Why the welfare state works

I have a new piece at HBR in which I review the research on the backgrounds of inventors and suggest that a more equitable society is the way to make the U.S. more innovative — not tax cuts. I see it as broadly in line with my writing on entrepreneurship and the welfare state.

I’ve also written a bit in the last year on redistribution and why it works. In that last link I cited Peter Lindert, and via Justin Fox I’ve found myself reading another of his papers. Here are some bits worth sharing:

This paper dramatizes a conflict between intuition and evidence. On the one hand, many people see strong intuitive reasons for believing that the rise of national tax-based social transfers should have reduced at least GDP, if not true well-being. On the other, the fairest statistical tests of this argument find no cost at all. Multivariate analysis leaves us with the same warnings sounded by the raw historical numbers. A bigger tax bite to finance social spending does not correlate negatively with either the level or the growth of GDP per capita. How can that be true? Why haven’t countries that tax and transfer a third of national product grown any more slowly than countries that devote only a seventh of GDP to social transfers?

He answers:

The keys to the free lunch puzzle are:

(1) For a given share of social budgets in Gross Domestic Product, the high-budget welfare states choose a mix of taxes that is more pro-growth than the mix chosen in the United States and other relatively private-market OECD countries.

(2) On the recipient side, as opposed to the tax side, welfare states have adopted several devices for minimizing young adults’ incentives to avoid work and training.

(3) Government subsidies to early retirement bring only a tiny reduction in GDP, partly because the more expensive early retirement systems are designed to take the least productive employees out of work, thereby raising labor productivity.

(4) Similarly, the larger unemployment compensation programs have little effect on GDP. They lower employment, but they raise the average productivity of those remaining at work.

(5) Social spending often has a positive effect on GDP, even after weighing the effects of the taxes that financed the spending. Not only public education spending, but even many social transfer programs raise GDP per person.

(6) The design of these five keys suggests an underlying logic to the pro-growth side of the welfare state. The higher the social budget as a share of GDP, the higher and more visible is the cost of a bad choice. In democracies where any incumbent can be voted out of office, the welfare states seem to pay closer attention to the productivity consequences of program design. In the process, those countries whose political tastes have led to high social budgets have drifted toward a system that delivers its tax bills to the less elastic factors of production.

The takeaway is that it depends on how you structure the taxes and what you spend the money on. To take an extreme example, if you taxed carbon dioxide emissions and spent the money on education you’d have every reason to expect growth to increase as a result. If you taxed land and spent the money on R&D, once again you’d absolutely expect growth to increase. These are not examples from the paper, but they illustrate the point. Lindert argues that actual welfare states often tax and spend in ways that are pro-growth or at least not terribly anti-growth. As he writes:

The overriding fact about the cases of costly welfare states, then, is that they never happened

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