One of the most common arguments against social democratic programs is that the taxes needed to finance them are simply too high. But citizens in social democracies get loads of benefits in return for those high taxes. Is it worth it to pay those extra taxes? Let's find out.
This isn't a straightforward question. Many of the services all citizens of social democracies get from the government are available in the American private market--like health insurance, day care, retirement plans, etc. In other words, the United States government doesn't provide (most) people with day care services, but that doesn't mean you can't have them--you just have to pay for them in the private market. Essentially, we're asking: Who gets a better deal? A typical Dane, who gets X, Y, and Z services from the Danish government? Or a typical American, who gets X from the government but purchases Y and Z from the private market?
To start, we'll compare the costs of both systems: How much a typical Finn pays in federal and social security taxes--versus how much a typical Americans pays in federal and social security taxes, plus the cost of social welfare services purchased through the private market (ie, employer-sponsored health insurance, day care, 401(k) contributions, etc). We'll then compare what services are obtained through those investments (whether taxes or private spending), and hopefully be able to see who gets a better deal.
Excited? I hope so. Let's start with what the typical American has to pay for social welfare services.
We want to represent the experiences of a typical household, so we'll take a household at exactly median income as our example. Median household income in the United States was in 2012 was $51,017 (if you look at purchasing power parity, median household income in the United States is remarkably similar to median household income in the social democracies). Since it's median household income, we'll assume a family with two wage earners.
An American household earning the median wage of $51,017 probably paid about 13% of their income in federal taxes. Social Security payroll taxes add an additional 7.65%. (For the wonks reading this, we're not interested in the tax incidence, because for now we're only interested in comparing sticker price.) That means that the median American household pays about 7.65% + 13% = 20.65% of their income to the federal government.
That's it for taxes--the rest of the typical household's social welfare services have to come from the private market.
The average cost of employer-sponsored health insurance is $5,279 for an individual and $15,199 for a family per year (for a family that's $10,704 average employee contribution; $4,495 average employer contribution). But any economist will tell you that there is no such thing as an "employer contribution." That's your compensation that is being spent on health insurance. So, if we add the $10,704 to your income where it rightly belongs, the new median household income is $51,017 + $10,704 = $61,721. The total cost of insurance, $15,199, is 24.6% of median household income of $61,721 (which includes the "employer contribution" to health insurance).
So, let's add this to our running tally. Already, for federal and payroll taxes, the median American household is paying 20.65% of their income. But, since we had to cash out the "employer contribution" to health insurance in order to make a fair calculation, the median household income is $61,721, not $51,017. 20.65% of $51,017 is $10,535. $10,535 is 17.1% of $61,721. So, if we count the "employer contribution" as employee compensation, the total federal tax burden (including Social Security payroll taxes) is 17.1%, not 20.65%.
Adding in the cost paid for private employer-sponsored health insurance, our running tally for the percentage of income paid for social welfare services by a median-income American family is 17.1% + 24.6% = 41.7%.
Social Security does provide a retirement pension, but it's a meager one. For most people, Social Security will only replace about a third of your working wages--potentially not enough to pay rent and basic expenses. Whereas in the social democracies, there is no need to supplement the government provided (or mandated) pension, in the United States, workers are recommended to supplement their Social Security retirement pension with a 401(k).
Experts recommend that you should save eight times your salary by the time you retire:
We got to 8X by starting with a hypothetical worker with average income and a willingness to save and invest. From there, we evaluated what salary multiple of her ending salary she would need at retirement to cover her estimated retirement expenses.Of course, for many families, it's laughable to assume any employer match. But for simplicity, let's assume that ludicrous 3% match is available to the typical American. To get eight times her salary, "Lily" starts by saving 6% but within six years is saving 12%. So, for six years, she saves 6%, and saves 12% for 36 years (from the ages of 31 to 67). Basically, she's saving 12%, but let's assume just 10% to be conservative.
Let’s call our hypothetical worker Lily. We assume she starts saving at age 25, retires at 67, and lives until 92. Lily’s salary grows from $40,000 at 25 to $73,640 at retirement (with no breaks in employment). She defers 6% of her salary at 25, escalating to 12% within six years. She receives a 3% company match and takes no loans or withdrawals. We assume her investments grow at 5.5% a year (3.2% after assumed inflation of 2.3%). When she retires at 67, we assume she will spend 85% of her ending salary after taxes (tax rates stay the same), and get $1,918 a month in Social Security income.
