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Posts Tagged ‘Social Security Privatization’

Over the years, I’ve shared many charts, graphs, and tables to help people understand that the welfare state is fundamentally unsustainable.

And, assuming there’s not genuine entitlement reform, many of these fiscal estimates show that the United States has a very perilous future.

According to the Bank for International Settlements, the United States is in worse shape than every nation other than Japan and the United Kingdom.

According to the Organization for Economic Cooperation and Development, the United States has a bigger long-run fiscal problem than all countries other than New Zealand and Japan.

And according to International Monetary Fund estimates of both future spending increases and the need for reform, no nation has a bigger problem than the United States.

So do all these numbers mean the United States is really in worse shape than basket cases such as Italy, Spain, Japan, France, and Greece?

Yes and no. I realize that answer makes me sound like a politician, but it is  hard to answer that question because America’s grim long-run numbers are largely a function of rapidly rising health care spending.

And if you assume that Medicare, Medicaid, and Obamacare are left unreformed, then the budgets for these programs will eat up an ever-larger share of our economy and we’ll eventually suffer a fiscal collapse.

However, if you assume that these programs at some point get reformed (and it better be the right kind of reform), then the long-run outlook is considerably less severe.

But notice that I wrote “less severe.” That’s because we still have a demographic issue. Any type of pay-as-you-go welfare state becomes increasingly expensive when there are more and more old people and fewer and fewer young workers.

This is why new projections from the Pew Research Center are so sobering. They show the change in age dependency ratio between now and 2050.

As you can see, we currently have about 50 young or old people for every 100 working-age people. By 2050, however, there will be 66 dependents for every 100 working-age people. And most of that added dependency will be caused by an aging population, not more children.

Age Dependency Ratio Pew

But here’s the good news. Compared to nations such as Spain and Japan, we’re in pretty good shape. Or, to be more accurate, we don’t face as deep of a problem. Indeed, it’s hard to see how those nations will survive.

Same with South Korea and Italy.

Even Germany has a very difficult future. Its welfare state may not be as bloated as some other nations in Europe, and the work ethic may be stronger than most other European countries, but as I already explained, any welfare state becomes unsustainable without new workers to pay taxes to support the dependent class.

In other words, demographics can be destiny. Look at this data on the nations with the lowest fertility rates. You’ll notice that Germans are not reproducing. And the same is true of the Japanese, Italians, and South Koreans (Spain is in 191st place, so they also aren’t having many kids).

Fertility Rate by Nation

I don’t know where this will lead, but it won’t be pretty. Simply stated, the welfare states in these nations will have to be reformed.

But how does that happen in countries where people have been told for decades that they have a “human right” to freebies from the government?

I fear that European nations are going to suffer some major dislocations. And as this Michael Ramirez cartoon suggests, the same problem could happen in America.

Let’s close with some optimism. You’ll notice that two of the four jurisdictions with the lowest fertility rates in the entire world are Hong Kong and Singapore. Yet there’s no major long-run fiscal crisis in those places.

Why? Because they have “pre-funded” retirement systems. In other words, they have personal retirement accounts instead of tax-and-transfer entitlement systems.

The moral of the story is that demographics can be destiny, but it doesn’t have to be.

Something to keep in mind next time there’s a discussion of Social Security reform.

P.S. Considering the high levels of pulchritude in Estonia, Latvia, and Lithuania, I’m mystified that there’s so little reproduction in those nations. Maybe I should volunteer to help out?

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As part of his State-of-the-Union speech, President Obama announced he was going to unilaterally create a new retirement savings account that supposedly would be available to all workers.

Employers would be mandated to facilitate these”MyRA” accounts, and the money collected would be invested in “guaranteed” government bonds.

There are some good features to the MyRA plan, most notably the fact that money in the accounts would be protected from double taxation. Workers would put after-tax money in the accounts, but there would be no additional layers of tax on any earnings, or when the money is withdrawn.

In other words, a MyRA would be akin to a back-ended (or Roth) IRA.

But there are some bad features, including the fact that taxpayers would be subsidizing the earnings, or interest, paid to account holders (though this would be a relatively benign form of government spending, at least compared to Obamacare, ethanol, etc, etc).

My biggest complaints, though, are the sins of omission, which I discuss in this interview for Blaze TV.

Simply stated, if Obama was concerned about low returns for savers, he should be directing his ire at the Federal Reserve, which has artificially pushed interest rates to very low levels as part of its easy-money policy.

But more importantly, MyRAs will be very inadequate for most workers with modest incomes. If the President really wanted to help ordinary people save for retirement, he would follow the successful example of more than 30 other nations and allow workers to shift their payroll taxes into personal retirement accounts.

This video explains why reform is so desirable.

Critics say it would be very expensive to make a transition to this modern system, and they’re right. If we let younger workers put their payroll taxes in a personal accounts, we’ll have to come up with a new source of revenue to finance benefits being paid to current retirees and older workers.

And we’re talking lots of money, as much as $7 trillion over the next few decades.

But that’s a lot less than the $36 trillion cash shortfall that we’ll have to somehow deal with if we maintain the current system.

In other words, we’re in a very deep hole. But if we shift to personal retirement accounts, the hole won’t be nearly as large.

P.S. The video mentions that Chile and Australia deserve special attention. Click here if you want to learn about Chile’s successful system and click here if you want to see how Australia’s “superannuation” system has been a big winner.

P.P.S. Some people already have asked me whether I was too Pollyannish in saying that there’s no risk for several decades that Washington will default. I could be wrong, of course, and I have shared BISOECD, and IMF data that reveals the United States has gigantic long-run fiscal challenges. But as I said in the interview, I think most other welfare states will collapse first, and that will lead to “flight capital” coming to America, which will help prop up our system.

P.P.P.S. You can enjoy some Social Security cartoons here, here, and here. And we also have a Social Security joke if you appreciate dark humor.

P.P.P.P.S. You probably don’t want to know how Obama would like to “fix” the Social Security shortfall.

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America desperately needs genuine entitlement reform to avoid a Greek-style fiscal future.

The biggest problems are the health entitlements such as Medicare, Medicaid, and Obamacare, but Social Security also has a huge long-run fiscal shortfall.

That’s why I’m a big fan of the very successful reforms in places such as Chile and Australia, where personal accounts are producing big benefits for workers. These systems also boost national economies since they generate higher savings rather than added unfunded liabilities.

