The Peak of the Welfare State Bubble

Governments have always provided social services such as streets and highways, but the concept of government providing comprehensive welfare for the people began in Germany in 1883. Socialist ideas were gaining favor throughout Europe, and Chancellor Bismark sought to reduce the appeal of the German socialist movement by fighting fire with fire. Bismark initiated statist consumer socialism in order to stifle the popularity of statist producer socialism.

Socialism arose in Europe in reaction to the growing inequalities and continuing poverty that accompanied allodial kleptocracy, the economic system in which labor and capital were private but the rent of land was redistributed to a few wealthy landowners. Much of the gains from economic expansion and progress go to higher land rent, so workers were bewildered and angry as labor suffered from periodic depressions, unemployment, insecurity, and harsh working conditions.

Socialism sought to provide as the remedy the replacement of private enterprise by government. With the means of production owned by the state, the government would then provide the goods in an egalitarian distribution. There is a superficial appeal in the thought that central planners can allocate resources for the public benefit, but as shown by the Austrian economist Ludwig von Mises in his 1922 book Socialism, state ownership of resources prevents the economic calculation needed for efficient production. Another Austrian, Friedrich Hayek, showed how central planners cannot obtain the knowledge needed to manage a large economy.

But superficial remedies are always more popular than effective remedies that require an economic understanding of implicit reality. Moreover, the effective remedies to social problems requires the reversal of the policies that subsidize the powerful interests that control the government. Since the central aim of the German Empire was to serve its landed interests, such as the Junkers of Prussia, Bismark had to appease the public with the superficial remedy, the welfare state, with the Health Insurance Act of 1883, accident insurance in 1884, and old age pensions in 1889.

Other European countries and then the United States copied the German welfare-state paradigm. There were two competing reformist ideologies in the USA during the progressive era that began with the publication of Progress and Poverty by Henry George in 1879. The Georgists promoted the single-tax movement to equalize the benefits of land while keeping private the labor, capital, and possession of land. The other ideology was a welfare state financed by a progressive income tax, thus redistributive consumer socialism.

The welfare socialists won the tax battle with the 16th amendment to the US Constitution, which removed the legal barriers that had struck down the 1894 income tax act. The Great Depression then eliminated the political and legal resistance to the welfare state. Like European countries, the US got Social Security and governmental medical provision, unemployment payments, and accident insurance.

The fatal flaw in the welfare state is that it preserved the privileges of the landed interests. While value-added taxation and progressive income taxation take some of the land rent, landowners get it back plus much more in the greater rent and land value generated by public works, civic services, and welfare-state benefits. If that were not the case, land rent would be zero.

With public revenue from land rent precluded, the welfare state has to cannibalize the economy, extracting much from wages and enterprise profits. Given the existing high level of taxation, even greater taxes are unpopular. Since the politicians of mass democracy need popular approval, they resort to unsustainable borrowing. Hence we see massive government debt in Greece, Ireland, Spain, Portugal, Italy, Japan, the United Kingdom, the USA, and many of the US states. We are now at a historic time in which unsustainable deficits can no longer be sustained.

The welfare state system peaked out in 2010, with the expansion of federal medical care in the US. With sovereign debt now considered to be increasingly risky, and with government chiefs facing promises they can no longer fulfill, welfare states in Europe are now practicing austerity, sharply cutting back on welfare-state spending, despite the public reaction of demonstrations and riots. US state governments are also cutting back.

The last remaining hold-out is the federal government United States, which still has good credit. The temporary prevention of tax-rate increases, plus a reduction in payroll taxes, will boost the economic recovery, but it will add another trillion dollars to the federal debt. The worst welfare state problem in the USA is the promised pension and medical-service promises that cannot possibly be kept in real value.

Thus the US too will have to start cutting back the welfare state. The extension of the ozo-decade tax rates has shown the political resistance to higher tax rates, so the line of least political resistance is the purchase of federal debt by money creation, as the Fed is now doing. But money creation too is unsustainable, as higher prices and higher nominal interest rates will make money creation ineffective. What then? Either we get the effective remedy of ending the subsidy and redistribution to landownership, or else an austerity that will create hardship and riots as the welfare-state bubble bursts and leaves us with a welfare hell.