Public Sector Crowds out Private Sector

With the election behind us and a tough legislative session looming, policymakers need to get a firm grip on our bloated government sector and shrunken private sector. As our latest research clearly shows, New Mexico pays a steep economic price in lower personal income for its inefficient government workforce.

Fundamentally, personal income – as defined by the bean counters at the U.S. Department of Commerce’s Bureau of Economic Analysis (BEA) – comes from two sources: the private sector and the public sector. More specifically, the BEA defines public sector spending as personal current transfer receipts (Medicare, Medicaid, Social Security, etc.) and government employee compensation (federal, state and local). All else is considered to be in the private sector.

The distinction between the two sectors is important because only the private sector creates new income. The public sector, in contrast, can only redistribute income through taxes and spending. The end result is that the public sector crowds out the private sector.

Of course, this is not a new phenomena, the crowding out of the private sector has been going on for a very long time. Based on the BEA data, in 1929 (the first year of available data), New Mexico’s private sector accounted for 87.2 percent of all personal income earned in the state. Eighty years later in 2009, the private sector share had fallen by nearly one-third to an all-time low of 58.9 percent of personal income – the fifth-smallest private sector in the country.

In the long run, a state’s private sector share matters a great deal. States with a larger private sector grow faster over time than states with a smaller private sector. For example, let’s compare two states that are virtually identical in every way except for the size of the private sector – New Hampshire and Maine.

In 2009, New Hampshire had the largest private sector (75.7 percent) and the 14th highest per household personal income ($111,402) whereas Maine had only the 41st largest private sector (63.6 percent) and the 41st higher per household personal income ($88,261). As such, New Hampshire’s per household personal income is 26 percent higher or $23,141 thanks to a more vigorous private sector.

Like Maine, New Mexico has also paid an economic price for its small private sector. In 2009, New Mexico’s average household income was $89,940 which is the 13th lowest in the country. In contrast, neighboring Texas has the 7th largest private sector (73 percent) and, correspondingly, the 12th highest per household income ($112,016).

New Mexico’s bloated government workforce plays a significant role in crowding out the private sector. In 2009, New Mexico’s state and local governments spent $8.7 billion in payroll (wages and salaries and benefits) which amounts to 12.4 percent of all personal income earned in the state – the 2nd highest in the country. The national average was a much lower 8.9 percent.

If New Mexico’s payroll for the state and local government workforce was trimmed to the national average, it would save taxpayers a whopping $2.8 billion dropping to $5.9 billion from $8.7 billion. Those savings from reducing the government workforce would amount to $3,731 for every household in New Mexico.

More importantly, in 2009, New Mexico’s private sector would be 7 percent higher jumping up to 63 percent from 58.9 percent. Our research finds that, on average, a 1 percentage point increase in the size of the private sector yields an increase in household income of $2,617. That means, in the long-run, the average household in New Mexico would see their income climb by $10,857 ($2,617 times 4.1 percentage points). With this extra income, New Mexico’s per household personal income would have ranked as the 23rd highest, rather than as the 13th lowest.

Overall, New Mexico is poorer thanks to its bloated government workforce. Not only would the average household save $3,732 in taxes per year with a right-sized government payroll, but over the long-run they would also have another $10,857 in personal income to spend on goods and services such as homes, cars, education and health care. The economic evidence is clear; a larger private sector means more jobs and higher income for all of New Mexico’s residents, not just those lucky enough to be employed in the public sector.
J. Scott Moody and Wendy P. Warcholik, Ph.D. are adjunct scholars with New Mexico’s Rio Grande Foundation. The Rio Grande Foundation is an independent, non-partisan, tax-exempt research and educational organization dedicated to promoting prosperity for New Mexico based on principles of limited government, economic freedom and individual responsibility.