It should mean that the government does less and taxes less, but in practice people have different things in mind which the government shouldn't do. For example

It should mean that the government does less and taxes less, but in practice people have different things in mind which the government shouldn't do. For example, Reaganite Republicans who like the phrase usually favor high defense spending and many who otherwise like 'small government' want the government to be more intrusive with respect to things like abortion and drugs. So it is true that in reality people use this phrase in a very unprincipled way.