Lecture 17: The Fiscal Crisis of the Social State in the 21st Century

Introduction

We have now analyzed the distribution of wealth and income inequalities in Europe since the 18th century. Inequalities of wealth are close to regaining or even surpassing their historic highs of the 19th century.

Keep in mind these two tables, which depict the trends in inequalities of total wealth (ownership of capital) and the inequalities of total income (labour + capital income) in Scandinavia, Western Europe and the USA. Note the magnitudes of difference.

inequality-of-capital-ownershipinequality-of-total-income

This begs the question – what is the role for government and the democratic state in shaping the politics of distribution in the 21st century? How do nation-states (democratically elected government) resolve the endemic conflict between private capitalist markets and democratic social rights?

Market competition or social rights?

Increasingly governments have to satisfy two different constituencies: markets and voters. This friction is reflected in two competing principles of resource allocation: markets and social rights. Governments can either tax (citizens, firms and consumers) or borrow (debt financed expenditure) to fund (pay for) public services.

To give an example of the new constraints facing the democratic state consider the following: in the aftermath of the great depression the US President, Herbert Hoover, raised the top marginal income tax rate to 80 per cent. In the aftermath of the great recession, the Obama administration struggled to increase it beyond 35 per cent.

The financial crisis revealed the importance of central banks (public institutions) and the social state (public welfare)  in mitigating the worst effects of the financial market. Absent government and central bank intervention, economies would have entirely collapsed.

But effective economic and social policy is not just about the level of income and capital taxation. The capacity to raise tax revenue is the fundamental characteristic of how contemporary democracies manage capitalist markets. Weak states struggle to raise revenue and provide services.

The constraints placed on the public finances in the aftermath of the international financial crisis was not an outcome of market imperfection. For Wolfgang Streeck it reflects a continuous and ongoing transformation of that fragile post-war creation that we now call democratic capitalism (a relatively recent creation in the long history of capitalist development).

The fiscal state

The role of the state in the economy has been constantly evolving, particularly since end of World War II.

But contrary to many of the assumptions of “neoliberalism” the state is not in retreat. The state is just as involved in shaping economic and market outcomes today as it was in the 1970’s. What has changed is the function of the state. Much like capital, the structure of the state has fundamentally changed over time.

On the one hand, nation-states require new supranational forms of governance to manage global financial markets (think about the European Union), whilst on the other, the domestic social state is in constant need of modernisation (changing tax and spend policies to reflect new realities/problems).

The simplest way to measure the role of the state in the economy (and society) is to look at the total amount of taxes relative to national income. Figure 13.1 shows the trajectory for Sweden, France, Britain and the USA.

Prior to WW1 the state had no real role in economic and social life. With taxes equivalent to 7-8 per cent of national income, the state could just about manage those “regal” functions of managing a police force and an army. The state existed to maintain social order and defend property rights.

Between 1920-1980 the share of national income that rich countries began to devote to social spending grew substantially. It increased by more than a factor of 5 in Nordic countries. But between 1980-2010 the tax share stabilized almost everywhere.

The fiscal revolution, which gave birth to the democratic social state, during the 20th century, is over.

The social state

Tax revenue has stabilized at around 30 per cent in the USA, 35 per cent in Ireland, 40 per cent in the UK, 45 per cent in Germany, 50 per cent in France and almost 55 per cent in Sweden.

This growing tax bill (revenue generation) has enabled the state to take on broader public service functions, which now consume between a third and a quarter of all government expenditure, depending on the country.

One half of this goes on health and education, whilst the other half goes on replacement incomes and transfer payments. Hence, for the most part, the social state is constituted by expenditure in healthcare, education, eldercare and social protection.

Politics is not just about elections. It is about making public policy. Policy regimes vary significantly between countries: neoliberal (USA), social (Scandinavia) and coordinated (Germany) market economies are not the same. They all manage the implicit tension between capitalism and democracy in different ways.

Trying to explain these differences (in terms of public policy outcomes) is a core part of the study “comparative” political economy. See this recent book, the politics of advanced capitalism.

Social rights

Public spending on health and education consumes around 10-15 per cent of national income in most capitalist democracies today.

Primary and secondary education are almost entirely free for everyone in the rich democracies of the world (although some countries, like Ireland, heavily subsidize private education as well).

