Economic growth dominates the relative price effect for investment purchases. The two effects are similar for transfer payments.