Why Doesn't the United States Have a European-Style Welfare State?

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EUROPEAN GOVERNMENTS REDISTRIBUTE income among their citizens on a much larger scale than does the U.S. government. European social programs are more generous and reach a larger share of citizens. European tax systems are more progressive. European regulations designed to protect the poor are more intrusive. In this paper we try to understand why.

The literature on the size of government is rich and varied. However, here we do not focus on the size of government as such, but rather on the redistributive side of government policies. Thus our goal is in one sense narrower than answering the question, "What explains the size of government?" since we focus on a single, but increasingly important, role of fiscal policy. Yet in another sense our focus is broader, because redistributive policies go beyond the government budget--think, for instance, of labor market policies.

We consider economic, political, and behavioral explanations for these differences between the United States and Europe. Economic explanations focus on the variance of income and the skewness of the income distribution before taxes and transfers, the social costs of taxation, the volatility of income, and expected changes in income for the median voter. We conclude that most of these theories cannot explain the observed differences. Before-tax income in the United States has both a higher variance and a more skewed distribution. There is no evidence that the deadweight losses from taxation are lower in Europe. And the volatility of income appears to be lower in Europe than in the United States. However, there is some possibility that middle-class households in the United States have a greater chance of moving up in the income distribution, which would make the median voter more averse to redistribution.

Political explanations for the observed level of redistribution focus on institutions that prevent minorities from gaining political power or that strictly protect individuals' private property. Cross-country comparisons indicate the importance of these institutions in limiting redistribution. For instance, at the federal level, the United States does not have proportional representation, which played an important role in facilitating the growth of socialist parties in many European countries. America has strong courts that have routinely rejected popular attempts at redistribution, such as the income tax or labor regulation. The European equivalents of these courts were swept away as democracy replaced monarchy and aristocracy. The federal structure of the United States may have also contributed to constraining the role of the central government in redistribution.

These political institutions result from particular features of U.S. history and geography. The formation of the United States as a federation of independent territories led to a structure that often creates obstacles to centralized redistributive policies. The relative political stability of the United States over more than two centuries means that it is still governed by an eighteenth-century constitution designed to protect property. As world war and revolution uprooted the old European monarchies, the twentieth-century constitutions that replaced them were more oriented toward majority rule, and less toward protection of private property. Moreover, the spatial organization of the United States--in particular, its low population density--meant that the U.S. government was much less threatened by socialist revolution. In contrast, many of Europe's institutions were established either by revolutionary groups directly or by elites in response to the threat of violence.

Finally, we discuss reciprocal altruism as a possible behavioral explanation for redistribution. Reciprocal altruism implies that voters will dislike giving money to the poor if, as in the United States, the poor are perceived as lazy. In contrast, Europeans overwhelmingly believe that the poor are poor because they have been unfortunate. This difference in views is part of what is sometimes referred to as "American exceptionalism." (1)

Racial discord plays a critical role in determining beliefs about the poor. Since racial minorities are highly overrepresented among the poorest Americans, any income-based redistribution measures will redistribute disproportionately to these minorities. Opponents of redistribution in the United States have regularly used race-based rhetoric to resist left-wing policies. Across countries, racial fragmentation is a powerful predictor of redistribution. Within the United States, race is the single most important predictor of support for welfare. America's troubled race relations are clearly a major reason for the absence of an American welfare state.

The Size and Structure of Redistributive Policies in the United States and Europe

In this section we review the basic facts about the level of redistribution to the poor in the United States and Europe.

Government Spending

Table 1 summarizes the magnitude and composition of government spending in Europe and in the United States, using data from the Organization for Economic Cooperation and Development (OECD). In addition to reporting averages for the countries in the European Union, we provide separate data on the United Kingdom (the one EU country with a relatively small government), Germany (the largest EU country), Sweden (as the prototype of a country with an especially large welfare state), and France.