Public health (either via insurance or direct provision) is universal in most European countries (although some countries, like Ireland, heavily rely on private provision too).

Childcare provision is also universal in most European countries (with some exceptions, such as Ireland).

Replacement income and transfer payments also consume almost 15 percent of national income in European countries (primarily because of high unemployment in the aftermath of the crisis).

In most developed democracies, the government taxes (workers, firms, consumers) and then spends this in terms of income replacement to households that cannot work (pensions, unemployment compensation, family, disability and children’s allowance), or in terms of social investment/services (health, education, research/development, childcare).

Pensions are the biggest component of “income replacement” in most countries. Think of this as a consumption replacement. But for most countries, services are the biggest expenditure.

The growth of the “fiscal state” over the last century reflects the constitution of the “social state”. This, in turn, reflects the democratic demand that citizens place on government, and often articulated in terms of social rights: education, healthcare, pensions (and in some countries, housing).

Modern redistribution

Modern redistribution is not primarily about transferring income from the rich to the poor but financing public services and replacement incomes for the elderly (and in periods of economic stagnation, the unemployed). It is built around a logic of democratic rights not market competition.

Democratic questions pertaining to social rights will never be answered by abstract principles and mathematical formulas.

The only way to deal with questions of social rights, and what the state should and should not provide, is through democratic deliberation. Further, there are very few examples in history where social rights were won without conflict and political confrontation.

The political institutions that govern democratic debate will, therefore, play a crucial role in shaping the politics and discourse of what constitutes fair distribution. Ideology clearly plays an important role here. Ideological attitudes toward the “state” are probably most divisive in the USA.

This is not just about comparative differences in electoral and political party rules (majoritarian and proportional systems of representation) but the variation in the relative power resources of interest groups and the persuasive capacity of different social actors to shape the terms of the debate.

See Jacob Hacker & Paul Piersons (2016) book “American Amnesia: How the War on Government Led us to Forget What made America Prosper“.

Conclusion

The revolution in the public financing of the social state is not likely to be reversed in any rich democratic country. That is, it’s hard to imagine a political party winning a democratic election, and form a government, on a platform to end public provision of health, education, eldercare, childcare and social protection.

There are certainly huge constraints on expenditure and taxation, particularly as it pertains to pensions, but no country is likely to cut social spending back to less than 20 percent of national income. This would require ending public service provision, and ending public sector employment.

On the contrary, there is huge fiscal pressure on the state to expand and to invest in new forms of social investment such as higher education; research/development; transport; housing; vocational training; water; childcare; sustainable energy; digital communications; broadband and a whole host of other new types of infrastructural investment.

This political and societal pressure to expand and invest, however, confronts the financial market pressure to consolidate public finances, and reduce expenditure i.e. austerity.Governments everywhere are trying to reduce their public debt burdens through cuts to expenditure and tax increases.

The implication is that the capacity of the state to engage in new forms of discretionary expenditure/investment is in decline.

Furthermore, the expansion of the state during the past 50 years was dependent upon one crucial condition that cannot be guaranteed: strong economic and productivity growth. Absent strong economic growth, governments, by definition, cannot raise revenue, as tax expenditures fall. Growth has slowed down almost everywhere.

Hence, for many the crisis of economic growth is the crisis of advanced capitalism, as it makes it increasingly difficult for governments to commit to continue to pay for what citizens expect as a social right. Future debates about the fiscal state are likely to revolve around issues of economic growth, structural reform, public sector modernisation and the consolidation of social spending.

It is in this context that the ability of large MNCs to avoid paying tax, through exploiting cross-national tax competition laws, has become politicised. In the EU, the ability of nation-states within the same Union to use corporate tax laws to attract module capital, is perceived as leading to a race to the bottom.

Discussion

The demand to reform the social state and improve the quality of public services is a very legitimate concern. Taxpayers tend to support public financing when they receive better quality services, and when they have higher levels of trust in government.

To tease out this fiscal crisis of the state discuss the following questions:

  • Should access to higher education be free?
  • Does it make a difference that it does not impact upon social mobility?
  • What about the right to retirement, does everyone have a right to a pension?
  • Who should pay for all this?
    • That is, who should pay the tax to fund these services/investment?

Lecture slides: lecture-16

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