Government: A different animal

The ‘economies of scale' model doesn't apply.

By Patrick R. Gibbons
  • Tuesday, January 6, 2009

A recent op-ed by Dr. Elliott Parker, an economist at the University of Nevada, Reno, no doubt had Nevada's big government spenders salivating. According to Dr. Parker, Nevada's revenue problems result from low taxes, not from high spending levels.  His argument relies on the fact that Nevada has a relatively small bureaucracy, which he claims ranks as the smallest in the country in terms of percentage of the state's population.

According to Parker, the concept of "economies of scale" suggests small states like Nevada should have larger bureaucracies in proportion to state population than larger states.

Say we have two states, one with 100 people and the other with 1,000, each wanting to build a road.  If it takes one person to build one road, larger states would have a cost advantage thanks to economies of scale.  One person would produce one road for 1,000 people instead of one road for 100.  Assuming state governments function consistently with economies of scale, the more populous states would use their employees most efficiently.

Except that states are not efficiency-maximizing entities.  Instead, being political entities, states operate within the norms of political reality, seeking to maximize financial and other benefits for their dominant players – i.e., interest groups and voting blocs.

Parker jumps to the conclusion that Nevada's bureaucracy is small because it's under-funded.  He thus assumes the very point in question.  He then jumps farther and presumes the alleged "under-funding" arises because the state doesn't tax enough – again assuming the point at issue.

In order for Parker's declarations to be salient, Nevada would need to have low tax-collection rates, low expenditure rates, and/or below-average state-employee salaries (or it could be that Nevada's state employees are paid more than average, which is why we have relatively few).  We should also be able to observe the alleged economies-of-scale advantage enjoyed by more populous states.  However, all these assumptions prove false.

The Tax Foundation ranks Nevada 44th in terms of state and local taxes paid by residents, but this, of course, excludes taxes paid by non-residents.  The Tax Foundation actually ranks Nevada 25th in total state and local tax collections per resident, and 17th in state taxes collected per household (see Table 12).  Meanwhile, the U.S. Census Bureau found that in 2006, Nevada's state tax collections ranked 34th nationally.  Anyway you slice it, Nevada's state and even local governments are hardly under-funded.

Nor are state employees underpaid.  According to the Statistical Abstract of the United States, Nevada state-employee pay in 2006 ranked 16th-highest in the country.  Additionally, Geoffrey Lawrence, fiscal policy analyst at the Nevada Policy Research Institute, recently demonstrated that state employee pay has risen as much as 33 percent since 2005.  The reason Nevada has a relatively small bureaucracy may well be that it – like Clark County – pays its employees so generously that it cannot afford to hire more employees.

Let's return to Parker's assumptions about economies of scale.  If state governments were taking advantage of economies of scale, we should see more populous states spending less per resident and employing smaller bureaucracies as a percentage of population.

A simple regression analysis demonstrates, however, that a state's population size and its spending per resident have no statistically significant relationship.  Furthermore, the relationship between a state's size and the size of its bureaucracy as a percentage of population is weak – the alleged economies-of-scale advantage would require a state to add 2.5 billion residents in order to reduce its "state employees as a percentage of total population" by just one percentage point.  That's hardly an economies-of-scale advantage.

Governments rarely take advantage of economies of scale, because they aren't under the same market pressures private companies face.  Lacking strong incentives, they are highly inefficient.

For example, everyone agrees public schools have far more students per teacher than do private schools.  Since there are more students per teacher in public schools, economies of scale would suggest public schools are cheaper per student.  Not so. According to the National Center for Education Statistics, in 2004 the average private-school tuition nationwide was just $6,600, while the average per-pupil cost at public schools (excluding capital outlays, debt payment and teacher pensions) topped $8,900.

Governments face too few incentives to be efficient or accountable, let alone to conserve tax dollars.  All Nevadans – liberal, conservative, socialist or libertarian – should be concerned about how efficiently and competently policymakers spend our money.  

Nevada doesn't need tax hikes.  We simply need more efficient, accountable and competent governance.

Patrick R. Gibbons is education policy analyst at the Nevada Policy Research Institute.

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