General government spending in the countries in the European Union averages 48 percent of GDP; it is 38 percent in the United Kingdom and 60 percent in Sweden. General government spending in the United States is smaller than any of these, at 36 percent of GDP. The composition of spending is also instructive. The largest differences between the United States and Europe are in transfers to households (including social security) and subsidies. In fact, the sum of these two categories of spending is almost twice as large, as a share of GDP, in Europe as in the United States (20 percent versus 11 percent). The difference in transfers and subsidies accounts for 9 percentage points of the 12-percentage-point difference in total spending. Consumption of goods and services and government wages are also higher in Europe, but the difference relative to the United States is much smaller than that for transfers. Public investment is actually higher in the United States than in the average EU country. Of course, military spending is higher in the United States than in Europe (data not shown), even today when U.S. defense spending is low by post-World War II standards. Western Europe since World War II has been a free rider on defense provided by the United States. If the United States had spent less to defend Western Europe and itself from the Soviet threat, the difference in the overall size of government would be even larger.

The OECD offers a different breakdown of government social spending; these data are presented in table 2 for 1995, the latest year for which they are available. In all categories except health, the United States spends a smaller proportion of GDP than the European average. The differences are particularly large in family allowances and unemployment compensation and other labor market programs. By this accounting, social spending in the United States was 16 percent of GDP in 1995, whereas the European average was 25 percent. (2)

Consider the other non-European OECD countries (not shown in the tables). The size of government in Canada (46 percent of GDP) is similar to that in France and slightly below the European average. Japan and Australia have governments that are smaller than Canada's (42 and 36 percent of GDP) but still slightly larger than the U.S. government, whereas New Zealand's government, at 41 percent of GDP, is roughly midway between those of the United States and Europe. The average for the non-European, non-U.S. OECD countries falls somewhere in between the United States and Europe. Thus, in comparing the United States and Europe, we are comparing two extremes in the OECD group.

Differences in the overall size of government or even in the size of transfer programs are only indirectly related to the extent of redistribution from the rich to the poor. For instance, the social security system involves flows from the young to the old as well as from the rich to the poor. Nevertheless, it is uncontroversial that a predominant share of public goods, and especially transfers, favors the poor disproportionately.

The Structure of Taxation

Table 3 summarizes the composition of government revenue in Europe and the United States. The most striking differences are in social security includes the wages of government workers in the health sector, which would be included under "Wages and salaries" in table 1. contributions and taxes on goods and services. However, there are important differences in the structure of taxation even within Europe. (3) Our concern here is with the tax burden of the rich relative to that of the poor. To calculate a precise measure of the progressivity of the tax system across all these countries would require an entire paper (at least) devoted to unraveling the intricacies of the different tax codes. Although such a task is beyond the scope of this paper, a simple attempt is made in figure 1. We assembled data on the different income tax brackets of the European countries and took a cross-country average. We then subtracted this average from the corresponding federal income tax brackets in the United States; figure 1 plots that difference. Thus, for a given level of income, a positive value in the figure implies that the marginal tax rate in the United States exceeds the European average, and a negative value indicates the opposite. The figure shows that marginal tax rates in the United States are higher than in Europe for low levels of income (up to about 50 percent of the average worker's wage) and lower for higher levels of income. Also, the difference between the United States and Europe becomes larger in absolute value as income rises. In short, the income tax system is much more progressive in Europe than in the United States. (4)

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Historical Trends in the Size of Government

Understanding the reasons for these striking differences between the United States and Europe requires that we know something of the history of redistribution in both regions. In particular, we want to know when the size of government, and especially the size of the welfare state in Europe, diverged from that in the United States. Did the two share a similar size of government for a while and then diverge, or has the difference always been present?

Table 4 provides a clear answer: from the very beginning of the expansion of the public sector in the late nineteenth century, the United States and Europe show very distinct patterns. Although the ratio of welfare spending was already high at the end of the nineteenth century, the absolute difference grew as the welfare state expanded both in Europe and in the United States, especially in the 1960s and 1970s. The observation that the difference is of long standing is important, because it allows us to exclude explanations of the difference that are specific to a certain period or event.

