WELFARE: SAVINGS NOT TAXATION.

• Author: Douglas, Roger
• Position: Essay

In many countries, the rising cost of publicly funded health care, retirement, and other welfare programs is forecast to put increasing pressure on government budgets. As a result, many governments are seeking to reform their welfare states so that costs to the taxpayer can be reduced, quality of outcomes increased, and the plight of low- and middle-income earners improved. Regrettably, there are currently at least three problems with much of the debate about reform of the welfare state.

First, disagreements are often focused around two opposing ideological viewpoints. One side is demanding more welfare spending and higher taxes, whereas the other is arguing for less welfare spending and lower taxes. Second, even when economists and others propose a welfare reform that appears promising in theory, designing the transition so that it is politically feasible is often overlooked. Third, the debates are typically quite narrow. They seldom focus on a comprehensive reform that would rewrite the rules governing the welfare and tax system as a whole, with the aim of making them work more fairly and efficiently.

This article shows how a country can move from a publicly funded welfare system to one that relies largely on private funding coming from compulsory savings accounts. The reforms we propose are designed to overcome the problems outlined above. We use New Zealand, a nation with which we are familiar, as a case study, although the comprehensive reform we recommend can be adapted elsewhere.

How does it work? Taxes currently paid on personal earnings up to $50,000 for single taxpayers go directly into the compulsory savings accounts. (1) A drop in the corporate tax rate and the removal of other government-imposed employee costs help employers fund contributions. These changes allow for privately funded welfare payments to substitute for public ones. Total spending levels can be maintained across most welfare categories, and transparent pricing of health care services and out-of-work cover can be introduced.

Provided that special privileges in the form of subsidies to businesses (i.e., corporate welfare) and grants to affluent families are discontinued, tax cuts can be made sufficiently deep to allow people to establish significant savings balances, while largely retaining pre-reform disposable incomes.

Even after our proposed tax cuts, the government retains sufficient revenues to act as an insurer of last resort, helping to pay for those individuals who cannot meet all of their own welfare expenses out of their savings accounts (e.g., the chronically ill).

Our "savings not taxes" reform offers the scope for efficiency gains, particularly in health care. While we believe these gains are plausible, they have not been factored into our estimated budgetary forecasts, which as a consequence probably understate the benefits of our reforms. One example of the scale of the possible gains comes from the experience of the pro-market reforms in New Zealand in the 1980s and 1990s (see Evans et al. 1996). Another example is Singapore, which uses compulsory savings accounts and currently spends just 4.8 percent of GDP on health and long-term care, compared with 17.2 percent in the United States and 9.5 percent in New Zealand, and yet maintains one of the highest quality services in the world.

More broadly, our "savings not taxation" reform is aimed at changing beliefs away from a culture of dependency to one of independence, whereby lower-income earners are given the opportunity to build up their own capital via tax relief and employer contributions, and can then choose from among a range of affordable services.

Background: The Long-Run Viability of Publicly Funded Welfare

Large publicly funded welfare states are under threat. The dependency ratio, which is the proportion of elderly to younger, economically active workers, is expected to rise all over the world. Severe pressures will be brought to bear on pensions and, in particular, public health systems.

The ratio of public health and long-term care expenditure to GDP has already been rising steadily for several decades. The latest projections for the next several decades highlight the growing pressures. In the OECD's "cost-pressure" scenario, average health and long-term care public expenditures are projected to almost double, reaching approximately 14 percent of GDP by 2060. Furthermore, public pension spending is forecast to grow from 9.5 percent of GDP in 2015 to 11.7 percent of GDP in 2050 across OECD countries (OECD 2013).

Having recognized the welfare state problems that face almost every developed nation, we must ask ourselves, "What can we do about it?"

First, we need to quantify the problem in a way that politicians, economists, the news media, and others cannot ignore. One way is to forecast health and pensions spending as a fraction of GDP over the next several decades. As noted above, the OECD (2013) reports strongly rising trends. Another way is to measure the "fiscal gap," which is the present value of projected future government expenditures net of the present value of future taxes. Using this approach, Kotlikoff (2013) argues that the true U.S. fiscal debt is not the $US 13 trillion usually reported by the government, but is instead over $US 200 trillion.

Alternatively, one can bring the gross value of unfunded liabilities into the government accounts using accrual accounting principles. (2) New Zealand had a 2015 fiscal deficit of 4 percent of GDP once an allowance was made for the increased accrued cost of health and pensions spending, which is due to the higher number of retirees at the end of the year compared with the beginning. That deficit stands in contrast to the cash surplus usually reported.

Second, we need to set aside traditional myths and return to fundamentals. This involves adopting several principles related to successful structural change (Douglas 1989):

* Only medium-term quality decisions, and not quick-fix solutions, make a difference. We must get the incentives and framework right to help ensure everyone acts more effectively.

* Decisions relating to welfare should identify and exploit economic and social linkages, so that every action will improve the working of the system as a whole. We should not treat every problem separately, as most countries do.

* Only large-scale reform packages provide the flexibility needed to demonstrate that any losses suffered by a group of people from one policy would be offset by gains for the same group in some other area.

Third, any fundamental reform of the welfare system would need to be based on improving opportunity, incentives, and choice if people are to accept widespread changes of the kind implemented in, for example, Singapore.

Singapore provides universal health care coverage at a lower cost than any other high-income nation. By most measures, such as infant mortality and life expectancy, outcomes are excellent. The cornerstone of the system is a compulsory medical savings account called MediSave. It is based on the idea that people should be helped to save for their own health care expenses. Individuals and their employers are required to contribute a specified portion of wages into each individual's account. The accounts are held within the government-managed Central Provident Fund.

Although MediSave funds belong to the contributing worker, the government has guidelines as to how the money can be spent. Its aim is to balance affordable health care against overconsumption and prevent the premature depletion of funds. For large bills that could otherwise drain one's MediSave funds...