Tough choices – State spending will be hard to cut given rising inequality
Mar 26th 2016 Economist
VOTERS’ anger over inequality is one explanation for the rise of politicians as varied as Donald Trump, Bernie Sanders and Marine Le Pen. This anger also makes it very difficult for the free-market right to realise one of its key aims: the shrinking of the state. In Britain a plan to reduce spending on benefits for the disabled has been sabotaged by the resignation of a government minister and a backbench rebellion. In America mainstream Republicans are horrified by the rise of Mr. Trump, who does not share their small-government ideals.
Ideally, conservatives would like people to be more self-reliant, owning their own homes and funding their own retirements. But many people do not have enough spare income to meet those goals. One study found that 21% of Americans lacked a savings account and 62% had less than $1,000 in their rainy-day funds. Similarly, in Britain, nearly 60% had less than £1,000 ($1,417) in liquid savings. Many of those people will have savings in another form, as part of a workplace pension scheme. Still, a Federal Reserve study found that around 31% of Americans had no private retirement savings at all, including nearly a quarter of those aged over 45.
This leaves people very dependent on the state. Around 60m Americans currently receive payments from the Social Security system. The average retirement benefit is $16,000 a year. A person with average earnings who retires at 65 can expect to receive around 40% of their final salary. More than half of retired people depend on Social Security for the majority of their income; for more than a third, it comprises over 90%. In short, this is a vital benefit for tens of millions of Americans, which they would have no way to replace. No wonder that cutting Social Security has long been known as the “third rail” of American politics.
Yet Social Security makes up around a quarter of all federal spending. Add in Medicare, a health programme for those over 65, which cost $546 billion in 2015, and 39% of the budget goes toward benefits for the elderly. With an ageing population, these figures are likely to go up, not down.
Meanwhile, attempts by government to encourage private saving for pensions have run into difficulties. Tax breaks may simply prompt workers to shift their savings from accounts that are more heavily taxed rather than to increase their savings overall. And the biggest gainers from tax shelters tend to be the better-off, blowing a hole in government revenues without helping the poor much.
Pushing up the retirement age would reduce the burden a bit. But many workers leave the jobs market before the official retirement age: figures show that such people account for around half of the marked decline since 2007 in the share of working-age Americans who are actually in work. In Europe, many of those who retire before earning a full pension still get state support of various kinds, reducing the saving for governments.
Then there is housing. High prices and stagnant wages make it harder for young people to own homes. Figures from the 2011 census showed that the proportion of British households that were owner-occupiers had fallen to 64% from 69% in 2001—the first decline in that figure in a century. The ratio of house prices to the incomes of first-time buyers in Britain is 5.2, close to the peak reached in 2007; in London, the ratio is a staggering 10.1, well above previous highs.
Attempts to encourage home ownership via tax breaks, such as the new lifetime individual savings account, may only push prices even higher. The fastest way to make prices more affordable would be a government-backed house-building programme, something that would be incompatible with attempts to cut the budget deficit and shrink the state.
Then there is automation, which may turn into the big policy challenge of the coming decades. Innovations such as driverless cars may threaten millions of jobs. Some academics, such as Erik Brynjolfsson and Andrew McAfee of the Massachusetts Institute of Technology, envision a two-tier labour market, divided between workers who complement machines and those who compete against them. At the least, this may mean increased government spending on retraining; it may also mean higher welfare bills. It could create demand for public-sector employment to absorb surplus labour.
In short, it is very hard to see how rising levels of inequality can be squared with a smaller state. Voters will surely demand that politicians either reduce inequality or maintain the safety net.