Area 1 Government Spending
1A General Consumption Expenditures by Government as a Percentage of Income
As the size of government expands, less room is available for private choice. While gov-
ernment can fulfill useful roles in society, there is a tendency for government to under-
take superfluous activities as it expands: “there are two broad functions of government
that are consistent with economic freedom: (1) protection of individuals against inva-
sions by intruders, both domestic and foreign, and (2) provision of a few selected goods—
what economists call public goods” (Gwartney, Lawson, and Block, 1996:*22). These
two broad functions of government are often called the “protective” and “productive”
functions of government. Once government moves beyond these two functions into the
provision of private goods, goods that can be produced by private firms and individu-
als, it restricts consumer choice and, thus, economic freedom (Gwartney, Lawson, and
Block, 1996). In other words, government spending, independent of taxation, by itself
reduces economic freedom once this spending exceeds what is necessary to provide a
minimal level of protective and productive functions. Thus, as the size of government
consumption expenditure grows, a jurisdiction receives a lower score in this component.
1B Transfers and Subsidies as a Percentage of Income
When the government taxes one person in order to give money to another, it sepa-
rates individuals from the full benefits of their labor and reduces the real returns of such
activity (Gwartney, Lawson, and Block, 1996). These transfers represent the removal of
property without providing a compensating benefit and are, thus, an infringement on
economic freedom. Put another way, when governments take from one group in order to
give to another, they are violating the same property rights they are supposed to protect.
The greater the level of transfers and subsidies, the lower the score a jurisdiction receives.
1C Insurance and Retirement Payments as a Percentage of Income
When private, voluntary arrangements for retirement, disability insurance, and so on
are replaced by mandatory government programs, economic freedom is diminished.
As the amount of such spending increases, the score on this component declines.
1D Government enterprises and investment (all-government index only)
When government owns what would otherwise be private enterprises and engages in
more of what would otherwise be private investment, economic freedom is reduced.
This variable, used only in the all-government index, is the country score for variable
1C in Economic Freedom of the World: 2017 Annual Report. A detailed description and
data sources can be found in that report, available at <
https://www.fraserinstitute.org/
studies/economic-freedom-of-the-world-2017-annual-report>.
Area 2 Taxes
As the tax burden grows, the restrictions on private choice increase and thus eco-
nomic freedom declines. We examine the major forms of taxation separately.
2A Income and Payroll Tax Revenue as a Percentage of Income
This variable includes all personal and corporate income taxes as well as payroll taxes
used to fund social insurance schemes (i.e., employment insurance, Workers Com-
pensation, and various pension plans).
2Bi Top Marginal Income Tax Rate7 and the Income Threshold at Which It Applies
Because marginal income tax rates represent the direct penalty on economic activity,
in addition to the revenue variable, we include a variable that incorporates the top tax
rate as well as the income level at which that rate applies. Top personal income-tax
rates are rated by the income thresholds at which they apply. Higher thresholds result
in a better score. More details can be found in Appendices A and B.
2Bii Top marginal income and payroll tax rate (all-government index only)
This variable, used only in the all-government index, is the country score for variable
1Dii in Economic Freedom of the World: 2017 Annual Report. A detailed description
and data sources can be found in that report, available at <
https://www.fraserinstitute.
org/studies/economic-freedom-of-the-world-2017-annual-report>.
2C Property Tax and Other Taxes as a Percentage of Income
This variable includes all forms of taxation other than income, payroll, and sales taxes
(which are already captured in variables 2A and 2D), with one exception. Revenue
from taxes on natural resources are excluded for three reasons: 1. most areas do not
have them; 2. their burden is largely exported to taxpayers in other areas; 3. they can
fluctuate widely along with the prices of natural resources (for example, oil), thereby
creating outliers that distort the relative rankings.
2D Sales Tax Revenue as a Percentage of Income
This variable includes all sales and gross receipts taxes (including excise taxes). Such
taxes are a major source of revenue for subnational governments.
