How expensive is the welfare state anyway? And does it really matter?

The expense of the welfare state comes up in all sorts of political and public conversations even if it’s not worded quite that way.  What to do about Social Security, Medicare, health care?  Make welfare recipients take drug tests?  Dock welfare payments from families who kids miss school?  They all have to do with money in some way, but are also code for ideologies and beliefs about who deserves help and how much the government should provide.  In the United States, the argument against a more universal approach to social welfare often comes down to money (at least on the surface).  Big welfare states are too expensive, we’re told.  I suggest that the money argument is a distraction from ideological differences that really underlie this ongoing debate.

Social spending includes things like old-age, survivor, and disability pensions; health care; family support; active labor market policies; unemployment; and housing. A number of studies that compare the cost of social expenditures across Organization for Economic Co-operation and Development (OECD) countries find that the expenditures in some countries (like Finland) are overestimated and in others (such as the U.S.) are underestimated because they don’t take into account taxation on benefits and private spending.

For example, one 2009 OECD report found that while gross public social expenditures for the U.S. (17.1% of GDP) were less than Finland’s (29.8% of GDP), the net total social expenditures were much closer (27.2% of GDP for the U.S. and 24.4% for Finland).  They account for this difference in three main ways:

1. Finland directly taxes public social benefits at a higher rate – about 18% for public and 22% for private transfers compared to 6% and 12% in the U.S.  They also tax different types of benefits differently.  In Finland, pension transfers and unemployment benefits are taxed and social security is deducted, but at a reduced rate.  In the U.S., pensions are taxed at a reduced rate and unemployment benefits are taxed as earning, but social security isn’t deducted from either.
2. Indirect taxes – the taxes we all pay on groceries, clothes, and other things – are different.  In Finland, the average indirect tax rate in 2009 was 20.8% compared to 4.3% in the U.S.  That means that the same amount of benefit doesn’t go as far in Finland as it does in the U.S.  OECD countries, like the U.S., that have low indirect tax rates also tend to have lower social expenditures.
3. The U.S. has more tax breaks designated as being for “social purposes” than any other OECD country (at about 1.5% of GDP in 2009).  These include lower taxes on some sources of income or for some types of households.  They also include things like tax credits for dependent children that reduce taxes or exempt some from paying a tax and are intended to do the same thing as a cash transfer.  And they include tax breaks that are intended to stimulate some sort of non-governmental provision of benefits like tax exempt non-profits or better tax deals for private pension and health care contributions.  These last two play a much bigger role in the U.S. than in Finland where they are virtually nonexistent.

So, monetarily there are fewer differences in the amount of social spending across OECD countries than we tend to think. The differences are in the ways in which that spending is funded (indirect and direct taxes versus tax breaks).

But are these two means to an end equivalent? And are they really intended to reach the same end anyway?

It turns out that the mix of public vs. private spending can end up with very different results, especially when it comes to income inequality.  Countries like Finland, where the amount of public social spending is above average and where public spending is a greater proportion of the total, also have below-average income inequality. Countries like the U.S., with low levels of public social spending and where private spending is a greater proportion of the total, have higher levels of income inequality.  This makes sense.  Private spending like tax advantages toward pensions and health care are more likely to benefit those who start out with more money.  Private employment-related benefits (like tax exclusions for employer contributions to health care) only shift income among those who are or have been employed.  When social expenditures rely more on private pending than public, the benefits are stacked in favor of those who have more from the start and there are bigger holes in the safety net for the most vulnerable to go tumbling through.

The U.S. stands out as having the least efficient net after-tax social spending with both spending and inequality higher than all other advanced economies except for France which has higher spending and Israel, Turkey, and Mexico which have higher inequality.

Of course, there is all sorts of political freight attached to notions of income inequality and public vs. private social spending.  But there is also growing evidence that inequality has real consequences.  This is true internationally as well.  The U.S. has greater private spending on health care and education, but notably poorer outcomes in mortality and graduation rates.  For those who don’t see inequality as an ethical issue, maybe money will talk since these consequences come with costs.