And I’m very happy that we now have more than 30 nations with personal accounts, even tiny little jurisdictions such as the Faroe Islands.

But many statists object to reform, presumably because they don’t want workers to become capitalists. They apparently prefer to make people dependent on government.

Not all leftists take that narrow and cramped approach, however. Some academics at Boston College, for instance, produced some research showing some big benefits from Australia’s private Social Security system.

And new we have some remarkable admissions about how minorities are net losers from Social Security in a study from the left-leaning Urban Institute.

We use historical and projected data from 1970 to 2040 to measure the ratio of old age, survivors, and disability insurance (OASDI) benefits received to taxes paid by members of each race or ethnicity each year. This measure captures the transfers that occur in a given year from current workers to current beneficiaries of each group. We then examine benefit-tax ratios for each race or ethnicity into the future to determine how these redistributions will play out in the coming years. Our conclusion: When considered across many decades—historically, currently, and in the near future—Social Security redistributes from Hispanics, blacks, and other people of color to whites.

Why does the program have this perverse form of redistribution?

On average, blacks are more likely to be low income and short lived and are less likely to marry than whites. …Given this, one would expect forced annuitization and auxiliary benefits related to marriage and divorce to redistribute from blacks to whites.

And that’s exactly what the research found.

…whites have clearly received a disproportionate share of benefits relative to the taxes that they pay in at a point in time. Their benefit-to-tax ratio has been higher than that of blacks, Hispanics, and other ethnic groups for as long as the system has existed, while projections continue that trend at least for decades to come.

Here’s a chart from the study showing how different races have fared in terms of taxes paid and benefits received.

Social Security by Race - Urban Institute

In other words, if folks on the left really cared about minorities, they would be among the biggest advocates of genuine reform.

By the way, it’s also worth noting that Social Security is a bad deal for everyone. The Urban Institute study simply investigates who loses the most.

And the system is getting worse for every new generation.

Recent studies have also documented how different generations are treated within Social Security, with succeeding generations achieving successively lower “returns” on their contributions.

This helps explain why the evidence shows personal retirement accounts are superior – even for folks who would have retired at the peak of the recent financial crisis.

Here’s my video on why we should replace the bankrupt tax-and-transfer Social Security system with personal retirement accounts.

P.S. You can enjoy some Social Security cartoons herehere, and here. And we also have a Social Security joke, though it’s not overly funny when you realize it’s a depiction of reality.

P.P.S. Thanks to Social Security, I made a $16 trillion mistake in a TV debate. Fortunately, it didn’t really change the outcome since I was understating the fiscal shortfall of the current system.

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I’m currently in the Faroe Islands, a relatively unknown and semi-autonomous part of Denmark located in the North Atlantic. Sort of like Greenland, but too small to appear on most maps.Faroe Islands

I’m in this chilly archipelago for a speech to the annual meeting of the Faroese People’s Party. According to Wikipedia, “the party is supportive of the economic liberalism.” But liberal in this context is classical liberal, so they’re my kind of people.

I spoke on the economics of fiscal policy and talked about issues such as my Golden Rule and the Laffer Curve, but today’s post is about what I learned, not what I said.

The current government of the Faroe Islands, which includes the People’s Party, has modernized its Social Security regime with a system of personal retirement accounts. Starting next January, workers will begin setting aside some of their income to finance a comfortable retirement income. When fully implemented, workers will be putting 15 percent of their income in their accounts, creating a system that’s even larger than the private retirement models in Australia and Chile.

So why did Faroese politicians take this step? Well, unlike politicians in most nations, they looked at the long-run data, saw that they had an aging population, realized that a tax-and-transfer scheme no longer could work, and decided to reform now instead of waiting for the old system to collapse.

Here’s a chart put together by the Nordic Council. As you can see, the Faroe Islands were (and other jurisdictions are) heading to an intolerable and unsustainable situation of too few workers and too many retirees.

Faroe Islands Age-Dependency Ratio

By the way, the same situation exists in the United States.

Our population is aging, the Baby Boomers are going into retirement, and birth rates have dropped. Our long-run numbers aren’t as grim as some other nations, but our Social Security system is basically insolvent.

Indeed, Social Security’s long-run deficit is measured in trillions, not billions. According to the most recent Trustee’s Report, deficits over the next 75 years are expected to equal $36 trillion. And that’s after adjusting for inflation!

For what it’s worth, if a private insurance or pension company kept its books in the same was as Social Security, it would be forced into bankruptcy and its managers would be indicted for fraud..

But when politicians operate a Ponzi Scheme, we’re supposed to applaud them for compassion!

This is why it might be worth the cost if we sent the politicians in Washington on a junket (using their taxpayer-financed fleet of luxury jets) to Torshavn, the Faroese capital. They could eat some lamb and fish and learn what it’s like to responsibly address a problem before it becomes a crisis.

Or we could save the money and simply force them to watch my video on personal retirement accounts.

P.S. In you like gallows humor, you can enjoy some Social Security cartoons here, here, and here. And we also have a Social Security joke, though it’s not overly funny when you realize it’s a depiction of reality.

P.P.S. You probably don’t want to know how Obama would like to “fix” the Social Security shortfall.

P.P.P.S. On Monday, I continue my tour of the North Atlantic with a speech in Iceland on the Laffer Curve. I don’t know if I’ll say anything memorable, but I’ll use the opportunity to learn more about some of that nation’s policies, including their very successful privatized fishery system. Iceland has some bad policies, of course, but it’s also worth noting that they wisely have rejected membership in the European Union, they’ve reduced the burden of government spending in recent years, and they also made the right decision when they decided (with help from an outraged electorate) to limit bailouts when their banks went bust. You won’t be surprised to learn, though, that the Paris-based OECD has been using American tax dollars to advocate bad fiscal policy in Iceland.

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Most Western nations have huge long-run fiscal problems because of unfavorable demographics and misguided entitlement programs.

That’s the bad news.

The good news is that dozens of nations have fully or partially shifted to mandatory private savings as a pro-growth way of modernizing bankrupt tax-and-transfer Social Security systems.

But good news in the short run doesn’t mean good news in the long run if greedy politicians decide to loot the wealth accumulated in personal retirement accounts.