Note about intergovernmental transfers and double counting
In examining the two areas above, it may seem that Areas 1 and 2 create a double
counting, in that they capture the two sides of the government ledger sheet, revenues
and expenditures, which presumably should balance over time. However, in exam-
ining subnational jurisdictions, this situation does not hold. A number of intergov-
ernmental transfers break the link between taxation and spending at the subnational
level.8 The break between revenues and spending is even more pronounced at the
all-government level, which includes the federal government. Obviously, what the
federal government spends in a state or a province does not necessarily bear a strong
relationship to the amount of money it raises in that jurisdiction. Thus, to take exam-
ples from both Canada and the United States, the respective federal governments
spend more in the province of Newfoundland & Labrador and the state of West
Virginia than they raise through taxation in these jurisdictions while the opposite
pattern holds for Alberta and Connecticut. As discussed above, both taxation and
spending can suppress economic freedom. Since the link between the two is broken
when examining subnational jurisdictions, it is necessary to examine both sides of
the government’s balance sheet.
Area 3 Regulation
3A Labor Market Freedom
3Ai Minimum Wage Legislation
High minimum wages restrict the ability of employees and employers to negotiate
contracts to their liking. In particular, minimum wage legislation restricts the ability
of low-skilled workers and new entrants to the workforce to negotiate for employ-
ment they might otherwise accept and, thus, restricts the economic freedom of these
workers and the employers who might have hired them.
This component measures the annual income earned by someone working full
time at the minimum wage as a percentage of per-capita income. Since per-capita income
is a proxy for the average productivity in a jurisdiction, this ratio takes into account dif-
ferences in the ability to pay wages across jurisdictions. As the minimum wage grows
relative to productivity, thus narrowing the range of employment contracts that can be
freely negotiated, there are further reductions in economic freedom, resulting in a lower
score for the jurisdiction. For example, minimum wage legislation set at 0.1% of average
productivity is likely to have little impact on economic freedom; set at 50% of average
productivity, the legislation would limit the freedom of workers and firms to negotiate
employment to a much greater extent. For instance, a minimum wage requirement of $2
an hour for New York will have little impact but, for a developing nation, it might remove
most potential workers from the effective workforce. The same idea holds, though in a
narrower range, for jurisdictions within Canada and the United States.
3Aii Government Employment as a Percentage of Total State/Provincial Employment
Economic freedom decreases for several reasons as government employment
increases beyond what is necessary for government’s productive and protective func-
tions. Government, in effect, is using expropriated money to take an amount of labor
out of the labor market. This restricts the ability of individuals and organizations to
contract freely for labor services since employers looking to hire have to bid against
their own tax dollars to obtain labor. High levels of government employment may also
indicate that government is attempting to supply goods and services that individuals
contracting freely with each other could provide on their own; that the government is
attempting to provide goods and services that individuals would not care to obtain if
able to contract freely; or that government is engaging in regulatory and other activi-
ties that restrict the freedom of citizens. Finally, high levels of government employ-
ment suggest government is directly undertaking work that could be contracted pri-
vately. When government, instead of funding private providers, decides to provide a
good or service directly, it reduces economic freedom by limiting choice and by typi-
cally creating a governmental quasi-monopoly in provision of services. For instance,
the creation of school vouchers may not decrease government expenditures but it will
reduce government employment, eroding government’s monopoly on the provision
of publicly funded education services while creating more choice for parents and
students and, thus, enhancing economic freedom.
3Aiii Union Density
Workers should have the right to form and join unions, or not to do so, as they choose.
However, laws and regulations governing the labor market often force workers to join
unions when they would rather not, permit unionization drives where coercion can
be employed (particularly when there are undemocratic provisions such as union
certification without a vote by secret ballot), and may make decertification difficult
even when a majority of workers would favor it. On the other hand, with rare excep-
tions, a majority of workers can always unionize a workplace and workers are free to
join an existing or newly formed union.
To this point in time, there is no reliable compilation of historical data about
labor-market laws and regulations that would permit comparisons across jurisdictions
for the United States, Canada, and Mexico. In this report, therefore, we attempt to pro-
vide a proxy for this component. We begin with union density, that is, the percentage
of unionized workers in a state or province. However, a number of factors affect union
density: laws and regulations, the level of government employment, and manufacturing
density. In measuring economic freedom, our goal is to capture the impact of policy
factors, laws and regulations, and so on, not other factors. We also wish to exclude gov-
ernment employment—although it is a policy factor that is highly correlated with levels
of unionization—since government employment is captured in component 3Aii above.
