Evan Soltas
May 29, 2013

The Pro-Market Welfare State

(Originally published here.)

Modern fiscal conservatism has wrapped itself in one whopper of a false choice: that the U.S. must decide between economic growth and the welfare state.

That’s wrong. Conservatives ought to recognize that where there is both robust growth and a sturdy safety net, the government tends to be highly efficient and market-friendly.

Economies can prosper in a laissez-faire model of low taxes and sparse social insurance, but they can do just as well in a highly competent welfare state. The problems arise when the state is both expansive in its goals and sloppy in its execution.

Peter Lindert, an economist at the University of California at Davis, helps explain why. "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," Lindert wrote in a 2003 paper, "Why the Welfare State Looks Like a Free Lunch."

Social insurance, Lindert explains, is only a free lunch if done correctly: by pairing the welfare state with pro-growth, pro-market policies such as privatization, deregulation and tax reform. Successful welfare states cut a conservative-liberal bargain. Their people are remarkably secure, and their economies are also remarkably free.

The U.S. is expanding its social welfare programs, from the Affordable Care Act to the Supplemental Nutrition Assistance Program. What it's not doing is putting in place the complementary policies to preserve economic growth.

Here are a few examples:

1) Privatize the Postal Service. And keep going.

My Bloomberg View colleague Peter Orszag wrote a column last year explaining this idea. For one, the USPS is bleeding money -- $6 billion this year, says Postmaster General Patrick Donahoe. Yes, today's deficits come partly from pension funding, but withering mail volume is the long-term threat. These are not challenges of government; they are challenges of industry.

Well-run welfare states treat public employment as subject to trade-offs. Tying up a large share of the workforce in what could be adequately handled by the private sector is a waste of public resources -- hence the privatized, or deregulated and competitive, postal systems across Europe. If the U.S. did this tomorrow, it would shrink the federal workforce by nearly 600,000 heads, 21.3 percent of the total. That would make it smaller than any time in the past 60 years.

We shouldn't stop there. There are similar opportunities to reform the Tennessee Valley Authority (an idea President Barack Obama supports), the Federal Aviation Administration's air -traffic control and, as I've written before, Amtrak.

2) Bring "flexicurity" to federal disability and unemployment insurance.

I spoke recently with Sally Satel, a psychiatry lecturer at Yale University's School of Medicine. She told me that the Social Security Disability Insurance program -- which has seen substantial growth in enrollment over the past decade, particularly due to mental illness -- could benefit from a major change in approach.

She suggested that the disability program could require and cover some form of initial treatment before it awards a benefit for mental disability. That would help the program get the most out of any dollar; better yet, it could help some overcome their disability.

"They often make their decision based on the short-term exposure to the person without any understanding of their treatment experience," Satel said. "As a clinician, you cannot make a real prognosis of mental health in that way, especially when the decision is 'you won’t be able to work now for the foreseeable future.'"

Satel's idea has echoes of Denmark's approach to labor markets, known as "flexicurity,” adopted more recently and in weaker form by the European Commission. The Danish welfare philosophy is that your status as a beneficiary comes with a duty to participate in retraining programs that make you an attractive potential employee. It's an idea the U.S. would do well to emulate where it can, as Robert Kuttner wrote in an old essay in Foreign Affairs.

3) Bring down the barriers to businesses big and small.

Here’s another common trait among pro-growth welfare states: a simple, low-rate, efficient corporate tax code. The U.S. code meets none of these criteria. The best way to rewrite it would be to pair changes to the corporate income tax -- which hits big companies -- with changes that work to benefit smaller firms.

For big firms, a problem worth fixing is the huge variation in tax rates between industries, which creates economic distortions in investment and business activity.

For small businesses, Representative Dave Camp, chairman of the House Ways and Means Committee, has put forth a plan that would radically simplify tax filing for "pass-through entities," a status that includes S corporations and partnerships. Such entities make up the overwhelming number of businesses and have a growing share of corporate revenue: 38 percent as of 2007, according to the Congressional Budget Office. Camp's proposal has gotten less attention than the proposed corporate-tax overhaul. It would be nearly as important.

Conservatives can’t make the welfare state go away. But they can make it work.