That’s already happened in Argentina and Hungary, and now it’s happened in Poland. Here’s part of a Financial Times report about the government stealing money from private pension funds.

Poland’s government on Wednesday took an axe to part of the country’s pension system in a bid to bolster public finances. Premier Donald Tusk said that part of the country’s obligatory pension system run by private funds would be dramatically revamped, with 120bn zlotys ($37bn) in government bonds held by the 14 funds being transferred to the government pension scheme and cancelled… The funds will keep control of the 111bn zlotys they hold in equities and current benchmarks will be loosened. The funds will be banned from investing in more government debt. Tusk said that the millions of Poles currently enrolled in the privatised system would have the choice of staying in the scheme or of transferring their assets into the government-run pension system. Market reaction to the long anticipated move was negative. The Warsaw Stock Exchange, where the private funds, known as OFEs, have a big presence, was down by more than 2 per cent. Yields on 10-year Polish government bonds jumped to 4.75 per cent, the highest in a year.

Is anyone surprised by the “negative” reaction?!? Of course markets are unhappy when politicians arbitrarily seize wealth for short-term political games!

Sounds like Poland wants to become the Argentina of Europe. Though there’s always plenty of competition in the contest for bad government policy.

But we do have a bit of good news.

Here is some interesting polling data from an article on the political preferences of young Americans.

…51 percent of Millennials believe that when government runs something it is usually wasteful and inefficient, up from 31 percent in 2003 and 42 percent in 2009: “Hardly a ringing endorsement for a bigger government providing more services.” There’s more: 86 percent of Millennials support private Social Security accounts and 74 percent would change Medicare so people can buy private insurance. Sixty-three percent believe free trade is a good thing. Only 38 percent of Millennials support affirmative action.

Wow, 86 percent of young people support personal retirement accounts. That’s very encouraging, particularly since the general population supports this pro-growth reform by a more-than 2-1 margin.

Here’s a video that explains why a privatized or “personalized” Social Security system is the only way of dealing with the current system’s bankruptcy without screwing younger workers.

I think the video is a good summary explanation, but I also invite you to look at these two charts, one showing the impressive private wealth being accumulated in Australia thanks to personal retirement accounts and the other showing the staggering future shortfalls for America’s pay-as-you-go Social Security scheme.

If those charts don’t convince you, I suspect you’re a genetic statist.

P.S. The thievery of the Polish government is a helpful reminder of why it’s good to have some of your money offshore, preferably managed by a non-US company. After all, does anyone doubt that American politicians are capable of the same venal behavior? They’re probably looking at the money in IRAs and 401(k)s and salivating at the thought of how many votes they could buy with all that money. If (or when) that tragic day arrives, the Americans who have their money beyond the grasp of the federal government will be very happy.

P.P.S. Here’s a good joke about the Social Security system. Except it’s not really a joke because it’s too close to the truth.

P.P.P.S. You can see President Obama’s proposed “solution” to the Social Security crisis by clicking here. I don’t think you’ll be surprised to learn that it means a big shift of money from taxpayers to politicians.

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I’ve done a handful of TV debates on Social Security, including the time I said that I wished Republicans had a secret plan for personal retirement accounts.

So I thought I was well prepared for this duel with a defender of the status quo on Fox Business Network.

I generally think the debate went well, but I confess that I didn’t have the updated numbers on the program’s long-run deficit.

I knew the long-run fiscal gap in past Trustees’ Reports was around $30 trillion, but I wanted to make sure I didn’t exaggerate. And since perhaps the economy’s modest improvement has impacted the long-run outlook, I decided to throw out a number that surely would be on the low side.

So I said $20 trillion.

Well, nobody can accuse me of exaggeration. Here’s a chart showing the program’s dismal long-run deficit, which is compiled from Table VI.F9 and Table V.B1 of the recently released Trustees Report. If you add up the annual deficits, you get $36 trillion. And that’s in today’s dollars!

Social Security Deficit

So I made a $16 trillion mistake. That’s a big number even by Washington standards.

But it doesn’t really matter since everything I said about policy was correct, regardless of whether the long-run deficit was $5 trillion, $50 trillion, or somewhere in between.

If you want to know more about right way to do Social Security reform, click here to see my video on personal retirement accounts.

And if you want to learn more about the wrong way to deal with the program’s huge long-run fiscal gap, click here to get the sobering details on the big tax increase that both President Obama and my debating opponent would like to impose.

P.S. One encouraging footnote is that personal retirement accounts continue to garner good support in public opinion polls. And with the very good results we’re seeing from nations such as Australia and Chile, I’m cautiously optimistic that reform can happen in America.

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I’m in Vienna, Austria, for the annual European Resource Bank meeting.

I had the pleasure last night of listening to Jose Pinera speak about economic reform in Chile, particularly the system of personal retirement accounts.

He shared a chart that conclusively shows why good economic policy makes a difference.

Chile Miracle

Wow. Look at how much faster the economy has grown since the communists were ousted in 1975 and replaced by a pro-market government.* And the poverty rate has plummeted from 50 percent to 11 percent!

Simply stated, economic reform has been hugely beneficial to poor and middle-class people in Chile. Something to remember as we try to rein in the welfare state in America.

Let’s look at some more data. A couple of years ago, I shared this chart showing how Chile had out-paced Argentina and Venezuela. In other words, Chile’s performance is ultra-impressive, whether examined in isolation or in comparison with other nations in the region.

The reason for all this success is that Chile didn’t just reform its pension system. As you can see from this Economic Freedom of the World data, Chile has made improvements in virtually all areas of public policy.

The nationwide school choice system, for instance, is another example of very beneficial reform.

It’s not quite Hong Kong or Singapore, but Chile is definitely a huge success story.

*The Pinochet government that took power in the 1970s may have been pro-economic liberty, but it also was authoritarian. Fortunately, Chile made a successful and peaceful transition to democracy in the late 1980s and has generally continued on a pro-free market path.

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As part of my “Question of the Week” series, I said that Australia probably would be the best option if the United States suffered some sort of Greek-style fiscal meltdown that led to a societal collapse.*

One reason I’m so bullish on Australia is that the nation has a privatized Social Security system called “Superannuation,” with workers setting aside 9 percent of their income in personal retirement accounts (rising to 12 percent by 2020).

