The purpose of this chapter is to provide an introduction to the nature of the public sector in modern market economies. It presents a review of data on the public sector which looks at its size, sources of income and patterns of expenditure. This reveals the extent and range of activities that the public sector undertakes. It also demonstrates the similarities between public sector behaviour in countries that are otherwise very different culturally.

3.1 Historical growth

The historical development of the public sector over the past century can be briefly described as one of significant growth. In most western economies, government expenditure was around 10 per cent of gross domestic product in 1900. Expenditure then rose steadily over the next sixty years, levelling out in the latter part of the century... It now exceeds a third of gross domestic product in all cases and, for France, exceeds one half. In the last 30 years there is a slowing, or even a stagnation, of the growth in public sector expenditure. The figure also suggests that there has been convergence in the level of expenditure between the countries.

3.2 Expenditure by category

The spending on the goods associated with the core functions of the state – defence and public order – make up only a tenth of spending on average. Costs of an administrative and governmental nature are recorded under the heading general public services and add no more than another 6 per cent on average. Health and education, despite providing benefits of an arguably largely private nature, are substantial in all countries. Spending on housing and community amenities, on recreation and culture, and on the transport and communications sectors are comparatively small. Subsidies to agriculture, energy, mining, manufacturing, and construction sectors are brought together here under the heading of other economic affairs and also appear relatively minor. Social security and welfare spending is the largest single item in all countries.

Certain items such as defence are always allocated to the centre. Redistributive functions also tend to be concentrated centrally for the reason that redistribution between poor and rich regions is only possible that way and attempts at redistribution at lower levels are vulnerable to frustration through migration of richer individuals away from localities with internally redistributive programs.

Education on the other hand seems in all these countries to be largely devolved to lower levels, either to the states or to local government. Public order is also typically dealt with at lower levels. Health spending, on the other hand, is always substantial at the central level but can also be important at lower tiers.

The fact that spending is made by lower levels does not mean that it is financed from local taxes. In most multiple-tier systems, central government partly finances lower-tier functions by means of grants.

3.3 Tax revenues

Total tax revenue as a percentage of GDP for seven countries from 1965 to 2000 mirrors that drawn from the expenditure data. Most of the countries have witnessed some growth in the tax revenues and there has been a degree of convergence. In 2000 the revenues in these countries as a percentage of GDP ranged between 27 per cent and 45 per cent.

The proportion of tax revenue raised by six categories of tax instrument in 2000 shows that income and profit taxes raise the largest proportion of revenue in Australia (57 per cent), the USA (51 per cent), Canada (49 per cent) and the UK (39 per cent). Social security taxes are the largest proportion in Japan (36 per cent), France (36 per cent) and Germany (39 per cent). Among these countries, Turkey is unique with taxes on goods and services the most significant item (41 per cent).

3.4 Taxation by level

For all the federal countries, the central government raises more revenue than state government. In all countries, local government raises the smallest proportion of revenue. The unitary countries in display the same general pattern.

Comparing the federal and unitary countries, it can be seen that local government raises slightly more revenue on average in the unitary countries than the federal countries. What really distinguishes them is the size of central government. The figures suggest that the revenue raised by central government in the unitary countries is almost the same on average as that of central plus state in the federal countries. The absence of state government does not therefore put more emphasis on local government in the unitary countries. Instead, the role of the state government is absorbed within central government.

Reading: Jean Hindriks and Gareth D. Myles (2004), Intermediate Public Economics

"... economies have a clear long-run upward path in public spending relative to gross domestic product" p12

"Starting at a level of public spending around 10% of gross domestic product in the late nineteenth century, the share increased markedly at around the time of the First World War and then continued to rise afterwards. It now exceeds a third of gross domestic product in all cases and, for France, exceeds one half.... in the last thirty years ... The picture this presents is of a slowing, or even a stagnation, of the growth in public sector expenditure." p12

"The most marked rises have come from social spending on items like health, education and pensions." p13