GOVERNMENT SIZE AND MACROECONOMIC STABILITY

We analyze the effects of government size on output variability in the context of a RBC model in which government size is parameterized by the income tax rate and the share of government purchases in output. The model implies that: (i) income taxes are destabilizing, and (ii) for most specifications considered, government purchases are stabilizing. We compare those predictions with the results of simple cross-country regressions using data for 22 OECD countries. The estimated relationship between empirical indicators of government size and measures of GDP variability appears far stronger than the model predicts, and often has the opposite sign.