David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 14 Government spending and revenue
boundaries, the tax base for taxing workers' incomes in Britain is much less sensitive to tax rates than the
tax base for capital taxes.
Even people are more mobile across national boundaries than they were a few decades ago. Communication
is easier, transport costs are lower and satellites pay no attention to national frontiers on a map. Migration
affects not just taxation but government spending as well. Suppose a country wishes to implement a
generous welfare state. As a closed economy, all it has to worry about is how much of its tax base disappears
from work into leisure. If welfare is too generous, people may not work enough. As an open economy, it
also has to consider whether more generous welfare provision will lead to more migration into the country
as foreigners take advantage, legally or illegally, of the generous welfare provision.
Closer economic integration with other countries - through trade in goods and movement of factors of
production - effectively undermines the sovereignty of nation states. If the tax rate was 80 per cent in
Liverpool but 20 per cent in Manchester, one would expect big movements of capital and people from
Liverpool to Manchester. The tax base in Liverpool would evaporate (even die-hard Everton supporters
could commute from Manchester). The local government of Liverpool has limited local sovereignty
because it is effectively in competition with Manchester.
As modern technology undermines even barriers between countries, the same process is at work. The
economic sovereignty of nation states, their freedom to do what they want, is steadily being constrained by
competition from foreign countries. More than one in ten cans of beer now consumed in England was
bought by British households in France, hopping across the Channel to take advantage of lower alcohol
taxes in France. UK Chancellors, caught between the pressure to raise revenue and support jobs in the UK
drinks industry, have been cutting the real value of UK alcohol taxes. They have already lost the sovereignty
to set tax rates at the high levels that they would have liked.
National sovereignty is undermined not just by competition between countries for tax bases but also by
two other forces. The first is other cross-country spillovers such as acid rain, greenhouse gases or the threat
of pollution from a nuclear accident. Banning nuclear power generation in southern England has limited
value if northern France is studded with nuclear power stations.
The second is the scope for redistribution. Economics is about equity as well as efficiency. In an important
sense, the right jurisdiction for government is the area within which citizens feel sufficient identity with
one another that the rich are prepared to pay for the poor, and the fortunate are prepared to assist the
unlucky. European nation states have long histories and strong national identities. But these are not always
set in stone. Countries such as Belgium, Italy, Spain and the UK have faced strong internal pressures to
allow parts of their country to secede. In the opposite direction, some Europeans now feel as much a
citizen of Europe as of their own particular nation.
Nation states are not yet obsolete. But they are coming under pressure. Further developments in technology
will increase the transnational scope of economic interactions and cultural identity. The proliferation of
e-commerce and the internet will only accelerate this process.
Political economy is the
study of how governments
make decisions.
Political economy: how governments decide
Firms are in business to make profits for their owners. Individuals buy affordable
combinations of goods that yield them most satisfaction. These simple assumptions
let economists explain most consumer and business decision making. What about
government decision making?
Government is the most important single player in the economy. It is important to develop theories of how
governments behave. There is no point analysing the consequences of a policy that a sane government will
never implement.
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