Thus, we ran statistical tests to determine how significant an effect government
employment had on unionization—a highly significant effect—and held this factor
constant in calculating the component. We also ran tests to determine if the size of
the manufacturing sector was significant. It was not and, therefore, we did not cor-
rect for this factor in calculating the component. It may also be that the size of the
rural population has an impact on unionization. Unfortunately, consistent data from
Canada, the United States, and Mexico are not available. Despite this limitation, the
authors believe this proxy component is the best available at this time. Its results are
consistent with the published information that is available (see, for example, Godin,
Palacios, Clemens, Veldhius, and Karabegović, 2006).9
Most of the components of the three areas described above exist for both the
subnational and the all-government levels. Total tax revenue from own sources, for
example, is calculated first for local/municipal and provincial/state governments, and
then again counting all levels of government that capture revenue from individuals
living in a given province or state.
Components added for the all-government index
To reflect the recent divergence in economic freedom between Canada and the United
States more closely, and to incorporate more accurately the differences in economic
freedom in the Mexican states relative to the rest of North America, we include a num-
ber of variables from the world index in our all-government index of North American
states and provinces. The index expands the regulatory area to include data on these
areas. Labour regulation becomes one of three components of Area 3: Regulation,
which comprises 3A: Labour market regulation; 3B: Credit market regulation (Area
5A from Economic Freedom of the World); and 3C: Business regulations (Area 5C from
EFW). (See Appendix A for a description of how Area*3 is now calculated.)
Why the regulation of credit and business affects economic freedom is eas-
ily understood. When government limits who can lend to and borrow from whom
and puts other restrictions on credit markets, economic freedom is reduced; when
government limits business people’s ability to make their own decisions, freedom
is reduced.
3A Labor Market Regulation
3Aiv Hiring regulations and minimum wage
3Av Hiring and firing regulations
3Avi Centralized collective bargaining
3Avii Hours regulations
3Aviii Mandated cost of worker dismissal
3Aix Conscription
3B Credit Market Regulation
3Bi Ownership of banks
3Bii Private sector credit
3Biii Interest rate controls/negative real interest rates
3C Business Regulations
3Ci Administrative requirements
3Cii Bureaucracy costs
3Ciii Starting a business
3Civ Extra payments/bribes/favoritism
3Cv Licensing restrictions
3Cvi Cost of tax compliance
We also include three other areas: Area 4: Legal System and Property Rights (Area
2 from Economic Freedom of the World), Area 5: Sound Money (Area 3 from EFW),
and Area 6: Freedom to Trade Internationally (Area 4 from EFW). See Gwartney,
Lawson, and Hall, 2016, for a complete description of these variables.
Area 4 Legal System and Property Rights
Protection of property rights and a sound legal system are vital for economic freedom,
otherwise the government and other powerful economic actors for their own benefit
can limit the economic freedom of the less powerful. The variables for Legal System
and Property Rights from the world index are the following.
4A Judicial Independence
4B Impartial Courts
4C Protection of Property Rights
4D Military Interference in Rule of Law and Politics
4E Integrity of the Legal System
4F Legal Enforcement of Contracts
4G Regulatory Restrictions on the Sale of Real Property
4H Reliability of Police
4I Business Costs of Crime
Area 5 Sound Money
Provision of sound money is important for economic freedom because without it the
resulting high rate of inflation serves as a hidden tax on consumers. The variables for
Sound Money from the world index are the following.
5A Money Growth
5B Standard Deviation of Inflation
5C Inflation: Most Recent Year
5D Freedom to Own Foreign Currency Bank Accounts
Area 6 Freedom to Trade Internationally
Freedom to trade internationally is crucial to economic freedom because it increases
the ability of individuals to engage in voluntary exchange, which creates wealth for
both buyer and seller. The variables for Area 6 from the world index are the following.
6A Tariffs
6Ai Revenue from trade taxes (% of trade sector)
6Aii Mean tariff rate
6Aiii Standard deviation of tariff rates
6B Regulatory trade barriers
6Bi Non-tariff trade barriers
6Bii Compliance costs of importing and exporting
6C Black-market exchange rates
6D Controls of the movement of capital and people
6Di Foreign ownership/investment restrictions
6Dii Capital controls
6Diii Freedom of foreigners to visit
More information on the variables and the calculations can be found in Appendices A
and B. (For detailed descriptions of the world-adjusted variables, readers can refer to
Economic Freedom of the World: 2017 Annual Report (
https://www.fraserinstitute.org/studies/
economic-freedom-of-the-world-2017-annual-report). The inclusion of these data from the
world index raise the scores for both the Canadian provinces and US states since both
Canada and the United States do well in these areas when compared to other nations,
as is done in the world index. The effect on the Mexican states tends to be the opposite.
