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A supply-demand model of the size of public sector and Wagner's law

Fedotenkov, Igor and Idrisov, Georgy (2019): A supply-demand model of the size of public sector and Wagner's law.

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In this paper, we develop a supply-demand model for the public sector, measured as governments' tax revenues divided by GDP. We use a political equilibrium with a rule of majority. The model takes into account inefficiencies caused by taxes and includes costs associated with public goods provision to consumers. We show that the size of the public sector depends on the median voter's income, size of population, costs associated with taxpaying, and quality of institutions, which reflect costs of public goods provision. The estimates for the OECD countries (2000-2017), using dynamic panel model techniques, are in line with the theoretical predictions; however, they do not confirm Wagner's law. Our estimates suggest that the size of the government sector grows as income increases, but at a slower rate. We show that the quality of institutions matters: a more effective government raises the share of public sector; better regulations, which permit and promote private sector development, reduce it.

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