Indeed, median income families on average save 9.6% of their income for retirement, so this estimation actually reflects what a median income family is really doing. 9.6% probably isn't as much as they should be saving, but it's close.
Remember, we have to adjust for the fact that we cashed out the value of the employer sponsored health insurance in the above section. 10% of $51,017 is $5,102; $5,102 is 8.4% of $61,721. So, adding a 8.4% to our running tally to pay for a supplemental 401(k) retirement plan brings us to 50.1%.
Certainly there is a lot more to private social welfare in the United States than health insurance and a 401(k). We haven't covered child care, university tuition, paid parental leave, paid extended sick or family leave, or long term care insurance. Problem is, I'm not sure how to account for these. Some people don't have children, and, unlike health insurance, you only use child care for the first few years of a person's life. Not everyone goes to college; not everyone will find medical, family, or parental leave applicable to their lives. So we're going to have to stop our running tally right here--but don't worry--as we'll see below, we can make a pretty good comparison.
Because things are usually clearer in chart form, here's what we've found so far:
Now, it's time to move on to the social democracies.
Taxes in Social Democracies
It's very difficult to compare tax rates in different countries. Taxes can be complicated, currencies are different, and income levels are bound to be different. Fortunately, KPMG released a study that included examining what someone making the equivalent of US$100,000 would pay in federal income and social security taxes in many different countries. Unfortunately, our median income household only makes about half that, so this isn't a perfect comparison. But it gives us a pretty good general idea. Here's how the social democracies tax someone at that income level:
(I intentionally left Austria out because their childcare services are less comprehensive. Iceland was omitted from KPMG analysis. This basically agrees with OECD findings of what someone earning their country's average wage pays in total taxes, which is also close--though not exactly--what we're interested in.)
What's amazing is that the social democracies aren't even at the top of the list. Belgium and Germany tax more than all the social democracies (at least at this income level), and France, Luxemburg, Portugal, and the Netherlands all tax more than all the social democracies except Denmark. These countries have higher taxes than the social democracies despite providing fewer services.
In any case, the average tax rate for social democracies at this level of income is 38.9%.
Are we ready to make a final comparison between the social democracies and the American system? Not exactly--the services that our hypothetical household receives in the United States and a social democracy are very different. Our comparison can't just be of the overall tax rate; we have to additionally compare what you're getting for your taxes. I've tried to compile all this information as simply as possible into this table:
There are so many caveats with this table that, taken alone, it's downright misleading. Before addressing these issues, a few points of clarification.
Primary and secondary education is free in the United States, but this table underestimates the cost. In the United States, federal taxes do support education, but so, too, do state, local, and property taxes (Average property taxes are just over $1,000; alone, this would add an additional 2% for taxes in the American column). Perhaps there should be another pink "sort of" for primary and secondary education. In social democracies, primary and secondary education (and college education) are paid for entirely by federal taxes (reminder: "taxes" in the American and social democracy columns indicates federal and social security taxes).
There is also a question of service quality. Health insurance and health care in the United States is of remarkably low quality ("...another 126,000 [American patients] die [each year] from their doctor's failure to observe evidence-based protocols for just four common conditions: hypertension, heart attacks, pneumonia, and colorectal cancer."). No one ever goes bankrupt from medical bills in a social democracy; yet in 2007, 62% of all personal bankruptcies in the United States were due to unpayable medical bills. Amazingly, 78% of those individuals medical bill-related bankruptcies had insurance at the onset of illness. Obamacare will make this much better, but not nearly as good as the social democracies; out of pocket maximums, when eventually implemented, will still be over $6,000. Child care services in the American private market are so low quality that they are frequently unsanitary and physically dangerous, despite being prohibitively expensive (see below). Even the top tier of the American welfare system delivers child care that is of much lower quality than that available to all families for at very low out of pocket cost in social democracies.
Let's also not forget the fact that services in social democracies are entitlements; you don't lose them just because you lose your job. For example, in the United States, if you lose your job, you won't be able to add to your 401(k) until you get a new job and start earning money. But in a social democracy, you don't have to worry about your security when you retire in 20 years if you lose your job today.