Income Support Policies and Safety Nets

In addition to the aggregate data provided above, it is useful to compare specific programs for income support and safety nets. We consider Germany, Sweden, and the United States, and we focus on a representative household. We determine the extent to which existing programs and their provisions can be beneficial to such a household when it experiences increased hardship. We examine the costs of raising a child, of sickness, of disability, and of extreme poverty (see appendix B for data sources). We discuss unemployment policies in the context of more general labor market regulations in the next subsection.

Our representative household is composed of two adults and two children. The adults, both aged thirty-five, are average production workers with fifteen years of work experience. The two children are aged eight and twelve, to take a benchmark often used by social security administrations. The monthly before-tax earnings of an average production worker in the three countries, in 1999 dollars adjusted for purchasing power parity (PPP), are $2,498 in the United States, $2,561 in Germany, and $1,880 in Sweden.

FAMILY BENEFITS. Child benefits are available in Germany and Sweden for every parent, without regard to income, until the child reaches eighteen (in Germany) or sixteen (in Sweden), but those limits can be extended if the child pursues higher education. By contrast, family allowances do not exist in the United States? However, special allowances for children of low-income families are allocated under the Temporary Assistance for Needy Families program (TANK which replaced the Aid to Families with Dependent Children, or AFDC, program in the mid-1990s), as discussed below. To summarize, each child entitles the representative household to monthly benefits (again in 1999 PPP-adjusted dollars) of $136 in Germany, $87 in Sweden, and zero in the United States.

HEALTH CARE. The public health care systems of Germany and Sweden also differ significantly from that of the United States. Both Germany and Sweden provide universal coverage, with unlimited benefits including payments of doctors' fees, hospitalization, and the cost of pharmaceutical products. The United States, on the other hand, relies on two programs, Medicare and Medicaid, which target mainly the elderly and low-income households, respectively. If one of the members of our representative U.S. family became sick and had to visit a doctor or stay in a hospital, he or she would not be eligible for public funds or services (although a large fraction of employers offer health insurance as part of their compensation package). In contrast, the representative German or Swedish household would have most of these expenses covered by the public health care program. A small part of the cost is borne by the household in the form of a deductible. In Germany the household pays a deductible of $9 for each day of hospitalization; in Sweden the hospitalization deductible is $8, and in addition there is a deductible of $10 to $14 for medical treatment, again in 1999 PPP dollars.

SICKNESS AND ACCIDENTAL INJURY BENEFITS. Sickness benefits are intended to replace the loss of earnings due to sickness of a household's income earners. Once again, the coverage and the extent of benefits differ radically between the United States and the two European countries examined here. Indeed, only five states in the United States offer any kind of sickness benefit (there is no federal benefit), whereas German and Swedish legislation guarantees benefits for all persons in paid employment; these benefits replace up to 70 percent and 80 percent of gross earnings, respectively. If the head of our representative U.S. household fell sick (and was fortunate enough to live in one of the five states that offer sickness benefits), he or she would receive (in 1999 PPP dollars) between $452 and $1,576 a month (between 18 and 63 percent of the average wage); the representative household head in Germany would receive $1,793 a month, and his or her Swedish counterpart would receive $1,504 a month. The U.S. household's benefits would last for a maximum of fifty-two weeks, whereas those of the German household would expire only after seventy-eight weeks, and those of the Swedish household could continue indefinitely.

Accidental injuries occurring in the enterprise or in connection with the working situation of the employee are covered in all three countries, including every state in the United States, and these benefits are quite comparable. German and Swedish workers who suffer on-the-job injuries see their income replaced according to the amounts allocated by sickness benefits, whereas American workers receive the equivalent of two-thirds of their average weekly earnings, up to a maximum of $270 to $714 a week, depending on the state.