Established almost 30 years ago, and made virtually universal about 20 years ago, this system is far superior to the actuarially bankrupt Social Security system in the United States.

Probably the most sobering comparison is to look at a chart of how much private wealth has been created in Superannuation accounts and then look at a chart of the debt that we face for Social Security.

To be blunt, the Aussies are kicking our butts. Their system gets stronger every day and our system generates more red ink every day.

And their system is earning praise from unexpected places. The Center for Retirement Research at Boston College, led by a former Clinton Administration official, is not a right-wing bastion. So it’s noteworthy when it publishes a study praising Superannuation.

Australia’s retirement income system is regarded by some as among the best in the world. It has achieved high individual saving rates and broad coverage at reasonably low cost to the government.

Since I wrote my dissertation on Australia’s system, I can say with confidence that the author is not exaggerating. It’s a very good role model, for reasons I’ve previously discussed.

Here’s more from the Boston College study.

The program requires employers to contribute 9 percent of earnings, rising to 12 percent by 2020, to a tax-advantaged retirement plan for each employee age 18 to 70 who earns more than a specified minimum amount. …Over 90 percent of employed Australians have savings in a Superannuation account, and the total assets in these accounts now exceed Australia’s Gross Domestic Product. …Australia has been extremely effective in achieving key goals of any retirement income system. …Its Superannuation Guarantee program has generated high and rising levels of saving by essentially the entire active workforce.

The study does include some criticisms, some of which are warranted. The system can be gamed by those who want to take advantage of the safety net retirement system maintained by the government.

Australia’s means-tested Age Pension creates incentives to reduce one’s “means” in order to collect a higher means-tested benefit. This can be done by spending down one’s savings and/or investing these savings in assets excluded from the Age Pension means test. What makes this situation especially problematic is that workers can currently access their Superannuation savings at age 55, ten years before becoming eligible for Age Pension benefits at 65. This ability creates an incentive to retire early, live on these savings until eligible for an Age Pension, and collect a higher benefit, sometimes referred to as “double dipping.”

Though I admit dealing with this issue may require a bit of paternalism. Should individuals be forced to turn their retirement accounts into an income stream (called annuitization) once they reach retirement age?

I’m torn on this issue. Paternalists sometimes do have good ideas, but shouldn’t people have the freedom to make their own decisions, even if they make mistakes? But does the answer to that question change when mistakes mean that those people will be taking money from taxpayers?

Fortunately, I don’t need to be wishy-washy on the other criticism in the study.

Australia’s system does have shortcomings. It is heavily dependent on defined contribution plans and is vulnerable to weaknesses in such programs.

I strongly disagree. A “defined contribution” account is something to applaud, not a shortcoming.

The author presumably is worried that a “DC” account leaves a worker vulnerable to the ups and downs of the market, whereas a “defined benefit” account promises a specific payment and removes that uncertainty. Sounds great, but the problem with “DB” accounts is that they almost inevitably seem to promise more than they can deliver. And that seems to be the case whether they’re supposedly based on real savings (like company retirement plans or pension funds for state and local bureaucrats) or based on pay-as-you-go taxation (like Social Security).

*Since I’m somewhat optimistic that America can be saved, I’m not recommending you head Down Under just yet.

P.S. I’m also a huge fan of Chile’s system of private accounts. At the risk of oversimplifying, Chile’s system is sort of like universal IRAs and Australia’s system is sort of like universal 401(k)s.

P.P.S. There’s much to admire about Australia, but its government is plenty capable of boneheaded policy. Heck, the government even provides workers’ compensation payments to people who get injured while having sex after work hours, simply because they were on a business-related trip. Talk about double dipping!

P.P.P.S. Here’s my video explaining why we should implement personal retirement accounts in the United States.

P.P.P.S. The death tax has been abolished in Australia, so there’s more to admire than just personal retirement accounts.

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This is a tough question.

I obviously want comprehensive reform of all entitlement programs, so selecting just one is a bit of a challenge. Sort of like being asked to pick your favorite kid.

Would I reform Social Security? That’s a logical choice. It’s the biggest program in the federal budget, so it’s presumably the biggest problem.

And it sure would be nice to have personal retirement accounts, just like Australia, Chile, and other nations that have modernized their systems.

CBO Health Care Long Term Spending ForecastBut Medicare and Medicaid are growing faster than Social Security and the Congressional Budget Office projects that those two entitlements eventually will become a bigger burden on taxpayers than Social Security.

And since our goal should be to minimize the long-run burden of government spending, that suggests that it’s more important to reform the healthcare entitlements.

But which program should be fixed first?

There’s certainly a strong case to deal with Medicare. The health program for the elderly already is very expensive and it’s going to become even more of a budget buster because of demographic changes.

Moreover, shifting to a “premium support” system would be good for seniors since they would have the ability to pick a plan best suited to their needs. Basically the same type of system now available to members of Congress.

All things considered, though, I would deal first with Medicaid. There are three reasons why I would target the health program designed to supposedly help the poor?

  1. Medicaid is hugely expensive today and will become even more costly over time.
  2. The block-grant reform proposal is a good first step for restoring federalism.
  3. Obamacare can be partly repealed by block-granting the exchange subsidies as part of Medicaid reform.

For more information, here’s my video explaining how to reform the program.

I’m not going to cry – or even complain – if politicians instead decide to fix Medicare or Social Security. Just so long as they’re taking steps in the right direction, I’ll be happy.

What I don’t want to see, however, is a gimmicky plan such as Simpson-Bowles that merely papers over the underlying problems for a couple of years. The wrong type of entitlement reform is probably worse than doing nothing.

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Washington is filled with debate and discussion about the economic burden of the federal income tax, which collected $1.13 trillion in FY2012 ($1.37 trillion if you include the corporate income tax).

Yet politicians rarely consider the economic impact of payroll taxes, even though these levies totaled $.85 trillion during the same fiscal year.

Yes, we had a gimmicky payroll tax holiday for the past few years. And it’s true that Obama has signaled that he wants to increase the payroll tax burden at some point to prop up the Social Security system.

But there’s rarely, if ever, a discussion of wholesale reform.

That’s actually a good thing. Compared to the income tax, the payroll tax does far less damage. And it’s not just because it collects less money. On a per-dollar-raised basis, the payroll tax is considerably less destructive than the income tax.

