How the Welfare State Hurts the Poor and Causes Unemployment

I’ve written about the negative relationship between government spending and economic performance, but most of my focus is on “macro” issues such as the overall diversion of resources from the productive sector to government.

This leads to the misallocation of labor and capital, I’ve explained, which means the economy isn’t as efficient and living standards stagnate.

But, with the exception of some posts about the harmful impact of unemployment insurance (including evidence that Paul Krugman and Larry Summers used to be on the right side before politics clouded their judgment), I’ve rarely explained this story from a “micro” perspective.

Fortunately, Professor Casey Mulligan of the University of Chicago has done some very solid work on this issue, some of which he recently wrote about in the New York Times.

The social safety net became more generous under Presidents George W. Bush and Barack Obama, and as a result massively altered employment patterns in the labor market. …public moneys have recently been used to help the unemployed, the poor and the financially distressed endure the recession, but at the same time have dramatically eroded incentives for people to maintain their own living standards by seeking, accepting and retaining jobs, as well as incentives for employers to create jobs that are attractive to workers.

This makes sense to me. After all, Bush was a reckless big spender, just like Obama. And we also know that if you make work less attractive and idleness more attractive, bad things will happen.

But Prof. Mulligan actually measures the net impact.

As a result of more than a dozen significant changes in subsidy program rules, the average middle-class non-elderly household head or spouse saw her or his marginal tax rate increase from about 40 percent in 2007 to 48 percent only two years later. Marginal tax rates came down in late 2010 and 2011 as provisions of the American Recovery and Reinvestment Act expired, but still remain elevated – at least 44 percent. …A few households even saw their marginal tax rates jump beyond 100 percent – meaning they would have more disposable income by working less. …work incentives were eroded about 20 percent for unmarried household heads…in the middle of the skill distribution, while they were eroded about 12 percent among married heads and spouses…with the same level of skill.

So what’s the bottom line? Well, Prof. Mulligan concludes that government policy hurt everybody, but it did the most damage for those least able to endure hardship, the low-skilled and unmarried.

The fact that marginal tax rates rose so differently for various groups means not only that redistributive public policy depressed the labor market but has also sharply, and arbitrarily, altered the composition of the work force in the direction of people who are married and more skilled.

This final point is worth contemplating for those who are still in post-election-analysis mode. Welfare state programs trap people in dependency. People in that situation naturally worry about who will take care of them, which makes them easily susceptible to snake-oil politicians who promise endless handouts financed by taxes on the so-called rich.

Some otherwise sensible politicians are reluctant to say no when asked to expand the welfare state because they fear it will hurt them at the polls. That’s definitely a possibility, but creating more dependency is a guaranteed way of making it harder to win future elections.

The moral of the story: Big government is bad for the poor.

Second moral of the story: Entitlement reform is good policy…and good politics.

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In the OECD’s Fantasy World, Higher VAT Taxes “Foster Growth and Employment”

Regular readers know I’m not a fan of the Organization for Economic Cooperation and Development. Heck, just take a look at some of the examples in this post and you’ll understand why.

Well, the Secretary-General of the Paris-based bureaucracy just pontificated about the value-added tax. Let’s see whether my knee-jerk hostility is warranted.

“Night is day, up is down, and higher taxes boost growth”

Here is the basic hypothesis from the OECD’s head bureaucrat.

Our VAT policies are important tools to foster growth and employment, but also to build stronger, cleaner and fairer economies.

That’s a bold sentence, so let’s dissect it. Starting with the last part, I’m not sure what he means by “cleaner,” so let’s set that aside. I assume “fairer” is a code word for class warfare, though it doesn’t make sense in this context since a VAT – for all its other flaws – is a proportional levy.

So what does he mean by “foster growth and employment” and making an economy “stronger”? Does that mean the OECD is recommending big reductions in VAT rates? That would make sense since the VAT is similar to the income tax in that it drives a wedge between pre-tax income and post-tax consumption.

But you have to remember we’re dealing with the OECD, and on policy matters the Paris-based bureaucracy inevitably supports statism. So you won’t be surprised to learn that the OECD thinks higher VAT rates are good for growth! I’m not joking. Let’s look at what the Secretary-General of the OECD said.

VAT policies are playing a strategic role in our recovery efforts, but they could do more. Many countries are seeking to raise additional revenues from VAT as part of their fiscal consolidation strategies. Between 2009 and 2012, sixteen OECD countries increased their VAT rates. Six more increased their VAT rates. This is reflected in the OECD average standard VAT rate that has risen from 17.7% in 2008 to 19% today. This is quite remarkable considering that the OECD average had remained stable for over ten years before 2008. Raising the standard rate is the easiest way to increase revenue. …Another option for governments is to consider broadening the tax base, such that goods and services that are now exempt or subject to reduced rates would gradually be taxed at the standard rate.

In other words, he’s bragging that the VAT is easy to raise and he’s happy that the average VAT rate has jumped significantly.

But what’s really amazing is that he claims this is pro-growth, part of “our recovery efforts.” So the OECD is just as clueless as the Congressional Budget Office and is embracing the view that higher tax burdens are good for the economy.

This is par for the course for the OECD, as you can see from this video.

Something to keep in mind for lawmakers who are looking for an easy way to save $100 million without taking away any goodies from American voters.

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