DISABILITY BENEFITS. All three countries also have provisions to replace income lost due to inability to engage in any gainful activity. Participation is compulsory in all three systems, and coverage is based on work history. The United States and Germany require at least five years of employment before a worker can receive benefits; in Sweden the requirement is three years. But the extent of coverage differs dramatically across the three countries. Whereas in the United States the disability pension is based on the worker's average monthly earnings, the Swedish scheme provides a basic minimum pension, augmented by an income-based supplementary pension, care allowances, and handicap allowances; German pensions are computed using the level of income and the number of years of contribution. For the representative production worker, disability benefits amount to $1,063 in the United States and $1,504 in Sweden (again in 1999 PPP dollars). These correspond to 43 percent and 80 percent of the average wage, respectively.

POVERTY RELIEF. In all three countries, certain government programs are directed at persons who are unable to support themselves but are not covered under the schemes described above. These persons may fail to meet eligibility criteria because of insufficient past contributions, or their incomes may be too low to allow them to take part in insurance schemes. The programs that provide these pure cash transfers differ in structure across the three countries. Germany and Sweden rely on unlimited and unconditional plans (called Sozialhilfe and Socialbidrag, respectively), which are meant primarily to alleviate poverty. Additional plans covering the costs of housing and heating are also available for German residents. The United States, on the other hand, offers an array of plans targeting different groups in the population. Supplemental Security Income (SSI) targets aged, blind, and disabled persons with annual gross income below about $14,500; the federal payment can be augmented by a state supplement. The TANF program, mentioned above, is limited to two years of assistance; recipients who are able to work must find employment at the end of that period. Other plans, such as those for food and nutrition assistance and those for housing assistance, also provide relief to low-income households.

A representative U.S. household that has zero income and has exhausted all other claims to regular benefits could be eligible for $1,306 in monthly benefits under these programs ($726 from SSI, or 29 percent of the average monthly wage, and $580 from TANF, or 23 percent of the average wage). (6) Its German counterpart would be eligible to receive $1,008 a month, and its Swedish counterpart $892 a month (39 percent and 47 percent of the average wage, respectively, again in 1999 PPP-adjusted dollars). These amounts do not include benefits available under additional programs such as housing allowances.

Labor Market Policies

Not all redistributive policies involve government expenditure. Legislation in several other areas also determines the degree of government involvement in redistributing income. An obvious case is that of labor market policies. Labor regulations such as those that set a minimum wage may keep real wages higher than they would be otherwise. (7) Table 5 summarizes the available data on minimum wages in Europe and the United States. The data are from several different sources, but all tell a very similar story. In the European Union the minimum wage is 53 percent of the average wage, against 39 percent in the United States. In France the minimum wage is around 65 percent of the average manufacturing wage, compared with 36 percent in the United States.

Table 6 reports various other measures of labor market regulation, using data assembled by Stephen Nickell and Richard Layard. (8) Although a fair amount of variation is observed within Europe, on all measures the United States scores lower (often much lower) than the European average. The first column of the table reports an index compiled by the OECD that combines several aspects of legislation designed to protect workers in the workplace (see appendix B). The minimum score (representing the least protection) is zero and the maximum 10. The second column reports an index of employment protection (that is, restrictions on the ability of enterprises to terminate employees), with 20 indicating the strictest protection. On the first measure the United States has a score of zero, and on the second a score of one. The next three columns report measures of minimum annual leave and the level and duration of unemployment compensation. On all three measures the U.S. score is below that of the European Union as a whole and below that of any of the individual European countries listed (except that the U.K. level of unemployment compensation is lower).

Scores on these measures for a group of non-European, non-U.S. OECD countries (Australia, Canada, Japan, and New Zealand; data not shown) lie somewhere in between those of the United States and continental Europe. On some measures these countries may be closer to the United States, and on others closer to Europe. Overall, however, the United States and Europe appear to be polar extremes.

Has It Worked?

The consequences of the greater expansion of the welfare state in Europe than in the United States are important, but well beyond the already broad scope of this paper. We want to explain the causes of this difference, not its consequences. Nevertheless, it is worth pausing to briefly characterize the conventional wisdom (if there is any) on this issue. Needless to say, the question of the impact of a large welfare state is difficult to answer and loaded with ideological biases. We think that a fair and relatively uncontroversial assessment of the effect of these different levels of redistributive policies in the broadest possible terms is as follows.