Why? Because it’s actually a form of flat tax.

  • It has only one tax rate. There’s a 12.4 percent tax for Social Security and a 2.9 percent tax for Medicare, which means a flat tax of 15.3 percent.
  • There’s almost no double taxation. The payroll tax applies to wage and salary income, as well as personal earnings from business activities (sometimes known as “Schedule C” income). But dividends, interest, and capital gains are generally spared – other than the 3.8 percent Obamacare surtax.
  • There are no loopholes or deductions for politically connected interest groups.

And because of these three features, the tax is remarkably simple and doesn’t even require a tax form unless taxpayers have Schedule C income.

None of this, by the way, means the payroll tax is a good or desirable levy.

  • It takes for too much money from the American people and is far and away the biggest tax paid by the majority of American workers.
  • Those revenues are used for two programs – Social Security and Medicare – that are actuarially bankrupt and contributing to the nation’s long-run fiscal collapse.
  • The 15.3 percent tax undermines work incentives by driving a wedge between pre-tax income and post-tax consumption.
  • And the tax is very non-transparent, particularly since many taxpayers don’t even realize that the “F.I.C.A.” tax on their pay stub only reflects 50 percent of their payroll tax burden. In a hidden form of pre-withholding, employers pay an equal amount to the government on behalf of their workers – funds that otherwise would be part of worker compensation.

In other words, the payroll tax is a bad imposition. That being said, it still does considerably less damage, on a per-dollar-collected basis, than the income tax.

With that in mind, I’m puzzled that some folks want to keep the income tax and get rid of the payroll tax.

My friends at the Heritage Foundation, for instance, have a tax reform proposal that would fold the payroll tax into the income tax. Since they’re also proposing to turn the income tax into a form of flat tax, with one rate and no double taxation, the overall proposal clearly is a big improvement over today’s tax system. But all of the improvement is because of reforms to the income tax.

The Washington Examiner has an even stranger position. The paper recently editorialized in favor of abolishing the Social Security portion of the payroll tax and expanding the income tax.

The payroll tax — 12.4 percent, split between workers and their employers to help finance Social Security – is one of the worst taxes on the books for several reasons. A basic economic principle is that when the government taxes something, the nation gets less of it. Because the payroll tax makes it more expensive and administratively burdensome for businesses to hire workers, it’s a drag on employment. Also, even the employer’s share of the tax is effectively passed on to workers in the form of lower salaries and benefits.

There’s nothing overtly wrong with the above passage. The tax does all those bad things. But the income tax does all those things as well, but in an even more destructive fashion.

The editorial addresses a couple of potential objections, starting with the notion that the payroll tax is a revenue dedicated to social Security.

There are two main objections to scrapping the payroll tax. The first is the theoretical idea that payroll taxes are a dedicated revenue stream for Social Security. In practice, it just isn’t true. All government expenditures ultimately come from the same place. Payroll taxes help subsidize other government functions, and the government will use other tax revenue and borrowing to pay for Social Security when revenues are short.

They’re right that all taxes basically get dumped into the same pile of money and that the relationship between payroll taxes and Social Security benefits is imprecise.

But since my argument has nothing to do with this issue, I don’t think it matters.

Here’s the part of the editorial that doesn’t make sense.

The other objection is the massive revenue hit to the federal government. In 2010 (the last year before the recent payroll tax holiday), social insurance taxes raised $865 billion in revenue, according to the Congressional Budget Office. But there are a number of ways to recoup that revenue. As stated above, eliminating the payroll tax would make it easier to get rid of a lot of credits, loopholes and deductions. Also, if lower-income Americans aren’t paying payroll taxes, they can pay a bit more in income taxes. This would also deal with a conservative complaint that the income tax system needs to be reformed so everybody has at least some skin in the game.

This passage has a policy mistake and a political mistake.

The policy mistake is that the proposed swap almost surely would make the overall tax code more hostile to growth. The Examiner is proposing to get rid of an $865 billion tax that does a modest amount of damage per dollar collected, and somehow make up for that foregone revenue by collecting an additional $865 billion from the income tax system – which we know does a very large amount of damage per dollar collected.

To be sure, it’s possible to collect that extra money by eliminating distortions such as the state and local tax deduction or the healthcare exclusion. Compared to raising marginal tax rates, those are much-preferred ways of generating more revenue. But even in a best-case scenario – with politicians miraculously trying to collect an extra $865 billion without making the income tax system even worse, it’s hard to envision a better fiscal regime if we swap the payroll tax for a bigger income tax.

The political mistake is the assumption that more people will have “skin in the game” if the income tax is expanded. That’s almost surely not true. The poor don’t pay income tax, but the payroll tax grabs 15.3 percent of every penny earned by low-income households. And since very few taxpayers pay attention to which tax is shrinking their paychecks, it doesn’t really matter whether the “skin” is a payroll tax or an income tax.

Since the Examiner isn’t proposing a specific plan, there’s no way of making a definitive statement, but it’s 99 percent likely that eliminating the Social Security payroll tax would result in low-income households paying even less money to Washington. I think everybody should send less to Washington, but I don’t think shifting a greater share of the tax burden onto the middle class and the rich is the right way of achieving that goal.

I have one final objection, and this applies to both the Heritage Foundation plan and the Examiner proposal.

Notwithstanding everything I just wrote, I actually agree with them that we should eliminate the Social Security payroll tax. But we should get rid of the tax as part of a transition to a system of personal retirement accounts.

This is a reform that has been successfully implemented in about 30 nations and it also should happen in the United States. But an integral feature of this reform is that workers would be allowed to shift their payroll taxes into personal accounts. Needless to say, that’s not possible if the payroll tax has disappeared.

This video explains why genuine Social Security reform is so desirable.

And let’s not forget that the Medicare portion of the payroll tax could and should be part of a broader agenda of entitlement reform. But that’s also less likely if the payroll tax is folded into the income tax.

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There are two serious problems with America’s Social Security system. Almost everyone knows about the first problem, which is that the system is bankrupt, with huge unfunded liabilities of about $30 trillion.

The other crisis is that the system gives workers a lousy level of retirement income compared to the amount of taxes they pay during their working years. Younger workers are particularly disadvantaged, as are African-Americans because of lower life expectancy.

These are critical issues, but perhaps looking at a couple of charts is the best way to illustrate why the Social Security system is inadequate.

