How does public spending affect the economy?

Public spending

Public expenditure is the state's expenditure on the fulfillment of its political, economic and social tasks. The totality of public expenditure is divided according to different criteria. This includes, above all, the breakdown by area of ​​responsibility, according to the ministerial principle or according to the economic and political function of the expenditure. The amount of public expenditure depends on the amount of public income from taxes and duties as well as borrowing.

In order to meet its obligations under the constitution and the formation of political will, the state has to make certain expenditures. The totality of the expenditure which the state covers with the means at its disposal is called the public budget. From it the salaries of the civil servants, the national defense, the expenses for social purposes, the creation of cheap housing are paid. In addition, the state uses funds to regulate and influence the economy (subsidies), supports international projects, gives financial aid to weaker nations and pays for measures to improve the quality of the environment.

The large number of public expenditures can be broken down according to various criteria. The most frequently used structuring principles are the ministerial principle and the task principle.

If one subdivides the public expenditure of the Federal Republic of Germany according to the task principle, the following scheme results:

  • Social security
  • defense
  • Public safety and order, legal protection
  • Schools, universities, other educational systems
  • Science, research and development outside the university
  • Cultural affairs
  • Health, sport and recreation
  • Housing and spatial planning
  • Business promotion
  • Transport and communications
  • Other areas of responsibility

According to the ministerial principle, the totality of public expenditure is subdivided according to the share that the individual ministries have in the total state expenditure. In the Federal Republic of Germany, the expenditure can then mainly be assigned to the following ministries:

  • Ministry of Economy
  • Foreign Ministry
  • Ministry of Defense
  • Ministry of Finance
  • Ministry of the Environment
  • Family Ministry
  • Home Office
  • Ministry of Labor and Social Affairs

The tasks that are ascribed to the state and that lead to public spending can also be differentiated according to economic criteria. A distinction is often used here in three major areas of responsibility of the state, which goes back to the American economists Richard and Peggy Musgrave. According to this concept, one can distinguish three functions of the state that lead to public expenditure:

1. The allocation function of the state

2. The distributive function of the state

3. The stabilization function of the state

The Allocation function of the state includes the provision of so-called public goods. These are goods that the citizens of an economy want, but cannot (can) be provided by the private sector. The reason for this is that with certain goods it is not possible to limit the benefits from consumption to the buyers of those products or services. An example of a typical public good is national defense: it is not possible for the army to only protect those who have paid for it. No consumer would be prepared to pay individually for such a good, since the use cannot be withheld from him. Everyone lives under the protection of national defense - regardless of whether they have paid for it or not. Other examples of public goods are environmental measures aimed at improving air quality or protecting water bodies. The lighting of public roads and the maintenance of the landscape are also typical public goods. But since nobody can be prevented from consuming these goods here either, i.e. nobody wants to pay for them individually, no private provider is prepared to offer such a good on the market. Public goods must therefore be made available either directly via the state or via private producers who are paid for by the state. Because only the state can share the costs with all users through taxes and fees.

The Distribution function of the state includes the state distribution policy. In general, the market-driven distribution of income and wealth differs from that which the majority of the population perceive to be fair. A distribution based solely on the valuation of the market is felt by many to be unjust. For example, there are services that society sees as important and useful, but that are not, or only to a limited extent, rewarded by the market. Most people find the achievement of a single mother to be important and useful. But the market does not honor them. The state can step in here. Through taxation, it siphons off part of the income of those whose performance is rewarded by the market and distributes it as a social benefit to those whose performance is ignored by the market.

In addition, it is felt to be unfair when people who cannot take part in the market process for reasons for which they are not responsible. These include, for example, the sick and the unemployed.

The obvious discrepancies between the distribution that the market can provide, which is also necessary for the functioning of the market process, and the distribution of income, which is perceived as fair or desirable, makes state distribution or redistribution activity necessary. However, it is always controversial how extensive the state's corrections to the market distribution should be. There is no general rule from which the optimal distribution can be calculated. The desired distribution is rather a question of the formation of political will. The state distribution policy does not only have an influence on the state's expenditures. It also has a significant impact on the state's revenue. With increasing redistribution, the willingness of many citizens to perform decreases, as the remuneration they receive from the market for their additional service is reduced by the state through taxes and distributed to others. The material benefit from the additional output becomes smaller and smaller with increasing redistribution and can even approach zero. If the redistribution reaches a critical point, the state's revenues decline as the workers reduce their performance. Conversely, it is becoming more and more interesting to live on social benefits instead of working, as the difference between the two sources of income is shrinking. This narrows the tax base. This in turn limits the state's ability to redistribute income.

The Stability function of the state is explained by the cyclical fluctuations to which an economy is subject. These fluctuations, if not smoothed out, can lead to extreme hardship in the economy, such as high unemployment and high inflation. The stabilization function of the state is therefore one of the most important tasks of the state in most economies. In Germany, the stabilization function is laid down in the so-called Stability and Growth Act. According to this, the state has to orient its economic policy in such a way that it contributes to the achievement of the four stability goals:

  • Full employment,
  • Price level stability,
  • external balance as well
  • adequate and steady economic growth.

The stability tasks of the state can, depending on the economic situation, have an impact on both the level of government spending and the level of tax revenue. In times of recession, for example, government expenditures are more likely to rise and revenues will tend to decrease, while government revenues will exceed its expenditures in boom phases.

The tasks of the state described above have been expanded more and more in recent years. This has meant that the state has had to take on more and more extensive expenditure. The share of the overall economic output that the state claims for this is known as the state quota. The government quota reflects the ratio of public expenditure to the gross national product of an economy. In the Federal Republic of Germany, the government quota has risen continuously. This means that the state is claiming an ever larger part of the national product generated in Germany. In 1950 the government quota in Germany (including social security expenditure) was 31.3 percent. In 1986 it was 46.9 percent. For 1996, a government quota of 50.5 percent was calculated.

The increase in the government ratio is related to the sharp increase in government spending. While the state was still primarily concerned with the protection of internal and external security at the turn of the century and its expenditure was thus essentially limited to the areas of the military, police, justice and diplomacy, it has taken on more and more tasks over the course of this century. State activity covered more and more areas: social welfare, education, health, etc. At the same time, however, the financial needs of the state continued to increase. In the last few years this tendency resulted in an ever higher tax burden for the citizens as well as a steadily increasing one National debt reflects, the call has grown louder to reduce government activity and thus government spending again.