As Vito Tanzi and Ludger Schuknecht forcefully argue in a recent study of the growth of government, averages of several key social indicators such as health measures, life expectancy, and educational achievement are not that different between countries with a large government like those in continental Europe and countries with a small government like that in the United States. (9) On the other hand, a large body of research has shown that after-tax income inequality is lower in countries with larger governments and, in particular, in countries with higher social spending. (10) As is well known, comparing inequality and poverty rates across countries is a minefield. However, it is quite clear that after-tax income inequality is relatively low in the Nordic countries, intermediate in central and southern Europe, higher in the United Kingdom, and higher still in the United States. (11)

When one compares the distribution of disposable income across population deciles in the United States and Europe, a striking and interesting difference is the much lower proportion of income accruing to the lowest decile in the United States. That is, the greater inequality in the United States does not stem from the top decile being particularly wealthy relative to the median, so much as from the bottom decile being particularly poor. For instance, in the 1980s the average income among the lowest decile was about a third of the median in the United States, compared with more than 55 percent in many European countries, including France, and more than 60 percent in several Nordic countries. (12) Another way of looking at this is to compute the fraction of the population with incomes below 50 percent of the median. (Many European countries use this as a definition of the poverty line.) Depending on the criteria used, this fraction was around 17 to 18 percent in the United States in the 1980s, against values of 5 to 8 percent in Sweden and Germany. (13)

In the 1990s income inequality increased sharply in the United Kingdom and somewhat less sharply in the United States. In the continental European countries, changes in income inequality in the last decade were smaller. It would appear that, because of a smaller emphasis on policies that redistribute toward the poor, the bottom decile of the income ladder in the United States is less well off than the bottom decile in European countries. That is, the U.S. poor are really poor. (14)

How much the reduction in inequality achieved by a more redistributive government "costs" in terms of slower growth because of higher taxation, more intrusive regulation, and so forth is a large and difficult question that we cannot even begin to answer here. Assar Lindbeck provides an excellent and exhaustive discussion of this issue for Sweden. (15) His conclusion is that in the long run the trade-off between redistribution and growth is rather steep. In 1970, before the explosion of its welfare state, Sweden had an income per capita equivalent to 115 percent of that in the average OECD country--the fourth-highest of all. By 1995, however, Sweden's income per capita was only 95 percent of the OECD average, and Sweden had fallen to sixteenth place. One may wonder whether the trade-off is so steep at levels of social protection less extreme than Sweden's. Other countries with extended welfare states have not done as poorly as Sweden. Also, certain aspects of redistributive policies, such as a well-functioning public education system, may foster human capital accumulation. A related issue is the cost in terms of employment formation and growth of labor protection, but this is another immense topic that would require not one but several papers to do it justice.

Charity and the Private Provision of Welfare

The preceding evidence makes it clear that European countries provide more public welfare than the United States. But Americans engage in more private provision of welfare (that is, charity) than do Europeans. As private citizens, Americans appear to give more of their time and their money to the poor than do Europeans.

We use the World Values Survey to calculate the share of adults in each of several European countries who are members of charitable organizations. The World Values Survey is a collection of surveys where the same questions are asked in different countries in different years. Between 600 and 2,000 people are interviewed in each country; appendix B provides details on the countries and survey years. Although membership in charitable organizations is an imperfect measure of the time contribution to charity (it does not measure the intensity of involvement), it is one of the best measures available. In the United States, 11 percent of respondents say that they participated in a charitable group over the last year; the average for the European countries in the survey is 4 percent. The European country with the highest proportion of membership in private charities is the Netherlands, with almost 9 percent of respondents saying that they participate. At the other end of the spectrum is Denmark, where 2 percent of individuals claim to have participated in these activities.