Let’s start by looking at some numbers from Australia, where workers set aside 9 percent of their income in personal retirement accounts.

This system, which was made universal by the Labor Party beginning in the 1980s, has turned every Australian worker into a capitalist and generated private wealth of nearly 100 percent of GDP. Here’s a chart, based on data from the Australian Prudential Regulation Authority.

Now let’s look at one of the key numbers generated by America’s tax-and-transfer entitlement system. Here’s a chart showing the projected annual cash-flow deficits for the Social Security system, based on the just-released Trustees’ Report.

By the way, the chart shows inflation-adjusted 2012 dollars. The numbers would look far worse if I used the nominal numbers.

The two charts aren’t analogous, of course, but that’s because there’s nothing to compare. The Social Security system has no savings. Indeed, it discourages people from setting aside income.

And Australia’s superannuation system doesn’t have anything akin to America’s unfunded liabilities. The closest thing to an analogy would be the safety net provision guaranteeing a basic pension to people with limited savings (presumably because of a spotty employment record).

So now ask yourself whether Australia should copy America or America should copy Australia? Seems like a no-brainer.

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The Social Security Board just released its Trustee’s Report, and it’s generated the usual hand wringing about the program’s long-term demise – much of which is perfectly appropriate for reasons I’ve already discussed.

But I’m usually unhappy about the press treatment of this issue.

Here’s some of what Stephen Ohlemacher and Ricardo Alonso-Zaldivar wrote for the Associated Press.

Social Security is rushing even faster toward insolvency, driven by retiring baby boomers, a weak economy and politicians’ reluctance to take painful action to fix the huge retirement and disability program. The trust funds that support Social Security will run dry in 2033 – three years earlier than previously projected – the government said Monday. …Unless Congress acts – and forcefully – payments to millions of Americans could be cut. …Potential options to reduce Social Security costs include raising the full retirement age, which already is being gradually increased to 67, reducing annual benefit increases and limiting benefits for wealthier Americans. Policymakers could also increase the amount of wages that are subject to Social Security taxes. Social Security is financed by a 6.2 percent tax on the first $110,100 in workers’ wages. It is paid by both employers and workers.

There are two flaws with what’s written in this story. One is a sin of commission, failing to expose the government’s dishonest accounting. The other is a sin of omission, analyzing the issue solely through the lens of government finances.

1. The sin of commission is that the story assumes the Social Security Trust Fund is real, when it is nothing but a collection of IOUs. When extra Social Security taxes are collected, the Treasury keeps those monies and spends them on other programs. In exchange, it engages in a bookkeeping exercise and credits the Social Security Trust Fund with some government bonds.

When one part of the government owes another part of the government some money, it is a wash. There’s no pile of assets to finance benefits. Those bonds simply represent a claim on future taxpayers.

This is why politicians can play dishonest games, such as approving a payroll tax holiday and declaring – by waving a magic wand – that this won’t affect the amount of IOUs in the Trust Fund. Just in case you think I’m joking, the AP story notes that “Congress temporarily reduced the tax on workers to 4.2 percent for 2011 and 2012, though the program’s finances are being made whole through increased government borrowing.”

Needless to say, that’s phoniness on top of phoniness. I guess the next step is for politicians to enact legislation adding several zeroes to all the existing IOUs. They can then declare that Social Security is solvent. Problem solved…other than the itsy-bitsy problem that there’s still no money.

2. The sin of omission in the story is that it focuses on the government’s finances and overlooks the implications for households. It is possible, at least on paper, to “save” Social Security by cutting benefits and raising taxes. But such “reforms” force people to pay more and get less – even though Social Security already is a very bad deal, particularly for younger workers.

My video on Social Security reform explains that personal retirement accounts are the only way to simultaneously deal with government finances and household finances in a constructive fashion.

Sadly, neither Obama nor Romney seem interested in this type of pro-growth reform.

By the way, I don’t mean to pick on the Associated Press. The report excerpted above simply happened to be the first one I read. You ‘ll find the same myopic analysis in the Wall Street Journal and Bloomberg, to cite just two of many examples.

In closing, Social Security reform is actually the least important of the entitlement reforms. The long-term fiscal problems caused by Medicare and Medicaid are much larger. This three-part video series looks at the reforms that could address all three programs.

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Most people have a vague understanding that America has a huge long-run fiscal problem.

They’re right, though they probably don’t realize the seriousness of that looming crisis.

Here’s what you need to know: America’s fiscal crisis is actually a spending crisis, and that spending crisis is driven by entitlements.

More specifically, the vast majority of the problem is the result of Medicaid, Medicare, and Social Security, programs that are poorly designed and unsustainable.

America needs to fix these programs…or eventually become another Greece.

Fortunately, all of the problems can be solved, as these three videos demonstrate.

The first video explains how to fix Medicaid.

The second video shows how to fix Medicare.

And the final video shows how to fix Social Security.

Regular readers know I’m fairly gloomy about the future of liberty, but this is one area where there is a glimmer of hope.

The Chairman of the House Budget Committee actually put together a plan that addresses the two biggest problems (Medicare and Medicaid) and the House of Representatives actually adopted the proposal.

The Senate didn’t act, of course, and Obama would veto any good legislation anyhow, so I don’t want to be crazy optimistic. Depending on how things play out politically in the next six years, I’ll say there’s actually a 20 percent chance to save America.

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Governor Rick Perry of Texas is being attacked by two rivals in the GOP presidential race. His sin, if you can believe it, is that he told the truth (as acknowledged by everyone from Paul Krugman to Milton Friedman) about Social Security being a Ponzi scheme.

Here’s an excerpt from Philip Klein’s column in the Examiner, looking at how Mitt Romney is criticizing Perry.

Mitt Romney doubled down on his attack against Texas Gov. Rick Perry this afternoon, warning in an interview with Sean Hannity that his critique of Social Security amounted to “terrible politics” that would cost Republicans the election. Romney’s decision to pile on suggests that he’s willing to play the “granny card” against Perry if it will help him get elected, a tactic more becoming of the likes of DNC chairwoman Debbie Wasserman Schultz than a potential Republican nominee.

And here’s a Byron York column from the Examiner looking at how Michele Bachmann is taking the same approach.

