Paying for the welfare state

Last night in my political economy class there was an interesting discussion about the pressures of globalization on the welfare state. One school of thought holds that the competing pressures of the global economy make the welfare state unsustainable, as the high taxes necessary to sustain it are no longer viable. If taxation is too high investment will simply go elsewhere. Others, however, believe that this is overstated, noting that the overall tax burden in the welfare states of Western Europe have actually not changed substantially in recent decades.

I place myself in the former camp. While it is true that the tax burden still remains high, it is interesting to study the composition of that burden. I think what one finds in Europe is that while taxes on labor, i.e. personal income taxes, remain relatively high that taxes on capital -- which is far more mobile -- have declined. Indeed, if one looks at European corporate tax rates they are often lower than in the U.S.

According to this 2005 report we find the following such rates:

Canada 34.3%
U.S. 39.2%
Germany 38.4%
Italy 39.4%
France 35.4%
Spain 35.0%
Norway 28.0%
Netherlands 31.5%
Finland 26.0%
Luxembourg 30.4%
U.K. 30.0%
Belgium 34.0%
Denmark 30.0%
Austria 25.0%
Ireland 12.5%
Sweden 28.0%
Iceland 18.0%

The U.S. actually has higher corporate taxes than every one of those countries except for Italy, where the jokes goes that the two national sports are soccer and tax avoidance. Particularly notable are the comparatively low rates in Scandinavia, which is synonymous with welfare and high taxes.

Again, where taxes remain high are on personal income tax and consumption taxes. Germany is a perfect example. The corporate tax was cut in recent years from a high of 52 percent. The new German government, meanwhile, has announced plans to increase its value-added tax from 16% to 19%. The tax burden is shifting from capital to labor. The people who benefit the most from the welfare state are increasingly being forced to bear its cost. I believe that as this trend continues that the appetite for government services will decrease -- the welfare state is great as long as someone else is footing the bill.

Now, an argument can be made that taxes can simply be increased on "the rich," allowing the poor and middle classes to still enjoy benefits without a substantial tax increase. But I would submit that just as capital is mobile and can be easily shifted out of a country that this is increasingly the case with high-end specialized -- and highly compensated -- labor. Tax potential high income earners too highly and they will strike out for greener pastures. There are signs this is already occurring.

Once the corporations, the rich (who have access to tax lawyers and shelters anyway) and the highly education leave, who is left to pick up the tab? It may not happen tomorrow, but the welfare state will meet its reckoning.