Sunday, March 13, 2016

Actually, even rich people would be better off in a social democracy

It's often assumed that rich families have nothing to gain from a social democratic social welfare system. To see if that's actually true, I'm repeating the analysis I did for a median income household for richer households. These are the key tables for a median income family:

Clearly, median income households are much better off in social democracy than in the American social welfare system. Though taxes are much higher in the social democratic system, the enormous out-of-pocket spending American households must spend on social welfare easily outweighs those higher taxes. Once we account for the private, out-of-pocket spending in the American social welfare system, it becomes obvious that the high taxes of the social democratic social welfare system are a very good deal for most families.

However, the same might not be true for rich families. Perhaps rich families can afford high out-of-pocket spending and would actually be financially better off with the high out-of-pocket spending and low taxes of the American social welfare system.

To find out, let's repeat this analysis using the exact same methods as median income, but for a rich household. We'll do the analysis for a household at exactly the 90th percentile for income. If over 90% of Americans would be better off under social democracy, that should be pretty convincing.

The 90th percentile begins at approximately $114,000 annual income; we're again assuming a two-earner family (with income from wages, rather than capital gains). And for estimations of tax rates, I'm still using Citizens for Tax Justice estimates for 2015 (for the richest 10%, or the "Next 10%"). Because we're assuming a 2-earner family, we don't need to worry about reaching the point where Social Security taxes are no longer collected. The state and local taxes cell uses data from the same Citizens for Tax Justice estimates.

As in the median income analysis, for the retirement cells I'm using the estimates from the Center for Retirement Research at Boston College. According to their calculations, a high earning household needs to replace 67% of their working income in order to maintain a comparable standard of living in retirement. To reach this goal, they can rely on Social Security benefits once they retire, plus savings equal to 16% of their income (see the bottom of the page for replacement rates analysis for retirement savings). A richer family actually has to save a higher percentage of their income than a median income family because Social Security replaces a lower percentage of wages for those at higher incomes.

Otherwise, I'm using the same sources as on the median income page, just with a different household income--refer to the median income page for any relevant links. Plugging in these numbers:

For the social democracy side on the first graph (the blue 50%), I explained in the median income post how 50% taxes is a reasonable ceiling estimate for taxes for richer households. Again, single parent families would pay a lower rate and single individuals without children would pay slightly higher.

For a more precise comparison, let's try to get an estimate of what a high income household would spend on consumption taxes (the blue 12% in the social democracy column). Again, the 12% consumption tax is as a percentage of household expenditures:
household gross labor costs > household income > household expenditures
Furthermore, higher income households usually spend a lower percentage of their income than other households. Because less of their income is spent on consumption, correspondingly less of their income goes to consumption taxes. A typical family American at of the top quintile saves about a quarter of their income:

If we assume a 23.6% savings rate, then only the remaining 76.4% of income (not gross labor costs) is subject to consumption taxes. With the 12% consumption tax rate and 23.6% savings rate, this comes out to an additional 9.6% of gross labor costs spent on consumption taxes.

Note what a fantastically bad deal some of these cells are for the American side. Even at the 90th percentile, employer-sponsored health insurance still consumes 13.3% of household gross labor costs.

Here is the table tallying additional social welfare costs for this family--in dollar amount, percentage of household income, and percentage of household gross labor costs. Aside from income/labor costs, there are two differences from the corresponding table for a median income family. Instead of student loans I've substituted annual tuition for in-state college. According to College Board surveys, average annual in-state tuition is $9,410 ($23,893 for out-of-state and $32,405 for private). I'm assuming that a household at the 90th percentile doesn't owe student loans but might instead be worrying about sending a child to college. Second, I've also reduced extended leave to 65% wage replacement since this benefit does have lower wage replacement rates at higher incomes. Here's the table:

The same issues of service quality affect this rich family as they did the median income family, and I don't need to repeat this here. In particular, however, the rich family has even more to lose if someone in their family is grievously injured and requires long term care services--they have much further to fall to meet the income and asset tests. The same high risks of the American health insurance and retirement systems also affect this family, though with higher income they are obviously in a better position to deal with these risks.

Clearly, out-of-pocket social welfare costs in the American social welfare system (except for long term care) are more manageable for this family--whether day care, health insurance cost-sharing, etc. With higher incomes, they are also better able to manage the risk of the American private health insurance and retirement systems. Nevertheless, they are clearly better off under the social democratic model: if the United States suddenly became a social democracy, this family would pay less of their income in taxes and social welfare, yet have access to more high quality benefits and services; they would also have far greater security in the social democratic model.

