Working Papers, University of California, Davis, Department of Economics 02-7
The econometric consensus on the effects of social spending confirms a puzzle we confront in the raw data: There is no clear net GDP cost of high tax-based social spending on GDP, despite a tradition of assuming that such costs are large. This paper offers five keys to this free lunch puzzle. First, it shows conventional analysis imagines costly forms of the welfare state that no welfare states have ever practiced. Second, better tests confirm that the usual tales imagine costs that would be felt only if policy had strayed out of sample, away from any actual historical experience. Third, the tax strategies of high-budget welfare states are more pro-growth and less progressive than has been realized, and more so than in free-market OECD countries. Fourth, the work disincentives of social transfers are so designed as to shield GDP from much reduction if any. Finally, we return to some positive growth and well-being benefits of the high welfare budgets, and then pose theoretical reasons why democracy may exert a crude form of cost control.
welfare state transfers deadweight costs incentives tax policy