…another Republican rival, Michele Bachmann, is preparing to hit Perry on the same issue. “Bernie Madoff deals with Ponzi schemes, not the grandparents of America,” says a Bachmann adviser.  “Clearly she feels differently about the value of Social Security than Gov. Perry does.  She believes Social Security needs to be saved, that it’s an important safety net for Americans who have paid into it all their lives.” … “She strongly disagrees with his position on that…”

Shame on Romney and Bachmann. With an inflation-adjusted long-run shortfall of about $28 trillion, Social Security is a Ponzi scheme on steroids.

But as I explain in this video, that’s just part of the problem. The program also is a terrible deal for workers, particularly young people and minorities.

Here’s what’s so frustrating. Romney and Bachmann almost certainly understand that Social Security is actuarially bankrupt. And they probably realize that personal retirement accounts are the only long-run answer.

But they’re letting political ambition lure them into saying things that they know are not true. Why? Because they think Perry will lose votes and they can improve their respective chances of getting the GOP nomination.

Sounds like a smart approach, assuming truth and morality don’t matter.

But here’s what’s so ironic. The Romney and Bachmann strategy is only astute if Social Security is sacrosanct and personal accounts are political poison.

But as I noted last year, the American public supports personal accounts by a hefty margin. And former President Bush won two elections while supporting Social Security reform. And election-day polls confirmed that voters supported personal accounts.

I’m not a political scientist, so maybe something has changed, but I wouldn’t be surprised if Perry benefited from the left-wing demagoguery being utilized by Romney and Bachmann.

P.S. This does not mean Perry has the right answer. As far as I know, he hasn’t endorsed personal accounts. But at least he’s telling the truth about Social Security being unsustainable.

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Welcome Instapundit readers. Notwithstanding my next-to-last paragraph full of caveats, some people are saying I’m too soft on the Aussies. This previous post should disabuse people of that notion.

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The Economist magazine has a couple of good articles about Australia’s increasingly enviable economic status. Here’s a blurb from the first article, which outlines the pro-market reforms that enabled today’s prosperity.

Only a dozen economies are bigger, and only six nations are richer—of which Switzerland alone has even a third as many people. Australia is rich, tranquil and mostly overlooked, yet it has a story to tell. Its current prosperity was far from inevitable. Twenty-five years ago Paul Keating, the country’s treasurer (finance minister), declared that if Australia failed to reform it would become a banana republic. Barely five years later, after a nasty recession, the country began a period of uninterrupted economic expansion matched by no other rich country. It continues to this day. This special report will explain how this has come about and ask whether it can last. …With the popular, politically astute Mr Hawke presiding, and the coruscating, aggressive Mr Keating doing most of the pushing, this Labor government floated the Australian dollar, deregulated the financial system, abolished import quotas and cut tariffs. The reforms were continued by Mr Keating when he took over as prime minister in 1991, and then by the Liberal-led (which in Australia means conservative-led) coalition government of John Howard and his treasurer, Peter Costello, after 1996. …By 2003 the effective rate of protection in manufacturing had fallen from about 35% in the 1970s to 5%. Foreign banks had been allowed to compete. Airlines, shipping and telecoms had been deregulated. The labour market had been largely freed, with centralised wage-fixing replaced by enterprise bargaining. State-owned firms had been privatised. …the double taxation of dividends ended. Corporate and income taxes had both been cut.

This chart (click for a larger image), from Economic Freedom of the World, presents a more rigorous look at this period. It shows how Australia’s economic freedom ranking had dropped to as low at 19 (out of 72 nations measured) and now is up to 8 (out of 114 nations measured). This is akin to moving from the 74th percentile to the 94th percentile.

There is also an accompanying article about Australia’s private Social Security system. Called superannuation, these personal accounts have generated tremendous results.

…most Australian workers, over 8m in total, now have a private nest-egg for their old age. No tax is paid when members withdraw from their fund; they can take all they want as a lump sum, subject to a limit, or buy an annuity. Aussies are now a nation of capitalists. At the same time the state pension system, and therefore the taxpayer, is being progressively relieved of most of the burden of retirement provision, since eligibility for the state pension depends on both assets and income. As supers take over, the provision for old folks’ incomes will be almost entirely based on defined contributions, not defined benefits. So Australia is in the happy position of not having to worry too much about the pension implications of an ageing population… The supers…have created a pool of capital in Australia that might not otherwise have existed. Collectively worth about $1.3 trillion—much the same as GDP—they have made Australia the world’s fourth-largest market for pension savings.

Australia is not exactly Hong Kong. Marginal tax rates are still far too high. The burden of government spending is lower than in the United States, but is still far too onerous. Nonetheless, the Aussies have made impressive strides in reducing the overall size, scope, and level of government interference and intervention. And this has translated into much better economic performance.

This video uses the Economic Freedom of the World index to explain why comprehensive free market reforms (like Australia) generate the best results.

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I was excited when I saw that Professor Martin Feldstein of Harvard University had a column in yesterday’s Wall Street Journal entitled, “Private Accounts Can Save Social Security.” This is great, I thought, another person advocating the kind of pro-growth, pro-freedom reform which has taken hold in about 30 nations all over the world.

Imagine my disappointment, then, when I read the column and discovered that Feldstein had unfurled the white flag. Instead of genuine reform, which would allow workers to shift their payroll taxes into personal retirement accounts, he wants everyone to remain trapped in the current system and then require individuals to pay extra into some sort of retirement account.

Social Security taxes are not to be invested in the stock market… Here’s how such a system might work. Each individual would designate a broad-based mutual fund from a large list of funds approved by the government. The designation could be done on the individual’s annual tax return and could be changed once a year. Employers and the self-employed would send an additional few percent of wages to the Social Security Administration each month in addition to the current payroll tax. The Social Security Administration would then forward those dollars to the mutual fund chosen by the individual. …The automatic extra payroll deduction could start with a less disruptive 1% or 2% and grow as high as 5%. Since every individual would have the option of requesting a refund of that payroll deduction on the following year’s income-tax form, the extra saving is strictly voluntary.

The only good news is that Feldstein would allow workers to recapture the money they are forced to put in these new accounts, so technically this is not an Obamacare-style mandate. Or, perhaps the right description is that it is a mandate, but with an escape hatch.

The right approach is to let workers shift their payroll taxes into a personal account. This video describes why this type of reform is the right approach.