Interested in quantifying some of the costs not included on the American side? Full time child care costs for a four-year-old range from $4,312 to $12,355 depending on the state, for an additional 7.0% to 20.0% of median household income. For an infant, costs range from $4,863 to $16,430 depending on the state, or an additional 7.9% to 26.6% of median household income. What if you and your spouse went to college? College tuition is free in social democracies (don't be quick to assume that American universities are of higher quality). On an income-based repayment plan for a family making $50,000 (before cashing out health insurance) where both parents have a typical amount of student loan debt, monthly payments would be $422--or 12.2% of household income ($422 x 12 / $61,721 = 12.2%). (For income based repayment plans for student loans, any remaining balance is forgiven after 25 years. Somewhat amusingly, this household wouldn't even be able to pay the full student loan balance by the time it's forgiven in 25 years.)
Paid leave is probably not offered to a family where two wage earners earn $51,017 (both parents making in the neighborhood of $25,000 per year; what job paying that level offers extended paid leave?). In the United States, the Family Medical Leave Act covers extended leave. 40% of employees are not covered by FMLA and are entitled to no leave whatsoever. If you're lucky enough to be covered by FMLA, it's illegal for your employer to fire you if you take unpaid leave for 12 weeks (no matter how severe your medical condition is--social democracies offer several years paid leave if your medical condition warrants it), but that's it. Governments in social democracies pay people 75-85% of their salary (depending on duration) to stay home and care for an ailing relative, recover from a surgery, welcome a new child into their family, etc. This is available to anyone who finds themselves in a position where they need to take an extended leave of absence from their job. For comparison, social democracies range from 32 (Finland) to 47 (Sweden) weeks of paid parental leave. American FMLA allows 12 weeks unpaid parental leave, and 40% of American employees are not covered.
So--here are the private costs of the social welfare services missing from the above table:
This is all more than slightly misleading
Returning to the first table, this is a pretty reasonable description of what a household making around $51,017 per year can expect to pay for social welfare services in the United States versus a social democracy. But it's misleading to take this table in isolation because it doesn't capture the full cost of each system. In other words, that table isn't a conclusion; it's a starting point for discussion. We've ignored any taxes that aren't levied directly on workers; in so doing, we have underestimated the total tax burden required to support these welfare states. In addition to corporate taxes, American employers must pay 7.65% in Social Security taxes; in social democracies, the social security tax burden on employers varies widely (some companies in Norway actually pay zero in social security taxes) but we'll take the typical ceiling contribution of around 25% (and sometimes it's not a tax but a mandatory contribution to a pension or social welfare fund--but the effect is the same).
In other words, employers in social democracies pay three times the social welfare tax as American employers. So--if we add this social security tax burden to our tallies, we get:
Social Democracy: 63.9%
Not a huge difference.
It would probably require a PhD dissertation to take this project to its conclusion. To complete it, you'd have to find apples-to-apples comparisons of corporate income taxes. You'd have to add state, municipal, and property taxes, which vary by state, county, and municipality--for both individuals and for employers. Sales taxes would have to be factored in, which vary by US state and are actually quite high in Scandinavia. You would have to find some studies that estimated the amount of income the typical person spends on sales taxes in a year, which cannot easily be estimated. Actually, this would be a great PhD project.
Rather, my point is this: Don't fear the taxes. Taxes in social democracies are high, but for a the vast majority of Americans, social democracy is a much better value. Once the hidden costs of America's social welfare system are added to the tally, the American system stops looking like such a great deal.
It's odd how people cry foul at 40% taxes in Scandinavia, but don't bat an eye at the 25% of median household income that private health insurance costs. This post seeks to abolish that double standard. I don't have the technical ability to tally the exact cost of each system, but this thought exercise demonstrates quite clearly that the costs are roughly comparable but the services provided are not. For approximately the same cost of health insurance, a retirement plan (Social Security + a 401(k)), disability insurance, unemployment insurance, elementary and high school education, in the United States, social democracies are able to provide those same services, plus child care, university education, long term care, and extended paid leave.
Even more remarkable, social democracies cover 100% of their citizens with all of these services. Before Obamacare, 15% of Americans lacked health insurance; with Obamacare, it's not much better. Child care coverage is also incomplete. Just 40% of American children under five attend child care. Only very high paying jobs offer paid extended sick or family leave. The United States can't even guarantee a single vacation or sick day for its workers; social democracies guarantee a month of both to everyone. Social welfare services in social democracies are not only a much better deal at the household level--they're much cheaper at the aggregate level as well.
How can this be? How can social democracies provide so many services for so little cost? The answer is that the social democratic system--where everyone contributes and everyone benefits--is the most efficient model for social welfare service provision. A country simply cannot provide so many services to so many people without the ultra efficient social democratic model. The patchwork American model will never be able to match the efficiency of the social democratic model (except Social Security and Medicare, which are social democratic programs).