The low service quality and high risks of the American social welfare system really are extraordinary; it's worth your time to read again about these risks on the median income page. Even a rich family should worry about these enormous risks, which don't exist in the social democratic model.

In sum, it's quite a stretch to argue that even a rich family--one richer than 90% of the rest of society--would be better off in the United States. I've expressed consumption taxes as 12% of expenditures, and it's fair to estimate this at 9.6% of gross labor costs based on the spending habits of the top quintile in the United States. If so, that brings the social democracy column to 59.6% taxes and social welfare spending as a percentage of gross labor costs, versus 58.9% for the United States--basically identical. In other words, the cost of each welfare state to this hypothetical high income family is almost identical.

However, if we start considering other pieces of the American social welfare state, the social welfare spending of rich families in the United States rapidly overtakes that of the social democracies. Even without a major health condition, a rich family can expect to spend out-of-pocket money on health care costs--copays, deductibles, uncovered medical services, etc--and this alone makes the social democratic model cost less for them. If this family has child in need of day care, a child about to go to college, or student loans to worry about, the social democratic model is far less expensive to them. And though this family is richer than 90% of the rest of the country, the mammoth risks the American retirement, health care, and long term care systems make them far better off in the social democratic system. Finally, this family would certainly benefit from being offered paid leave benefits--for example, sharing a year of paid parental leave following the birth of a child, paid extended sick leave if one of them was temporarily too sick to work, or paid family leave to care for an ailing family member. Clearly, the social democratic model is far better even for a family at the 90th percentile for income.

Tying this all together, we would have to make some pretty unrealistic assumptions about this family for the American system to look like a good deal--because again, the overall cost of both systems to this family is nearly identical. We would have to assume this family never has any children and thus would never benefit from paid parental leave or need day care services. We need to assume that everyone in this household is orphans and thus would never need to take any family leave to take care of an ailing elderly relative. We would need to assume that nobody would ever get sick so they would never have to worry about health insurance cost-sharing. We need to assume that no one ever becomes temporarily too sick to work (like following a major surgery) and needs paid extended sick leave, and that no one ever becomes disabled and needs long term care. We would also have to assume that no one in this high income family ever went to college and thus has student loans to pay back (we've already assumed they are orphans and so have no relatives who paid their tuition for them), and that no one in this household will ever be interested in one day going to college. Because for the exact same price, all of these things are provided by a social democratic welfare system.

But there's more. We would also have to assume that they only choose stocks in their 401(k) that equal or better the historical returns of the stock market, that they own their own home and they live in a place where the price of their house rises equal or better to historical trends, and that inflation doesn't rise. And we have to assume that nobody in this household loses their job and they fall to a lower income level (where they would surely be better off in the social democratic model). These factors--healthy stock market returns, ever-rising home prices, low inflation, no recessions--are completely out of their control. For the exact same price, this family does not have to worry about these things in the social democratic model.

Clearly, even rich families (defined here as at exactly the 90th percentile for income) are better off in social democracy. In other words, over 90% of Americans would be better of in a social democratic social welfare state.

The technical details on retirement system replacement ratesI've used all the same sources of information for this page as the median income page, and don't need to paste those links here. Refer to the median income page to see where these numbers are coming from.

The rest of this post will examine wage replacement rates for the retirement systems.

The estimates for a high earner family from the Center for Retirement Research calculations hold that--if everything follows historical trends--16% savings rate during their working years will bring this family 67% wage replacement in retirement. Again, this is a sum of Social Security benefits and their individual savings for retirement.

How does this compare to the pensions of the social democracies? The OECD ran simulations of wage replacements according to public or compulsory private pensions (social democracies, high earners, marked with red box):

For high income households, the range is a low of 38.9% wage replacement in Norway to 73.1% in Sweden, with an average of 58.2%. Clearly, there can be a wide range of wage replacements depending on the particular benefits and contribution structures of the pensions. If we threw out Norway (because it is clearly an outlier; 16.2 percentage points separate Norway from the second lowest, Denmark, whereas just 5 percentage points separate the second highest, Iceland, from the highest, Sweden), we get an average of 63.0% wage replacement--basically equal to the estimations of the Center for Retirement Research.

But--as discussed in the median income post--the American retirement system exposes retirees to extraordinary risks that the social democracies do not. I don't need to repeat this here, but keep in mind that the wage replacements of social democratic retirement systems are guaranteed; American system is not. The American retirement system exposes individual would-be retirees to extraordinary risks of retiring into poverty.

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