The Online Library of Liberty

A project of Liberty Fund, Inc.

• Introduction
• Part One: the Needless State (chapters 2, 3, 4 Are Not Available Online For Copyright Reasons)
• 1: Who Gave Us Order? On Exclusion, Enforcement, and Its Wherewithal *
• 5: Empirical Evidence *
• Part Two: Redistribution (chapter 7 Is Not Available Online For Copyright Reasons)
• 6: A Stocktaking of Perversities *
• 8: Disjunction, Conjunction *
• Part Three: Justice (chapters 10, 11 Are Not Available Online For Copyright Reasons)
• 9: Justice As Something Else *
• 12: Slicing the Cake Nobody Baked *
• Part Four: Socialism
• 13: Ownership, Agency, Socialism *
• 14: Market Socialism: “this Square Circle” *
• Part Five: Freedom
• 15: Right, Wrong, and Economics *
• 16: The Paretian Liberal, His Liberties and His Contracts *
• 17: The Bitter Medicine of Freedom *
• Works Cited

8

Disjunction, Conjunction*

A society can, for the purpose of understanding distribution problems, be seen as the aggregate of three groups of adult residents arranged in decreasing order by income per head or per household: the Top, the Middle, and the Bottom group. Let all members of these groups have two social options: to emigrate, or to submit to a social choice rule by which two groups together decide the distribution of aggregate income among all three. Any two groups can form a coalition and cause the redistribution, to themselves or to sub-groups designated by them, of some part of the pre-tax income of the third group. The relative sizes and initial pre-tax incomes of the groups is such that the potential gain from applying this distribution rule is greatest if Bottom and Middle combine to take income away from Top. In democracy with simple majority rule, Top and Bottom are ideally each 50 percent of the electorate, and Middle is a single person, the median voter; this maximizes the size of Top, hence also the potential gain to Middle and Bottom from redistributing Top’s pre-tax income to themselves or to sub-groups they wish to favor. In real life, one may usefully relax this maximization condition, and think of Top as 40–45, Middle as about 10–20, and Bottom as about 40–45 percent of the electorate.

Under these conditions, rational use of the social choice rule results in a partial or total disjunction of benefits from costs in the politically determined domain of distribution. Benefits are unrequited cash transfers and free or subsidized goods and services in kind. Resources to meet their costs come from two sources: taxes of all kinds (including “social” insurance contributions that, being mandatory, function like taxes) and net public borrowing. The former give rise to interpersonal, the latter to intertemporal redistribution. In the former, gainers and losers are both identifiable, and their gains and losses are simultaneous. In the latter, gains precede losses, the identity of the future losers is uncertain, but it is a fair conjecture that they are, broadly speaking, the young and the unborn members of all three groups, with future members of Top bearing a more than proportionate share.

If the full cost of a benefit is not borne by the beneficiary, excess demand is likely to be generated for the benefit. If the cost-benefit disjunction were total, excess demand for transfers and benefits in kind as a whole would be infinite. (If a particular good or service were subject to saturation, a non-saturated one would be demanded in excess of supply). Partial cost-benefit disjunction may be perceived as total. This will be the case if an individual ignores the effect of his own consumption of “free” benefits in kind and transfer receipts on his own taxes—an effect that is individually negligible though it may become significant at group level.

II.

The “Mature” Welfare State

If the above mechanism, once installed and bolstered by doctrinal legitimization, requires time to operate, the demand for benefits will be met by some supply, not instantaneously, but by gradual increments. The welfare state will have relatively modest beginnings; it will then go on growing in terms of the size and diversity of the benefits provided; and a ratchet effect is liable to prevent any substantial reduction or withdrawal of a benefit once granted.

There is no obvious equilibrating tendency setting an upper limit that the growth of the welfare state may approach but not breach. Instead, it “matures” and its growth abates, and then it approaches one of two constraints.