The conclusion is overwhelming; when you add tax money and money that must be shelled out to the private market in the United States to provide services that are free (or nearly free) to all citizens of a social democracy, the United States' low taxes are a pretty lousy deal. The endless parroting of "deadweight loss" is wearing quite thin. There can be no deadweight loss if taxes pay for something, like health insurance, that would have been purchased in the private market anyway; there can be no deadweight loss if public health insurance costs half that of private health insurance (or if other services, like child care or paid extended leave, can be provided more efficiently by the government); there can be no deadweight loss if tax dollars are going to something that makes the economy more efficient, like university tuition, extended paid sick and family leave, or health insurance.
The winners of our inefficient welfare state
Years ago, I would have ended this post without this last section. "See," I would have said, "this is the most efficient, effective social policy model. Obviously, we should use this model," and I'd be done with it.
But I started this blog because I realized that our political system generally gets the outcome it wants. Our welfare state is an unfair, inefficient nightmare because or political system wants it that way. If it wasn't beneficial to the people with the power to fix it, it would have been fixed by now.
As always, one person's inefficiency is another person's profit. We concluded that a median income household pays 50.1% of their income for some social welfare services, which is far more than the 38.9% paid for many more services in the social democracies. But remember, our analysis was for a median American household--one making exactly $51,017. What if we consider a household that makes $1 million per year instead of $51,017? Let's repeat our analysis for a household making $1 million per year.
People making $1 million per year typically do not to earn wages, but capital gains. Capital gains are taxed at 20% for the 2013 tax year, and were taxed at 15% for the 2012 tax year and a decade prior. Households whose income comes exclusively from capital gains do not pay any payroll taxes (so very rich people neither contribute to nor benefit from Social Security; that contributes to their wanting to destroy it and redistribute its wealth to themselves). That's it for taxes--20% (or 15% for 2012 and the entire decade prior).
As for health insurance, let's assume boutique insurance coverage, so instead of paying $15,199, it's $25,000. $25,000 is 2.5% of $1 million. So far, we're up to 22.5% (20% + 2.5% = 22.5%) (or 17.5% for 2012 and earlier).
And, as I argued here (in the section entitled "Designed by the wealthy, for the wealthy"), 401(k) contributions by people whose money is all in the stock market aren't actually savings for retirement; the 401(k) is simply a tax free vehicle for the investor class to do with their money what they would have done with their money with or without a 401(k): invest it in the stock market. That means that our analysis is done: a household earning $1 million per year pays 22.5% (as of the 2013 tax year, or 17.5% for the decade ending 2012) of their income for the same social welfare services that a household making $51,017 per year must pay 50.1%. Actually, they get better services; their health insurance is way better, and they have far more money for their retirement.
But it's better still. Want to pay $50,000 per year for a child to go to an elite college (or elementary school)? That's a mere 5% of annual household income. $20,000 for boutique child care? That's but 2% of annual household income. No matter how you slice it, a household making $1 million per year will scarcely pay more than 25% of their annual income in social welfare services (or 20% for the entire decade ending in 2012)--and their social welfare services will be far better than everyone else's. Even long term care is not unaffordable. Why on earth would a household making $1 million per year want to pay 38.9% for the bottom 99% to have access to the same services that they do when they can pay 20-25% and get far better services than everyone else?
But what about households making even more? What if we repeat this analysis for a household making $10 million per year? Rather than 20-25%, such a household will only spend 2-2.5% of their total annual income on social welfare services. The ultra wealthy have no need for a welfare state.
So you can see that this "problem" of a shockingly inefficient, tragically ineffective welfare state isn't really a problem. If you're very rich, it's a very good system indeed. And since our political system only responds to the wishes of the wealthy, this "problem" isn't a problem that our political system has any interest in solving. If you only represent the rich, our deficient, inefficient, ineffective social welfare system isn't even a problem at all. Aside from Social Security, our welfare state functions pretty much exactly how the very wealthy want it to function--and that's why they're trying to dismantle Social Security and largely leave the rest as is.
UPDATE (05/31/2014): Part 2 compares welfare state efficiency by examining the total amount of money spent on social welfare services (both public and private) in the United States versus the social democracies. The social democracies spend about the same percentage of GDP on social welfare services (public and private), yet have universal coverage for far more, and far higher quality social welfare services.