First "holy shit" moment in public policy

So, the scuttlebutt about social welfare spending in the US is that the American welfare state is small – somewhere around 15% of GDP whereas for European and in particular Scandinavian countries, it accounts for about 30% of GDP.

Well, some people have long argued that the way in which OECD used to compile this info (measuring direct government spending) doesn't capture the American reality. Check put page #28 in this document
(it’s actually page 29 in the .pdf, but because of the cover page it’s numbered 28.)

You see that the US leads all countries in what is called private social spending. This takes up a couple of different forms, but mostly it means tax revenue that the federal government is foregoing. What does this include? Well, tax deductions, for one.

While spending on section 8 housing is a small percentage of government entitlement programs, the revenue the government gives up on mortgage interest deductions is huge. (And who does that benefit? The little guy or the medium guy?)

We may spend little per capita on welfare programs, but not once you consider that there’s a child tax credit in the tax code too. Similarly, we have two big sources of income that are not taxed: health benefits (which are considered part of your income in European countries and are taxed – so every dollar you get in health, the Swedish government gets, say, 25 cents of the money back that it’s giving you. It’s just a book-keeping thing that OECD statistics don’t capture very well.) The other is your pension plan – your employer is giving you a ton of money that, as long as you wait till you’re a certain age to use, will not be taxed as income.

So, the issue isn’t that the US spends little, it’s that the US spends weirdly, disjointedly – if you buy the argument that foregone revenue to the fed = federal spending. (Most people do, and I include myself in that category if you limit the rationale to this area of discussion. The problem here is the presumption that the lack of revenue is a form of spending. Then isn't not spending also a form of revenue? Didn't the U.S. then make billions of dollars by not heeding Lieberman's call to bomb Yemen? Also, the Ron Paul-types will object to the presumption that government has any right to my income in the first place – how dare they count money they’re not taking from me, which is rightfully mine, as foregone revenue? In any case, next time you look at your pension plan statement, thank the federal government for not taking a chunk out of it, and thank yourself and all the other taxpayers for allowing you to do that.)

Now, there’s a good argument for enacting social policy through the tax code. For one, you can encourage things you’d like to see – people buying homes and having kids – without setting up a whole separate office or program to administer it. It’s cost-effective in that sense – it’s just one more line on the tax form, and the IRS is already set up to look at that form anyway.

Now, the big problem with spending federal dollars this way is that administering benefits through the tax code is inherently regressive. This is the lightbulb moment for me:

If you’re taxed at the 36% marginal tax rate, each additional dollar of “income” via pension plans or health benefits that does not get taxed is worth 36 cents to you, right? If they taxed you on those dollars as income, you’d be losing 36 cents on the dollar. Yay for you and the high wage earners! But what if you are at the 22% rate? You’re already making less, and you’re “saving” less – only 22 cents – from not having those dollars taxed as your income would be. Inherently, administering benefits through the tax code means that those who are well-off will benefit the most, those who are so-so off will only benefit so-so, and those who don’t itemize to begin with or who can't wait a whole fiscal year to get a government entitlement are up a creek.

Now, think about the fact that many of these programs, as currently set up, date back many many decades. Think about the babyboomers, about the greatest generation, about the expansion of the middle class, and about how those interests have developed over time. Government spending is path-dependent – once you’ve carved out a trail of spending, it becomes easier to justify that path as the way to spend money.

First-movers, in economics-speak, have tremendous advantages: they stake out a claim to that benefit, and once they’ve benefitted from it, financially, they are better armed to fight for the preservation of that benefit. When you start to think about US social spending in that light, you begin to see that our strata of the middle class has a lot to gain from this system, and that we would lose a lot from a more progressive way of spending (ie, direct government spending.)

And while this may all be painfully obvious to some people, I didn't put it all together until just over a week ago. Which goes to show just how grad school can make you smarter, I guess.