A supply-demand model of public sector size

• Published in: Economic systems 2021-06, Vol.45 (2), p.100869, Article 100869
• Main Authors: Fedotenkov, Igor, Idrisov, Georgy
• Format: Article
• Language: English
• Subjects: Median voter; Political equilibrium; Size of public sector; Tax burden; Wagner's law
• ISSN: 0939-3625; 1878-5433
• DOI: 10.1016/j.ecosys.2021.100869

•A supply-demand model for the public sector is developed and estimated.•A greater dependency ratio and the Gini coefficient increase the share of the public sector.•Greater government effectiveness increases the public sector.•Wagner's law is not confirmed. We develop a supply-demand model for the public sector with a political equilibrium. The model considers the inefficiencies caused by taxes and includes costs associated with the provision of public goods to consumers. We show that the size of the public sector may depend on the median voter's income, population size, costs associated with paying tax, and quality of institutions, all of which reflect the costs of provisioning public goods. The estimates for the Organisation for Economic Co-operation and Development member countries are compatible with theoretical predictions; however, they do not confirm Wagner's law, which holds that the public sector share does not grow with an increase in income. A greater dependency ratio and the Gini coefficient increase demand for redistribution policies. Greater government effectiveness is a supply-side factor that increases the public sector's share in an economy.