Academic journal article The Cato Journal

Welfare: Savings Not Taxation

Academic journal article The Cato Journal

Welfare: Savings Not Taxation

Article excerpt

In many countries, the rising cost of publicly funded health care, retirement, and other welfare programs is forecast to put increasing pressure on government budgets. As a result, many governments are seeking to reform their welfare states so that costs to the taxpayer can be reduced, quality of outcomes increased, and the plight of low- and middle-income earners improved. Regrettably, there are currently at least three problems with much of the debate about reform of the welfare state.

First, disagreements are often focused around two opposing ideological viewpoints. One side is demanding more welfare spending and higher taxes, whereas the other is arguing for less welfare spending and lower taxes. Second, even when economists and others propose a welfare reform that appears promising in theory, designing the transition so that it is politically feasible is often overlooked. Third, the debates are typically quite narrow. They seldom focus on a comprehensive reform that would rewrite the rules governing the welfare and tax system as a whole, with the aim of making them work more fairly and efficiently.

This article shows how a country can move from a publicly funded welfare system to one that relies largely on private funding coming from compulsory savings accounts. The reforms we propose are designed to overcome the problems outlined above. We use New Zealand, a nation with which we are familiar, as a case study, although the comprehensive reform we recommend can be adapted elsewhere.

How does it work? Taxes currently paid on personal earnings up to $50,000 for single taxpayers go directly into the compulsory savings accounts. (1) A drop in the corporate tax rate and the removal of other government-imposed employee costs help employers fund contributions. These changes allow for privately funded welfare payments to substitute for public ones. Total spending levels can be maintained across most welfare categories, and transparent pricing of health care services and out-of-work cover can be introduced.

Provided that special privileges in the form of subsidies to businesses (i.e., corporate welfare) and grants to affluent families are discontinued, tax cuts can be made sufficiently deep to allow people to establish significant savings balances, while largely retaining pre-reform disposable incomes.

Even after our proposed tax cuts, the government retains sufficient revenues to act as an insurer of last resort, helping to pay for those individuals who cannot meet all of their own welfare expenses out of their savings accounts (e.g., the chronically ill).

Our "savings not taxes" reform offers the scope for efficiency gains, particularly in health care. While we believe these gains are plausible, they have not been factored into our estimated budgetary forecasts, which as a consequence probably understate the benefits of our reforms. One example of the scale of the possible gains comes from the experience of the pro-market reforms in New Zealand in the 1980s and 1990s (see Evans et al. 1996). Another example is Singapore, which uses compulsory savings accounts and currently spends just 4.8 percent of GDP on health and long-term care, compared with 17.2 percent in the United States and 9.5 percent in New Zealand, and yet maintains one of the highest quality services in the world.

More broadly, our "savings not taxation" reform is aimed at changing beliefs away from a culture of dependency to one of independence, whereby lower-income earners are given the opportunity to build up their own capital via tax relief and employer contributions, and can then choose from among a range of affordable services.

Background: The Long-Run Viability of Publicly Funded Welfare

Large publicly funded welfare states are under threat. The dependency ratio, which is the proportion of elderly to younger, economically active workers, is expected to rise all over the world. …

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