This work corroborates the large literature on private charity in the United States. For example, the U.K. National Council for Volunteer Organizations and the not-for-profit group United for a Fair Economy document that charitable contributions in the United States totaled $190 billion in 2000, or $691 a person. This compares with reported contributions per capita of $141 in the United Kingdom and $57 for Europe as a whole. Notably, a large fraction of American donors make charitable contributions even though they take only the standard deduction on their income taxes. This means that, for many Americans, contributions are not being driven by the tax deductibility of charitable donations. Theda Skocpol, Marshall Ganz, and Ziad Munson document the national coverage of the many U.S. volunteer groups who provide a rich variety of forms of assistance. (16)

These results suggest, but hardly prove, two implications. First, public provision of welfare in part crowds out private charity. As argued by Glaeser and Andrei Shleifer, if government transfers to particular individuals fall as private donations rise, these transfers will reduce the incentive for private charity. (17) These results also suggest that Europe's more generous provision of welfare does not stem from a greater innate endowment of altruism in Europe.

Theory and Discussion

In this section we present a brief formal model on the determinants of the level of redistribution. (18) We model the welfare system as a schedule of transfers that is indexed with a single parameter: the tax rate on income [tau]. In this system each individual receives net transfers equal to [tau]([delta]Y- Y), where Y is the individual's income, Y is average income in the country, and [delta] < 1 represents the waste involved in redistribution. This welfare system is self-financing, in the sense that the average payment in the country is equal to zero. The parameter [delta] is meant to capture a wide range of possible inefficiencies related to government, such as administrative costs and politically motivated spending on programs with little social value. It can also capture the welfare losses due to tax distortions; in this case [delta] should be a function of [tau], to capture the fact that social welfare losses generally rise proportionately to the square of the tax rate, but for simplicity we assume that [delta] and [tau] are independent.

The timing of the model is such that, in the first period, individuals receive income equal to [Y.sub.0] and choose [tau] for the second period. The first-period tax rate was already fixed, and we do not model consumption or saving during this period. First-period income serves just as a signal for second-period income, and its distribution is captured by a density function g(.).

In the second period, incomes are revealed and redistribution and consumption occur. Income in the second period, Y([Y.sub.0],[epsilon]), equals (1 - [theta])[Y.sub.0] + [theta] [[mu]([Y.sub.0]) + [epsilon]]. The parameter [theta] captures the extent of income mobility: a low value of [theta] means that income in the second period will be almost equal to income in the first period. The variable [mu]([Y.sub.0]) is the mean of the second-period income shock, which is a weakly increasing function of prior income. This function will also capture the extent of income mobility. For example, if [mu]([Y.sub.0]) = [Y.sub.0], then incomes will be much more fixed than if [mu]([Y.sub.0]) is constant across individuals. The term e represents a mean zero disturbance term that is assumed to be orthogonal to the other terms and distributed with density f(.).

Individuals consume all of their second-period income (net of redistribution) and receive utility from personal consumption equal to U((1 - [tau]){(1 - [theta])[Y.sub.0] + [theta][[mu]([Y.sub.0]) + [epsilon]] + [tau][delta]Y]}). Thus, expected utility (as of the first period) from second-period personal consumption equals

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We assume that people care about the consumption of others as well as their own. For tractability we measure altruism as follows: each person puts a weight [alpha]([Y.sub.0]) on the utility he or she derives from the private consumption utilities of other people; this term reflects interpersonal altruism, and we assume that [alpha]([Y.sub.0]) [greater than or equal to] O. Total expected utility from private consumption and interpersonal utility equals

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We represent the political process as the social choice problem of maximizing a weighted sum of all people's expected utilities. The political arrangement is captured by the weights that different people get in the political process. In particular, each person receives a weight of [lambda]([Y.sub.0]) in the social choice problem, where [lambda]([Y.sub.0]) [greater than or equal to] 0. This weight is a function of their initial endowment. For example, under a system of majority rule when preferences for redistribution (the level of [tau]) have a single peak, the social …