TCS Daily

Fiscal Harmageddon?

By Johnny Munkhammar - June 18, 2004 12:00 AM

Why does the German Agenda 2010 exist? Why have the EU countries invented the Lisbon process? Why are the governments in Italy and France discussing major changes in the pension systems? Why did New Labour not roll back the reforms of the Thatcher governments?

The answer is simple, yet almost never mentioned: The European Social Model is not sustainable. And now is about time to start talking openly about this, and about what kind of society will come after big government. Between 1950 and 1980, the average tax pressure in Western Europe more than doubled. Government became an ever larger part of society. High taxes are now financing large public monopolies in the fields of welfare services and social security. Now that model has reached its final days.

The model was harmful from the start. High taxes are always a burden on production and are thereby eroding the basis of all prosperity and welfare. Moreover, public monopolies have no incentives to increase efficiency and adapt services to people's demands. So you get harmfully high taxes and bad welfare services. Why was this model chosen? Mainly because the choice was made at a time when many politicians and economists were impressed by the idea of a centrally planned economy.

Today, the planned economy has collapsed. And the cracks in our planned part of the economy -- big government -- get more obvious every day. Basically for the same reason: the system doesn't work. Despite the high taxes, the public systems are unable to deliver the welfare that people want. That difference between supply and demand of welfare services will grow, since services get more expensive every year. And since taxes cannot increase more, the resources for welfare services are actually decreasing.

European growth, and thereby the possibility of improved living standards, is slow. The GDP gap with the US is widening and China, which passed France last year in economic size, has an annual growth that is 5-10 times higher than in Western Europe. The fact that high taxes on work and production is a great barrier to growth is evident in both theory and practice. For example, in the countries of Western Europe, a person has to earn between €4,000 and €9,000 before taxes to have €1,000 left after tax. If we want growth, tax levels will have to be lowered.

Thanks to big government, every year fewer working people are supporting a growing part of the population which doesn't work. In Sweden in 1970, the average working person in the private sector supported himself and 0.8 additional persons in the public systems. By the year 2000, that had increased to 1.5 persons. The average Swede only works 8 percent of his life. On an ordinary day, 3.4 million Swedes go to work -- from a total population of 9 million. A large public sector and social security system -- all tax-financed -- places a heavy burden on the productive forces of society. Few have incentives to work and produce.

Now two strong forces -- one from the inside and one from the outside -- will hasten the process towards the fall of big government: demography and globalization. The demographic development shows two main signs -- that we fortunately live longer and that unfortunately fewer are born. With the current systems, ever fewer working people will be supporting an ever larger part of society. If we stick to the same definition of "working age" as today, the population of working age in Germany will decrease from today's 56 million to 41.5 million by 2050. In Italy, the drop will be even more dramatic -- from 39 million to 22 million.

If pension systems are not reformed, expenses will explode. In Spain, for example, expenses in the public pensions system would increase from 50 percent of total social expenditures today to about 80 percent in 2030. One study from Standard & Poor warned that this could increase government debts to several hundred percent of GDP. An aging population also increases the demand for health and elderly care. Obviously this so-called "fiscal Harmageddon" will be avoided by making fundamental changes in the systems.

From the outside, globalization pushes for change. Since 1980, China's GDP has increased by 750 percent, while the economy of EU-15 increased by 60 percent. Great possibilities that are opened by globalization -- though trade, mobility, information exchange -- also create a radically more tough competition. To increase our growth and create better jobs we have to get vastly more competitive. The enlargement of the EU shows this clearly, as does the debate about jobs moving to Asia. If European jobs that move shall be replaced by better ones as in the US, we have to lower the heavy burden of high taxes.

High taxes pay for an unsustainable system which cannot deliver. Hence, European politicians have made reforms for lower taxes, increasing growth and cutting public expenses. But they are scratching the surface and voters are largely unaware of the purpose of this and the aim of it all. European leaders should tell people where we are heading. Taxes will be lowered, the public welfare services and social security will mostly be for those who cannot pay for themselves and for the rest of us there will be private welfare companies and private insurance.

It is a positive vision. Today, we have low growth and insufficient welfare. Tomorrow, we will have high growth and everyone will have the welfare services and social security they demand. With lower taxes, most people could afford to buy their own private welfare. The public sector will help those in need instead of aiming to do everything for everyone. A large sector of health care, education and insurance will be opened to private companies and develop through competition.

The author is Senior Advisor, Confederation of Swedish Enterprise. This fall he is publishing a book: "The Collapse of Big Government"


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