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People periodically ask me why I’m so down on David Cameron, the Prime Minster of the United Kingdom. I’ve already pointed out that his pre-election agenda was big government. And I’ve pointed out that his post-election record is more spending.

(and you can read more of my whining and complaining here, here, here, here, and here)

But now I’m really disgusted, because the United Kingdom’s version of  George W. Bush is now reversing one of the few pro-market aspects of British policy.

The Wall Street Journal Europe is appropriately disappointed.

On Tuesday Iain Duncan Smith announced a sweeping reform of the U.K.’s state-pension system. In the name of simplification, the Work and Pensions Secretary plans to raise the basic pension, eliminate the current multitiered system—and pay for it all by rolling back the personal retirement accounts that were first introduced by the Thatcher Government in 1987. Pension systems across the developed world are being stretched to the breaking point as populations gray and governments face ballooning public debts. Britain today is in the privileged position of possessing on top of its public savings system an extensive private one, relatively insulated from the government’s increasingly uncertain ability to deliver on its pension liabilities. Pity, then, that Mr. Duncan Smith’s reforms serve in the long run mostly to entrench the unsustainable elements of the British system and trash the desirable ones.

Addendum: Jose Pinera reminds me that George W. Bush actually proposed personal retirement accounts in 2005, one of the few positive actions of his eight-year reign. So Cameron’s actions may put him even further to the left than Bush on economic policy, a rather challenging achievement.

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There are two crises facing Social Security. First the program has a gigantic unfunded liability, largely caused by demographics. Second, the program is a very bad deal for younger workers, making them pay record amounts of tax in exchange for comparatively meager benefits. This video explains how personal accounts can solve both problems, and also notes that nations as varied as Australia, Chile, Sweden, and Hong Kong have implemented this pro-growth reform.

Social Security reform received a good bit of attention in the past two decades. President Clinton openly flirted with the idea, and President Bush explicitly endorsed the concept. But it has faded from the public square in recent years. But this may be about to change. Personal accounts are part of Congressman Paul Ryan’s Roadmap proposal, and recent polls show continued strong support for letting younger workers shift some of their payroll taxes to individual accounts.

Equally important, the American people understand that Social Security’s finances are unsustainable. They may not know specific numbers, but they know politicians have created a house of cards, which is why jokes about the system are so easily understandable.

President Obama thinks the answer is higher taxes, which is hardly a surprise. But making people pay more is hardly an attractive option, unless you’re the type of person who thinks it’s okay to give people a hamburger and charge them for a steak.

Other nations have figured out the right approach. Australia began to implement personal accounts back in the mid-1980s, and the results have been remarkable. The government’s finances are stronger. National saving has increased. But most important, people now can look forward to a safer and more secure retirement. Another great example is Chile, which set up personal accounts in the early 1980s. This interview with Jose Pinera, who designed the Chilean system, is a great summary of why personal accounts are necessary. All told, about 30 nations around the world have set up some form of personal accounts. Even  Sweden, which the left usually wants to mimic,  has partially privatized its Social Security system.

It also should be noted that personal accounts would be good for growth and competitiveness. Reforming a tax-and-transfer entitlement scheme into a system of private savings will boost jobs by lowering the marginal tax rate on work. Personal accounts also will boost private savings. And Social Security reform will reduce the long-run burden of government spending, something that is desperately needed if we want to avoid the kind of fiscal crisis that is afflicting European welfare states such as Greece.

Last but not least, it is important to understand that personal retirement accounts are not a free lunch. Social Security is a pay-as-you-go system, so if we let younger workers shift their payroll taxes to individual accounts, that means the money won’t be there to pay benefits to current retirees. Fulfilling the government’s promise to those retirees, as well as to older workers who wouldn’t have time to benefit from the new system, will require a lot of money over the next couple of decades, probably more than $5 trillion.

That’s a shocking number, but it’s important to remember that it would be even more expensive to bail out the current system. As I explain at the conclusion of the video, we’re in a deep hole, but it will be easier to climb out if we implement real reform.

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Here’s my debate on Larry Kudlow’s show about Social Security personal retirement accounts. 

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My Cato colleague Jose Pinera makes a powerful argument for “privatizing” Social Security, which is something that has happened in about 30 nations.

My Ph.D. dissertation was on Australia’s private system, so I’ve always had a soft spot for this issue. Sadly, Washington is busy creating new entitlements instead of fixing the ones we already have.

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No, not these kind. Instead, I’m in Stockholm for a meeting of the Mont Pelerin Society, and this gathering of classical liberals (i.e., the Adam Smith types that believe in freedom, not the modern liberals that favor collectivism) has featured some discussion of the Scandinavian social welfare state – often referred to as the Swedish Model.

What is particularly interesting is that Sweden is not the left-wing paradise that some imagine. Yes, government is far too big, consuming about 50 percent of economic output. But Sweden also has an extensive system of school choice. Equally remarkable, Sweden has a system of personal retirement accounts. Indeed, if one removed fiscal policy variables from the ratings, Sweden would be more free market than the United States in the Economic Freedom of the World rankings.

But even in the area of fiscal policy, Sweden is making progress. In recent years, policy makers have abolished both the death tax and the wealth tax. And the corporate tax rate has been reduced significantly below the U.S. level.

Sweden often is cited as an example of a nation that proves a big welfare state is not an obstacle to being a rich society. But as I wrote in my study comparing the United States and the Nordic nations:

Many prosperous nations in Western Europe have large welfare states. This leads unsophisticated observers to sometimes assume that high tax rates and high levels of government spending do not hinder growth. Indeed, they sometimes even conclude that bigger government somehow facilitates growth. …This analysis puts the cart before the horse. It is possible for a nation to become rich and then adopt a welfare state. …A poor nation that adopts the welfare state, however, is unlikely to ever become rich. Before the 1960s, Nordic nations had modest levels of taxation and spending. They also enjoyed—and still enjoy—laissez-faire policies and open markets in other areas. These are the policies that enabled Nordic nations to prosper for much of the 20th century. Once their countries became rich, politicians in Nordic nations focused on how to redistribute the wealth that was generated by private-sector activity. This sequence is important. Nordic nations became rich, and then government expanded. This expansion of government has slowed growth, but slow growth for a rich nation is much less of a burden than slow growth in a poor nation.

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