One constraint is a complex set of dysfunctional effects that come into play as the share of incomes received in the form of unrequited transfers and “free” benefits in kind increases. These benefits are either independent of personal effort, or may indeed be inversely related to it; with other things equal, their increase reduces effort. It also reduces that part of personal saving that can be imputed to precautionary motives. Further, associated effects spring from welfare fraud, tax fraud, the erosion of the economic raison d’être of families, and a host of others that space does not permit to enumerate. When the growth of the welfare state presses against this constraint, heavy efficiency losses tend to arise.

The other constraint operates upon intertemporal redistribution through the well-known effect of the public debt trap. In as much as the public debt is not indexed nor denominated in foreign currency, escape from the debt trap is in principle possible through inflation. However, if holders of the debt understand this and anticipate inflation, this escape route will be rapidly closed. In addition, refinancing the public debt will probably require sharply higher real interest rates.

Allowing the economy to press against one of these constraints, let alone against both at the same time, entails serious material and moral losses. It is for this reason that the call arises for “reforming” the mature welfare state, instead of passively letting the above constraints do the work of limiting it, as it were, “naturally.”

III.

Collective or Individual Rationality

It is irrelevant, or nearly so, whether policy-makers or informed public opinion understand or not that society as a whole is in some sense worse off when the welfare state reaches the vicinity of these constraints. Even the more precise claim, that a reduction in the provision of welfare benefits would in fact increase potential well-being in the sense of meeting the Kaldor-Hicks compensation criterion, would not be decisive. For while reducing the benefits would presumably be “collectively rational,” it would be individually irrational, as long as by imposing an excessive, collectively irrational level of welfare provision, a majority (e.g., the Bottom and the Middle) could still obtain some gain at the expense of the minority (e.g., the Top)—quite irrespective of whether the resource loss of the losers was larger than the resource gain of the gainers.

This is saying no more than the trivial truth that a player in a distribution game can do best by maximizing his own payoff even if his doing so causes the payoff of the other player(s) to decrease by more than his marginal gain (i.e., if individual maximization decreases the game sum). There is no known method of assuring that a “social” bargain is reached that would reconcile the conflict between collective interest and individual majority interest. It is even debatable whether such a solution is conceivable in the face of the dependence of the collectively efficient resource allocation on an income-distribution that favors a minority.

Nor is there much reasonable ground for believing that collective rationality can prevail at the constitutional level if it cannot prevail in ordinary fiscal legislation. If it is irrational for a winning coalition to forego potential gains, it is equally irrational for it to adopt a constitution that would oblige it to forego potential gains. If such a constitution is in fact accepted, it is not necessary; if it is necessary, it will not be accepted (or will be circumvented).

IV.

A Fiscally Neutral Delayed-Action Reform

Recent history in both Western and Eastern Europe and the United States suggests that this logic does in fact operate most of the time, and political systems based on procedural social decision rules do not lend themselves to any radical rolling back of the welfare state. Voters do most of the time punish almost any curtailment of “free” benefits. In order to have even a minimal chance of success, a major reform attempt must for this reason meet two fundamental conditions. It must restore the conjunction of benefits and their costs at least at the margin; and it must incorporate this in an integrated, non-separable set of fiscal measures that is at least marginally favorable to a possible majority coalition, which may be the existing one or a new combination to replace it.

Is such a set of measures feasible? For feasibility, I shall assume, as minimum necessary conditions, that it must not directly clash with what seem to be political imperatives in mature welfare states (of which the Swedish political scene is probably one of the most characteristic examples); heavy progressive taxation of persons (combined with light corporate taxation to discourage the emigration of mobile factors, capital, and enterprise); egalitarian provision of welfare goods and services (no “first and second class” in health care, education, etc.); universal entitlements (no means testing) are features that, where they obtain, can only be undone at high political risk. However, should these political imperatives prove to be less compelling than expert opinion now believes, welfare reform would of course gain some degree of freedom. In broad outline, the following measures, taken together, take account of the several considerations discussed earlier in this paper, and might have some chance of attracting a majority coalition:

• a. All cash transfers are to be broadly maintained.
• b. Entitlements to welfare goods and services in kind are to be replaced by welfare credits (vouchers or credit cards). Some interchangeability between credits to particular goods or services may be admitted.
• c. The total of vouchers or credit cards issued in the initial period is to be equal to, e.g., four-fifths or nine-tenths of the expenditure on these goods in the previous period, one-fifth or one-tenth being put in a reserve to meet exceptional needs (costly illness, incapacity to earn income, and other hard luck cases).
• d. The total of welfare credits or vouchers is to be distributed to households regardless of pre-tax income, but having regard to the number of dependents and their age (infancy, school age, or retirement).
• e. The major part of a household’s vouchers is to be non-transferable and available only for the purchase of welfare goods and services; a minor part (perhaps one-third or one-quarter), however, is to be redeemable by the state at a moderate discount at face value in cash at the holder’s option. This provision aims at two effects. One is that above some fixed level the consumption of welfare goods, i.e., the non-redemption of the voucher for cash, should have a positive marginal cost; moreover, this cost is to be of the same order of magnitude as the good’s cost of production. The other intended effect is that the probable shift of consumption from welfare goods to ordinary market goods and to private saving, permitted by the redemption of the vouchers for cash, should result in some public saving by virtue of the discount.
• f. The total cost of these benefits is to be met, as before, from general state revenue. However, the mode of raising it is to be altered. A substantial part of the income tax, perhaps all of it over and above some low flat rate, is to be replaced by a number of earmarked welfare taxes levied on income at rates assuring the politically required degree of progressivity. Each welfare tax is notionally to be devoted to the (incremental) financing of a particular welfare good or service (education, health, pensions, etc.). At the margin, financing is to be met entirely by the tax in question, so that the rate of each tax becomes perceptibly responsive to any rise or fall in the cost of the welfare benefit in question. (The purpose of this provision is to reduce taxpayer indifference, and in some cases positive benevolence, towards increases of a particular benefit. There may be attendant advantages, including greater clarity and publicness about who pays what for whom.)
• g.The set of measures from a to f is fiscally neutral in a first approximation, before allowing for the behavioral changes induced by the altered mode of benefit allocation and taxation. To encourage its adoption in preference to the status quo, it may seem advisable to make it more palatable either to the existing coalition of Bottom and Middle, or to a new one of Middle and Top. Changes favoring Bottom and Middle are prima facie more apt to obtain the support of Middle than their presumably more parsimonious opposites that would favor Top and Middle. This consideration would seem to speak for playing to the existing ruling coalition, and increasing the progressivity of taxation even beyond its existing degree. However, this would be undesirable for efficiency as well as other reasons, and seems a heavy price to pay for what is initially a fiscally more or less neutral reform. The alternative, shifting some of the welfare taxes from Top and Middle to Bottom, may or may not be feasible or decisive.It is, however, quite possible that the electorally decisive element in these measures is the option to redeem some part of welfare entitlements for cash, albeit at a discount. While having the option cannot make anybody worse off, it is virtually certain to be preferred by many (by all whose preference for a freely chosen over a designated good exceeds the discount). The latter are likely to be randomly distributed over all income groups, loosening up the rigid income-determined division of interest groups, and ceteris paribus possibly tipping the electoral balance in favor of such a reform.

V.

With the Grain

Clearly, as long as politics is unrestrained by deontological taboos about property and contract, men will always use it to disjoin benefits from their costs, get the former, and make others bear the latter. The reform sketched in Section 4 would, for evident reasons, fall far short of offsetting this primordial political drive. It would, however, establish at least a few cost-benefit conjunctions. They would be less efficient and less potent than the standard marginal equalities of cost and benefit prevailing in ordinary market exchanges. But though initially modest, they should have delayed and possibly important effects. For both the individual option to switch from welfare to market goods, and the closer and more visible links between welfare benefits and their costs, are likely to operate over electoral processes in future periods to curb excess demand for “welfare” by its consumers and willingness to meet it by its providers. With such mechanisms in place, the welfare state would acquire at least a modest built-in tendency to reform itself, so to speak, with the grain, rather than against the grain under the destructive pressure of its efficiency and debt constraints.

Part Three

Justice

[* ]Reprinted with permission from Can the Present Problems of Mature Welfare States Such as Sweden Be Solved?, edited by Nils Karlson (Stockholm: City University Press, 1995), 20–27.